Do you hate taxes? Do you bleed red, white, and blue? Then opportunity zones are for you!
The incentives associated with Opportunity Zone investments are certainly appealing—where else can you get higher returns via the elimination of federal capital gain taxes while simultaneously helping to reinvigorate an underserved community?
While Opportunity Zones offer considerable tax benefits from an investor’s perspective, their unique structure presents benefits for bridge lenders and sponsors associated with the project as well. Read on to learn more about the history of Opportunity Zones and underwriting strategies bridge lenders can implement for deals in these unique developments.
Understanding Opportunity Zones
Opportunity Zones—or “OZs”—are specified areas across the country that have been designated by state and federal entities as being in need for economic rehabilitation. These include places one might not have considered as under resourced, such as several blocks along the Las Vegas Strip and surrounding areas, across the street from the Staples Center in Los Angeles, or a stone’s throw away from Central Park in Midtown Manhattan. To get favorable federal tax treatment, investors must direct their capital to a Qualified Opportunity Fund (“QOF”). QOFs are investment vehicles that are structured as a corporation or partnership with a minimum of 90% of its assets being in qualified opportunity zones.
The applicable legislation additionally imposes a requirement that the QOF must be a “substantial improvement” to existing properties—meaning that the renovations to the structure must be equal to or greater than the purchase cost of the property less the land value. There is also a timeline requirement, meaning that all improvements must be completed within 30 months of the QOF’s acquisition of the OZ property. The short timeline is exactly why OZ properties are unique funding opportunities for bridge lenders.
OZ Investments & Bridge Lenders
Because OZs tend to be in communities that carry a higher risk profile from an investor’s perspective, the intent is that the potential benefits will be adequate to entice daring new investors. Subsequently, OZs are a hot topic in the real estate investment sector. The legislation governing OZs mandates that the QOF’s investment must be “substantially improved” by 30 months. This requirement could be beneficial for a bridge lender because value-add approaches in truncated timelines are what they specialize in.
Still, bridge lenders must closely analyze the economic viability of the proposal as part of their underwriting process. Even though an area has been deemed as needing extra incentive to invest by the federal government does not mean that it is necessarily an unreasonable risk for lenders. Lenders can look up the location of the investment using tools such as the OZ Index-a ranking of all 8000 OZs in the US compiled by Develop LLC.
Unlike traditional real estate investments that have no mandatory end date for project completion, investments in OZs must complete “substantial improvements” within 30 months. Borrowers thus have quicker turnaround deadlines and will be looking for short-term loans, which makes them ideal potential clients.
