1031 Investors Are Taking a Closer Look at Qualified Opportunity Zones

By Pete LaMassa, Managing Director, Capital Markets:

Real estate professionals are showing increased interest in Qualified Opportunity Zones (QOZs) as the COVID-19 pandemic has made it more difficult to complete 1031-exchange transactions. These investors – who, in some cases, have been utilizing 1031 exchanges for decades – report that they cannot sufficiently diligence prospective properties, that debt is harder to secure, and that it is difficult to get a handle on post-COVID operations or agree on terms with prospective sellers to deal with these risks.

 

Steve Gebing, Executive Managing Director at Institutional Property Advisors, has observed this trend since the virus took hold, noting, “Given the lack of available inventory, prominent 1031-exchange buyers are shifting their focus to Qualified Opportunity Zones, recognizing the differentiated set of tax benefits realized through this alternative investment vehicle.”

QOZs and 1031 exchanges do indeed offer different tax benefits:

  • A 1031 exchange requires principal and profit to be invested, while a QOZ investment only requires profits to be invested.
  • A 1031 exchange must be for a like/kind asset while a QOZ can invest in any type of qualified real estate (or a qualified operating business) that is in one of the 8,700 designated opportunity zones.
  • After ten years, the QOZ investment can be sold without any taxes due on capital appreciation of the investments; a 1031 investor must find another 1031 exchange to continue to defer taxes.
Relative to a 1031 exchange, a QOZ investment can provide for enhanced liquidity upon the sale of the real estate asset, as well as meaningful diversification. Perhaps the most compelling difference between the two is that a QOZ investment can be sold tax-free if it is held for at least ten years. In contrast, serial 1031 exchange investors must continue to roll into the next deal, or they will be forced to pay taxes.

A 1031-exchange investor generally has a 45-day window to identify a replacement property, and then they must complete the exchange within 180 days. In April, the IRS announced a one-time deadline extension due to the COVID-19 pandemic. If an investor had taken the first step – selling the old property – and if the 45-day or 180-day deadline fell between April 1 and July 15, 2020, the deadline was extended to July 15, 2020. As such, the final 1031-exchange deadline has passed for many investors. This may prompt more real estate professionals to explore QOZs as an investment option. “Now that the 1031 extension has passed, I bet that QOZs get hit with a wave of potential investors,” said James Nelson, Principal and Head of Tri-state Investment Sales at Avison Young, an NYC-based commercial real estate firm.

The original QOZ rules generally required an investor to reinvest the eligible gain into a QOZ within 180 days of the realization of the gain in order to defer realized gains from an appreciated asset. The IRS has given some relief to QOZ investors as well – any eligible gains that would have been required to be invested by April 1, 2020 to be eligible for QOZ treatment can now be invested through the end of 2020. As a result, gains from October 5 through the end of 2020 as well as 2019 K-1 gains can invest in a QOZ through the end of this year.

Last year, Bridge Investment Group (“Bridge”) deployed approximately $950M into QOZs. In the coming months, we plan to invest an additional $330M into a multifamily-focused portfolio of development assets in fast-growing cities. We believe that multifamily is well-suited to the 10-year hold required by the QOZ rules. A supply/demand imbalance for multifamily exists in the U.S., caused primarily by the Millennial and Gen Z generations moving into apartments, according to Fannie Mae. Bridge expects that yield-hungry investors will look to purchase durable multifamily assets at attractive cap rates when we are in the market to sell these developments. When we can, we add a workforce and affordable housing component to our QOZ developments, where we partner with non-profits to provide extensive social and community services for our tenants, such as activities and education for youth, job skills enhancement, personal finance training, health education and nutrition programs.

We have spoken with many real estate professionals who are taking a serious look at Qualified Opportunity Zones and some have made commitments to a QOZ offering. We expect to have additional conversations over the remainder of 2020.
The foregoing is provided by Bridge for informational purposes only and is not an offer, or invitation of an offer, in any security of Bridge or any affiliate. Any offering will only be made pursuant to a confidential private placement memorandum in compliance with applicable securities laws. No investor should place undue reliance on any statements contained herein.