In short, an Opportunity Zone is an IRS sponsored area, set by the Tax Cuts and Jobs Act of 2017, for investing in funds that are going to help gentrify developing, or low-income areas. The first set of Opportunity Zones were designated on April 9, 2018, and included portions of only 18 states. While the tax benefits of investing in these predefined zones might seem very attractive, one must be wary to not approach this investment opportunity wearing rose-colored-lenses.
A common theme throughout this article will be assessing whether or not Opportunity Zone investing makes sense for your personal investment goals. There are 5 distinct caveats that come to mind when analyzing Opportunity Zones. These are leverage, 1031 tax-deferred exchanges, absence of disparity pricing, prolonged construction, and fees. Leverage. Investors who deploy their capital to a fund lose access to one of the most important benefits of investing in real estate, which is debt. The benefit of leverage in funds is diluted due to management fees, and additional fees are taken at the time of profit distribution. For those already investing in real estate, getting into an Opportunity Zone might not be the most sensible course of action. 1031 Tax Deferred Exchanges might make more sense than rolling over the capital gains from a previous real estate sale into an Opportunity Zone. If one receives any capital gain from selling stocks, bonds, or any other asset, the Opportunity Zone might be an interesting way to get into real estate when on the search for a place to park earnings. ￼
Disparity pricing is a huge upside to investing in real estate. This is also known as making money on the buy. Disparity pricing is also missed out on when investing one’s capital with a fund. They might be able to find a deal and take advantage of a great price reduction but, the individual with capital in the fund will not see as great of a return from the price reduction on the buy. The combination of disparity pricing and leverage become powerful tools inexperienced investors hands.
Opportunity Zones are based on the premise of construction. Funds are essentially being entrusted to find the right developers, contractors, property managers, and correctly gentrify a neighborhood (that people might not particularly want to invest in at the time). This is a big ask, especially when facing the reality that construction projects frequently take longer than expected, and come in over budget. Fees are the lifeblood of a fund and can catch non-informed investors in less than optimal situations. One must be wary of the rules of the fund, not only to buy in but when you are allowed to sell. When capital is taken off the table in 5-10 years time, it is imperative to be aware of the fees taken after the dust settles. An investor must ask themselves if they are going to end up giving the fund an equivalent of otherwise obligatory taxes. In an effort to find an exemption, one might end up paying more.