As year-end approaches, so does the deadline for investors hoping to maximize their tax savings through the Tax Cuts and Jobs Act of 2017’s (the “Act”) Opportunity Zone program (the “OZ program”).
Established by the Act to encourage investment into designated low-income census tracts, the OZ program has created a unique opportunity to bring capital to these areas while offering investors the potential for significant tax breaks on otherwise fully taxable capital gains derived from the disposition of other investments - e.g. gains from the sale of stocks, bonds, real estate, or a business.
To be eligible, among other requirements, qualified investors must invest their capital gains in a qualified OZ investment - structured through an investment in a Qualified Opportunity Fund (“QOF”) - within 180 days of the disposition of the investment that triggered such capital gains.
Year-End Deadline to Invest
In response to the COVID-19 pandemic, in June 2020 the IRS issued new guidance for OZ investors (Notice 2020-39), extending the 180-day window as follows:
If a taxpayer’s 180 day window to invest capital gains in a QOF would have expired on or after April 1, 2020 but before December 31, 2020, the taxpayer’s deadline to invest such capital gains in a QOF shall be deemed December 31, 2020.
OZ Tax Benefits
QOFs generally offer investors three key potential tax savings:
- Tax deferral. An investor can defer taxes on their realized capital gains from elsewhere, provided these gains are invested in a QOF within the investor’s 180-day window (now extended to year-end, as previously noted). The deferral lasts until the end of 2026 or until the QOF is sold, whichever comes first.
- Tax reduction. An investor can reduce the amount of deferred taxes owed on those deferred capital gains by up to 10%.
- Tax free gains. An investor can eliminate 100% of the capital gains taxes on gains from the QOF investment itself, provided the investor holds the investment for at least 10 years. This is why many OZ projects target hold periods of at least 10 years.
While the tax benefits of the OZ program can be significant, investors are always advised to consult with their own tax and legal professionals to understand how the OZ program applies to their individual circumstances.
Cadre’s Approach to OZ Investing
Opportunity Zone investing at Cadre harks back to early 2019, when the Opportunity Zone regulations were still being refined, making Cadre one of the first managers to offer investors access to a QOF. Importantly, we understood that while the tax advantages for investors could be attractive, successfully achieving tax free gains from the underlying investment is contingent on the performance of the underlying investment.
As with any investment, solid market fundamentals are key to performance. Locations designated as Opportunity Zones are challenged in many, but not necessarily all, dimensions. Opportunity Zones are, by definition, communities with below average incomes and higher poverty rates, and census tracts designated as Opportunity Zones tend to have relatively high unemployment and low home values. That said, we have found that it is, in fact, possible to identify individual OZ locations that have surprisingly strong growth potential.
One way of doing this is by leveraging predictive demographic data, using variables that can be forecasted with reasonable accuracy - examples include income and population growth data, key drivers of long-term real estate demand that have historically been projected with reasonably high accuracy. We also internalize structured and unstructured data around points of interest, drive times, influence from adjacent census tracts, and walkability & transit orientation. We then rank the more than 8,700 Opportunity Zone census tracts, identifying clusters of higher scoring OZ areas and narrowing in on a subset of those clusters where we believe our operating partner network will have actionable investment opportunities and relevant local insight. Finally, within these target OZ markets, we evaluate a broader set of supply and demand variables to assess specific opportunities alongside our operating partners. The result is a healthy combination of top-down, data-driven market analysis and bottoms-up, relationship-driven sourcing.
OZ Case Study
One of Cadre’s first Opportunity Zone deals - in fact, one of the first in the country - was a multifamily development project in Atlanta, undertaken in partnership with a leading national multifamily operator-developer. The project, which is situated in a qualified Opportunity Zone ranking in our 99th percentile for projected demographic growth, in all other respects contained all the characteristics that make a compelling investment - strong submarket, experienced sponsor, attractive cost basis, and solid value creation potential:
- Submarket - The property is located in the heart of downtown Atlanta, with excellent pedestrian access to numerous amenities and public transit. Catalyzed by $6.4bn of projects underway in conjunction with the Downtown Atlanta Master Plan, population and income growth from 2018 to 2023 in the surrounding neighborhood are estimated to outpace the nation by a factor of 4.5x and 3.5x, respectively.
- Sponsor - One of the largest multifamily operator-developers in the nation, the sponsor has developed over 38,000 units since 1993 and manages 437,000 units with over 12,000 units owned or managed in the Atlanta metro area.
- Development Cost - The project’s discounted development basis relative to nearby Midtown Atlanta will allow for competitive rents representing a 14% discount to comparable apartments in Midtown.
- Value Creation Potential - Business plan entails the development of a high-end but affordable high-rise apartment atop an existing parking structure. Upon completion, the property is expected to be among the highest quality products in the market.
How to Invest in Opportunity Zones
Opportunity Zones, with the right investment strategy, are capable of generating attractive risk-adjusted pre-tax returns, as well as attractive post-tax returns. Moreover, as the OZ program matures, these investment dollars could drive meaningful social and economic impact within these underserved communities. Investors can learn more about Cadre’s Opportunity Zone program by requesting access to the Cadre platform.
Importantly, any potential benefits of the Opportunity Zone program are subject to significant tax and regulatory risks, including the potential legislative changes that could be made to the program, the interpretation and possible evolution of tax laws and regulations, and consequently, the possible impact on Opportunity Zone investments. Also see the Opportunity Zones Disclosure below. ↩︎
The views expressed above are presented only for educational and informational purposes and are subject to change in the future. No specific securities or services are being promoted or offered herein.
This communication is not to be construed as investment, tax, or legal advice in relation to the relevant subject matter; investors must seek their own legal or other professional advice.
Performance Not Guaranteed
Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections are not guaranteed and may not reflect actual future performance.
Risk of Loss
All securities involve a high degree of risk and may result in partial or total loss of your investment.
Liquidity Not Guaranteed
Investments offered by Cadre are illiquid and there is never any guarantee that you will be able to exit your investments on the Secondary Market or at what price an exit (if any) will be achieved.
Not a Public Exchange
The Cadre Secondary Market is NOT a stock exchange or public securities exchange, there is no guarantee of liquidity and no guarantee that the Cadre Secondary Market will continue to operate or remain available to investors.
Opportunity Zones Disclosure
Any discussion regarding “Opportunity Zones” — including the viability of recycling proceeds from a sale or buyout — is based on advice received regarding the interpretation of provisions of the Tax Cut and Jobs Act of 2017 (the “Jobs Act”) and relevant guidances, including, among other things, two sets of proposed regulations and the final regulations issued by the IRS and Treasury Department in December of 2019. A number of unanswered questions still exist and various uncertainties remain as to the interpretation of the Jobs Act and the rules related to Opportunity Zones investments. We cannot predict what impact, if any, additional guidance, including future legislation, administrative rulings, or court decisions will have and there is risk that any investment marketed as an Opportunity Zone investment will not qualify for, and investors will not realize the benefits they expect from, an Opportunity Zone investment. We also cannot guarantee any specific benefit or outcome of any investment made in reliance upon the above.
Cadre makes no representations, express or implied, regarding the accuracy or completeness of this information, and the reader accepts all risks in relying on the above information for any purpose whatsoever. Any actual transactions described herein are for illustrative purposes only and, unless otherwise stated in the presentation, are presented as of underwriting and may not be indicative of actual performance. Transactions presented may have been selected based on a number of factors such as asset type, geography, or transaction date, among others. Certain information presented or relied upon in this presentation may have been obtained from third-party sources believed to be reliable, however, we do not guarantee the accuracy, completeness or fairness of the information presented.