There’s more to opportunity zones than the tax deferment they offer. Here’s what hoteliers should know before pursuing this program.
LOS ANGELES—The tax deferments available through opportunity zones offer hotel investors and developers an incentive to build in low-income areas, but sources caution to make sure the deal makes sense on its own.
There are 8,700 opportunities zones in the United States, making up 12% of the U.S. Census tracts, said Guy Maisnik, partner and vice chair of the global hospitality group at Jeffer Mangels Butler & Mitchell, as he moderated the “What you need to know about opportunity zones” panel at Meet the Money 2019. It’s one of the few times when Congress and the White House came together and did something right, he said.
“I don’t think there’s anybody who walks down the street who doesn’t see homelessness, see problems in the community,” Maisnik said. “If they can make this program work, where it doesn’t just improve the necessary areas but helps avoid the displacement of those in the area, this will be one of the most significant pieces of legislation.”
The tax law governing opportunity zones allow investors to defer tax on any type of prior capital gain when they invest it in a qualified opportunity zone fund for new construction or property improvements, said Jamie Ogden, partner at JMBM. The taxes on those gains can be reduced depending on how long the investor holds onto the investment.
According to the Internal Revenue Service FAQ on opportunity zones, those who hold onto the investment for longer than five years will receive a 10% exclusion of the deferred gain. Holding for at least seven years sees that 10% turn to 15%. Those who hold for at least 10 years are “eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged.”
Ali Jahangiri, founder and CEO of EB5Investors.com, said his company has been working with opportunity zones for the past eight months. He said it’s a hot area for investors, and it’s only going to get hotter. He warned investors and developers not to get distracted “by the shiny object” that is the tax deferment.
“It’s about getting a good deal first, not the tax break first,” he said. “If your deal makes sense and it’s in an opportunity zone, then great. … The safer deals are the good deals to go with. At the end of the day, a good tax break is there to juice up your returns, but the deal is to look at each individual development deal and the investment as a true investment.”
Sondra Wenger, managing director of investments at CIM Group, said her company makes sure there are improving demographics for any opportunity zone project in which it might invest and looks for markets that have sufficient levels of private investment.
“What we don’t want is to go into an opportunity zone and no one else sees the vision of that zone,” she said.
Her company believes that investing dollars builds up the community, Wenger said. The best way to create or enhance value in a community is to invest in the community as a whole.
When looking at a hotel project in an opportunity zone, her company considers more established hotel markets with opportunity zones, she said. Downtown Portland, San Jose and Scottsdale all have opportunity zones, and areas like these make more sense for developing hotels than the Bronx, which might see residential projects perform better.
“It’s very product-specific,” Wenger said.
It’s relevant for CIM Group to know where its development partners are in their timeline and the entitlement process, Wenger said. If the developers don’t have their entitlements set, they’re not in full control, which means they probably also don’t fully understand their costs, she said.
“The biggest problem that we see is you can get into a deal, and once you commit to a deal, it’s a binary thing,” she said. “Once you’re in, you’re in. If you have entitlement issues or costs go up and all of a sudden your deal is no longer feasible, you’re committed to that deal.”
As an investor, her company needs to see that entitlements are done, and it doesn’t want to be in a situation in which the deal is no longer feasible due to costs, she said.
Mark McGregor, managing director of North America at Relevant Group, said his company has seen the whole gamut of investor types. Relevant Group is currently in the middle of closing on a joint-venture project with a large quasi-institutional, tax-incentivized investor to build a hotel, he said.
His company is entertaining several possible projects because it’s being approached by large institutional investors who see his company’s projects nearing completion, he said. That lowers the risk a great deal for what they have, he added.
Hawkins Way Capital has raised its money through family offices, which is where it has found most of its success, said Ross Walker, co-founder and managing partner. Family offices are the best type of investor because with their low-basis stock, they can take some “funny money” and put it into real assets and diversify their portfolio, he said.
“They have the most flexibility,” he said. “Those families can hold longer. If we approach institutions, it’s harder to convince them because they have more of a timing issue with the capital.”
The families who have invested with his company like this approach because with hotels they can see what they’re investing in and understand how it works, he said.