In December, the U.S. Treasury Department and the IRS issued final regulations implementing the federal Qualified Opportunity Zones Tax Incentive. Now, many developers and investors are waiting to see how these regulations will help them with projects that will revitalize distressed areas.
Created by the Tax Cuts and Jobs Act of 2017, these zones offer capital gains tax relief for investments in economically distressed regions.
The program gives investors breaks on federal capital gains taxes in exchange for investments that support small businesses and housing projects in low-income areas. Investors can avoid federal taxable capital gains on investments in those areas if they retain ownership of a project for at least a decade.
These Opportunity Zones include areas in Allentown, Bethlehem, Easton, Reading, West Reading, Stroudsburg, Pottstown, Tamaqua, and Phillipsburg, New Jersey.
Though Gov. Wolf identified the Opportunity Zones in 2018, since that time there has not been a large-scale rush of investments to capitalize on the program. It’s questionable whether the Opportunity Zone program will actually benefit distressed areas.
“I think that the program is potentially very impactful, but I think it’s too early to tell,” said Steve Bamford, executive director of the Allentown Neighborhood Improvement Zone Development Authority. “The final regs were anticipated by investors so there’s a real good chance that a lot of capital sat on the sidelines because of the uncertainty until the final regs were issued,” he said.
The final rules should provide clarity for opportunity funds and their eligible subsidiaries in determining qualification and levels of new investment in Opportunity Zones. They also provide guidance regarding the types of gains that qualify for Opportunity Zone investments, as well as gains that investors could exclude from tax after a 10-year holding period.
To qualify for the tax incentives, investors must invest in a qualified opportunity fund, a private-sector investment vehicle that puts at least 90 percent of its capital in Opportunity Zones. The model will allow investors to pool their resources, increasing the scale of resources going to underserved areas.
Charles Jefferson, principal at Jefferson-Werner LLC, a real estate development company in Allentown, said he has not had the opportunity to review the new regulations. However, he said the Opportunity Zone program has potential to revitalize distressed communities. Jefferson, through PNC Bank, invested $4 million in Brinker Lofts in South Bethlehem, the first Opportunity Zone project in Pennsylvania.
Jefferson completed that project this year, which involved renovating a former cold storage building on Adams Street between Third and Fourth streets into a residential project with 30 market-rate apartments with a courtyard and a retail space.
He also has plans for Bethlehem’s former Boyd Theatre on Bethlehem’s north side. He plans to select an architectural firm shortly that would transform the long dormant property into a $22 million apartment project with new retail space. That project too would benefit from funding through the Opportunity Zone program.
Bamford said he believes more capital will flow into qualified Opportunity Zone funds.
Investors can capture other tax incentives, such as the City Revitalization and Improvement Zone incentive in Bethlehem and the Neighborhood Improvement Zone benefit in Allentown in addition to tax benefits from Opportunity Zones in these areas.
Allentown’s NIZ has helped rejuvenate the city by spurring more than $1 billion in new construction and renovation in downtown Allentown.
A community like Allentown has been able to demonstrate a successful track record in attracting investment and communities like that will continue to be attractive to investors, Bamford said.
“It’s possible that you could have real estate development projects that could utilize the NIZ and Opportunity Zones,” Bamford said.
The NIZ is not particularly useful for residential development projects but the Opportunity Zone program is, so the two incentives complement each other, he said.
Bamford said he has researched and read about Opportunity Zone projects in other areas of the nation and quite a few have been residential ones.
“Often, I am reading about activity in larger communities,” Bamford said. “If we do see more capital flowing into the qualified opportunity funds, you would think they would look at other markets like the Lehigh Valley.”
Benefit as an add-on
Jeff Brown, owner and operator of Bell Hall restaurant in Allentown is also founder and principal of Charles Street Capital, a real estate developer and advisory firm. He said he has looked at both the NIZ and Opportunity Zone programs and noted how the NIZ can change the fundamentals of a project.
Meanwhile, the Opportunity Zone program can make it easier to improve the return on equity, Brown said.
With an Opportunity Zone program, an investor has to have a project in mind, he added.
“I haven’t heard of any communities being benefited by it,” Brown said. “Those projects have to work on their own.”
Brown said he is not planning to invest in any Opportunity Zone projects right now. “I have looked at projects in South Bethlehem but we are not doing any right now,” Brown said.
Still, he thinks South Bethlehem could be good for Opportunity Zone investments.
“You’ve got to have a project all put together,” he said. “The Opportunity Zone is one way you get potential equity capital that you couldn’t get otherwise. They certainly can’t hurt, but someone has to be a project champion and put that together or a municipality has to have some capital improvement project in mind.”
However, he believes that anyone with a capital gain has an interest in Opportunity Zone projects.
“It’s not going to turn a loser into a winner, it will just add a little bit of gravy,” Brown said.
Jefferson said he remembers how investors sat on the sidelines when the government introduced another tax incentive program 20 years ago, the New Markets Tax Credit Program, which also was an incentive for investment in low-income communities.
The educational process for these incentives, including the Opportunity Zone program, involves getting the attorneys, consultants and accountants up to speed, which takes time, Jefferson said.
Though the federal government introduced the Opportunity Zone program two years ago, investors did not have clarity until the release of the new regulations in December, he added.
“You can’t judge success or failure in the first two years, given that fact,” Jefferson said.
There’s no question that the business of rental real estate is in the distressed areas that the Opportunity Zones include, he added.
“Everybody sits on the sidelines waiting,” Jefferson said. “Investors are notoriously cautious. They are going to learn how to structure the deal.”