According to the IRS, opportunity zones were created to fulfill the goal of spurring economic development and job creation in distressed communities. Opportunity zones are the subject of heavy interest from multifamily investors because of the potential they carry to reduce or eliminate capital gains.
It seems like almost every commercial real estate headline is focusing on this. Some firms are raising capital and funds solely for investment in opportunity zones. While investors are primarily focused on the tax incentives these areas provide, purchasing an apartment building in an opportunity zone should be evaluated like any other apartment investment. Consider some of the following ideas when analyzing your potential investment in an opportunity zone.
Manage The Renter Profile
In any apartment investment, it is essential to consider the renter profile to know how you will manage your building to meet the needs of that profile. Opportunity zones are generally in lower-income areas. If you have not owned apartments in lower-income areas before, it is important to understand the differences in managing this property so that you maintain high tenant service, retention and rent collection.
Prospective tenants in opportunity zone areas are often subsidized by local, state or federal programs. It is important to understand the needs of these tenants as well as the rules and regulations of the entities providing the subsidies to make sure you have a management plan for compliance. Investors unaccustomed to allocating resources for managing subsidy programs may be caught off guard, and your tenants will also be unhappy, leading to higher vacancy and/or collection loss. If you are new to subsidized rent, consider hiring a third-party management firm for your first opportunity zone investment.
Learn The Market
A fundamental principle of any real estate investment is location. For apartments, what makes the location work for an investment? Learn the local market. Why will your tenant profile live in the area and why will they be attracted to your building? Are there opportunities for employment, transportation or services needed by lower-income tenants that make the area attractive?
You can create a great building and have the best management practices possible, but if you have not carefully learned the market and chosen the right location, no one will show up to rent from you. What looks good on paper may not work unless the market and location support your plan.
Do The Numbers Work?
Part of the requirements for qualifying for benefits in an opportunity zone investment is making substantial capital improvements to the building. Remember that the tax benefits of opportunity zone investments are long-term, so you need to run detailed analyses of cash flows and returns to prove out that the investment carries itself in the short term, especially given the additional capital investments required.
Whether or not the building is viable in the short term should be the primary factor for investing, but this is sometimes lost in the hype of the tax benefits of opportunity zone investment. Make sure the projected rent/subsidies carry not only the acquisition costs, but the renovation expenses for the capital improvements required.
Although opportunity zones are indeed attractive, take a step back and consider fundamentals of real estate investment. Is your firm best equipped to do business in an opportunity zone market with these dynamics? If so, opportunity zones may provide unique benefits. If not, you could be swimming in uncharted water and waste time, energy and money. Remember that opportunity zone incentives can be the icing on the cake of apartment investing — but always remember that these incentives are not the cake.