Opportunity Zone Recent Changes

Per Costar 4/19/19

Opportunity Zone Regulations Could Give New Life to Long-Vacant Buildings

'This Was a Surprise to Us All'

Some distribution centers that have been vacant for many years, could get a boost from new Opportunity Zone regulations. Image: iStock

New U.S. Treasury regulations issued this week to stimulate more investment in opportunity zones is likely to open the floodgates on billions of dollars that have been sitting on the sideline, according to opportunity fund executives.

The guidelines clear the way for projects such as the conversion of an office building in Cincinnati to apartments or the redevelopment of three contiguous parcels in downtown San Jose into a mixed-use project with 76,000-square feet of office space. They also promise to be boon to the owners of buildings that have long been sat dormant. 

As originally written, the opportunity zone law required investors to double the purchase value of their investment through new construction or improvements to a property. The new regulations would eliminate that provision for buildings in opportunity zones that have been vacant for five years or more.

"This was a surprise to all of us," said Craig Bernstein, principal of OPZ Bernstein, a Washington, DC-based opportunity fund seeking to raise $500 million. "If the building has been vacant for longer than five years, you would not be required to do the substantial improvement test."

From an investment standpoint, that is a significant difference. Without the new interpretation, if investors had bought the building for $100 a square foot, they would have to put in another $100 a square foot into improvements or expansion.

"Now we could get away with just painting and doing new carpeting as an example," Bernstein said. "Or let's say we got a building that has just been mothballed. Tenants could move in tomorrow and flip on the lights and we would have to do no improvements to the building."

"We've identified, and there are probably over 100 buildings right now across the United States, that would qualify. And that would enable us from an investment perspective to mitigate the construction risk, rezoning and redevelopment risk from the equation," he said.

Bernstein's opportunity zone fund is now ready to move forward with its first investment. The fund will be undertaking a $15 million adaptive re-use project in Cincinnati converting an office building into a multifamily community. It currently has several other deals in the pipeline that Bernstein now expects to fund over the next 90 days.

"People have been patiently waiting on the sidelines, and given what came down yesterday, the regulations are better than anyone was previously anticipating," Bernstein said.

Erik Hayden, president and managing partner of Urban Catalyst in San Jose, reacted similarly. Urban Catalyst has targeted raising $250 million for its first opportunity fund.

"The regulations really gave us a sense of clarity and finality when it comes to structuring a multi-asset real estate equity funds," Hayden said. "We are now able to sell fund-owned property as long as we reinvest those profits back into the fund within 12 months. We can also refinance some of our assets and distribute those funds to our investors tax free."

Urban Catalyst is looking to revamp or fully redevelop three contiguous parcels in downtown San Jose into a mixed-use project with 11,000-square feet of ground-level retail space below 65,000-square feet of office space.

That is the first of what Hayden is projecting to be in the neighbor hood of 30 buildings in the downtown San Jose area over the next 10 years.

"The most exciting part of [Wednesday's] regulations is the clarifications regarding how to invest in operating businesses, specifically start-ups," Hayden said. "The primary geographic focus for Urban Catalyst is the redevelopment of the downtown San Jose Opportunity Zone. Every new Silicon Valley start-up with angel investor or venture capital backing is going to be incentivized to locate their start-up in there."

In announcing the new guidelines, the Treasury Department specifically touted the new guidelines treatment of investing in businesses in an opportunity zone. As written, the law required that 50% of businesses gross income come from doing business within an opportunity zone. The new guidelines substantially widen that definition.

According to the new guidelines, that 50% rule can now be measured as 50% of hours worked or 50% of the amount paid for services performed in an opportunity zone or, even more widely, if 50% of the work performed in a zone was necessary to generate 50% of gross income.

"We wanted to create flexibility," Steve Mnuchin, the U.S. Treasury Secretary said Wednesday in announcing the new guidelines. "We didn't want just to have businesses that were located in the opportunities zones and sold things only in the opportunity zones. That would have been very limiting. You know, as I like to say, hopefully the next Google and Facebook get started in opportunity zones."