Qualified Opportunity Zones and New Washington Leadership

By: Pete LaMassa, Managing Director, Client Solutions Group

Over the course of the last two years, Bridge Investment Group LLC (with its affiliates, “Bridge”) has funded approximately $2 billion of equity in more than $4.5 billion of real estate projects in qualified opportunity zones (“QOZs”), a program that makes it possible to direct capital to historically underinvested communities, manage to ESG principles, and help taxpayers capitalize on an attractive tax break aligned with long-term value creation.

Given our position in the space, private investors and other stakeholders often ask us how we think the QOZ regulations may evolve as the new administration moves forward with its agenda in Washington D.C. Here are our views, from several angles.
BIPARTISAN SUPPORT

While the QOZ legislation passed to stimulate economic development as part of the Trump-era Tax Cuts and Jobs Act of 2017, it is important to point out that it was originally developed during the Obama Administration and had the bipartisan cosponsor support of almost 100 members of Congress. Bridge believes that QOZs provide quantifiable benefits and have legs in the new administration.

During the presidential campaign, President Biden’s platform referenced the three steps that his administration would want to take regarding QOZs:

  • Incentive QOZs to partner with non-profit or community-based organizations with a focus on creating jobs for low-income residents and otherwise providing a direct financial impact to households.
  • Ensure that the QOZ tax benefits are reviewed by the Treasury to confirm the tax benefits are being used when there are clear economic, social and environmental benefits to the communities.
  • Mandate that QOZs provide detailed reporting and public disclosure.
Bridge is committed to ensuring that our projects have a positive social impact on their communities. We intend to provide detailed reporting to investors, and public disclosure where required.

First, Bridge is an experienced workforce and affordable housing manager. Throughout the country, we own and manage approximately 10,000 units through our Workforce and Affordable Housing vertical. In this strategy, 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. All of this is part of Bridge’s ongoing effort to create living spaces and communities that are “more than four walls and a roof.”

When possible, we seek to incorporate affordable units into our QOZ developments. So far, 13 of our QOZ multifamily projects are expected to have an affordable component, representing over 700 affordable apartments in high-cost cities like New York and Washington, D.C., and high-growth metros like Atlanta and Newark, N.J.

Another QOZ benefit is that new multifamily developments, once leased-up, will increase the tax bases of the local governments that have experienced meaningful declines due to the pandemic. On a January 2021 QOZ panel[i], Steve Glickman, CEO of Develop LLC, a QOZ advisory firm, and co-founder of the Economic Impact Group (which catalyzed the QOZ movement and provided the framework for the legislation) said, “When you speak to governors and mayors, you wouldn’t even know which party they are with when it comes to opportunity zones – they all talk about being cash-starved. They want to be able to pay for policemen and better schools, hospitals and universities.” Bridge believes that the mixed-use and residential projects that we are building in dynamic QOZ areas will help alleviate the housing needs of the growing communities while increasing tax revenue.
REPORTING REQUIREMENTS

As a real estate manager with thousands of institutional and private investors, Bridge believes that our existing investor reporting would likely satisfy any additional standards that would be instituted by the federal government. In addition to annual audited financial statements and quarterly unaudited financial statements, we expect to soon provide our QOZ investors with our first semi-annual QOZ Impact Report, which will quantify our progress in certain areas, including:

  • Apartments, workspaces and amenities created
  • Affordable housing units created
  • Estimate of jobs created
  • Environmental savings expected with building materials, energy, lighting, appliances, construction methods, etc.

WHAT IF THE CAPITAL GAINS TAX RATE INCREASES?

An investor who contributes eligible gain to a QOZ defers a capital gain to 2026 and will pay the deferred tax bill at the prevailing rate at that time. As such, some potential investors ask if higher tax rates could reduce or cancel out the potential benefits of QOZs.

We calculated how the QOZ benefit would change if the Biden Administration did indeed raise long-term capital gains taxes (for example, if federal long-term capital gains tax rates were increased to ordinary tax rates). Our work concludes that a QOZ investment still provides benefits relative to a taxable investment, even if long-term capital gains rates go up.

Yes, increasing long-term capital gains rates would result in QOZ investors paying more in 2026 than he/she otherwise would have if the gain had not been deferred, but that would be the case with any investment that the client made today and sold in a higher tax regime. All else equal, our data suggests that the power of the initial tax deferral (which you can think of as a zero-interest loan from the government), the step up in basis for QOZ investments made prior to January 1, 2022, and the tax-free sale of the QOZ fund’s assets after a ten-year hold remain attractive despite the possibility of paying more taxes in 2026.[ii].

That said, a new administration does not necessarily mean higher capital gains tax rates. In a recent research piece, UBS Wealth Management noted that it expects that the Biden Administration will seek Congressional support for higher taxes but will encounter Republican opposition. “Narrow majorities in the Senate and House are expected to limit the scope of tax legislation,” UBS wrote, adding that Biden will find it difficult to implement higher capital gains taxes. [iii]
OTHER POTENTIAL ADJUSTMENTS

In our discussions with QOZ stakeholders, we have heard buzz about potential tweaks to the QOZ regulations. We believe that most of the modifications being discussed by industry participants would be welcomed by investors, including enhancement of certain incentives, adjustments to key deadlines or an expansion of eligible areas. Any of these modifications would require bipartisan legislation in Congress. Given the broad support of QOZs, we believe that potential Congressional changes could enhance, not necessarily detract from, the QOZ benefits.

Bridge Investment Group endeavors to follow the letter AND spirit of the QOZ legislation. As a leader in the space, we understand that we need to set the bar for others as we build communities in QOZs.
This analysis is for informational purposes only and is not an offer, or solicitation of any offer, for any securities or funds offered or managed by Bridge Investment Group LLC (together with its affiliates, “Bridge”). Any such offer or solicitation will only take place pursuant to a confidential private placement memorandum in accordance with applicable securities laws. Recipients are cautioned to consult with their own legal and tax advisers and must not place undue reliance on the analysis provided herein. The analysis above contains forward-looking statements that represent our beliefs as of the date hereof and are subject to change. These forward-looking statements include our expectations regarding how the political environment may impact tax or QOZ regulations, our beliefs regarding benefits provided by our communities, the benefit of investing into QOZs and the benefits of tax deferral, and any potential revisions to QOZ regulations. These forward-looking statements are not guarantees of future outcomes or performance, and are subject to various risks.

[i] "Real Estate Investing in Opportunity Zones - A Discussion with the CalALTs Real Estate Special Interest Group," January 25, 2021.

[ii] Bridge Investment Group’s research assumed that a taxable investor (i.e., someone who realized a gain and paid taxes in the 2021 tax year, made a new non-QOZ investment with the remaining proceeds and then sold that investment in ten years and paid long-term capital gains taxes at ordinary rates) and a QOZ investor (i.e., someone who realized a gain in 2021 and invested it into a QOZ in 2021 while deferring the capital gains tax to 2026 when he/she paid the tax at ordinary rate with a 10% reduction, and then paid no taxes when the properties were sold after a ten-year hold) both generated a 9% rate of return. All else equal, our research concludes that a QOZ investment outperforms a taxable investment on an after-tax basis if long-term capital gains rates increase to ordinary rates. This analysis does not take potential state tax rate increases or other tax potential changes into consideration. Bridge Investment Group does not provide tax advice and this example is provided for illustrative purposes only. Every taxpayer’s situation is different.

[iii] After the Inauguration: Investment Implications of Biden’s policy agenda, January 25, 2021. UBS Global Wealth Management Chief Investment Office.