Exploring Opportunity Zones: Part II

September 23, 2019

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How effective was the latest guidance issued on the Opportunity Zone program? Primior’s Johnney Zhang weighs in on the topic and discusses how the initiative influenced land prices.

Johnney Zhang, Founder & CEO, Primior. Image courtesy of Primior

In Part II of this series, Commercial Property Executive talked with Johnney Zhang, founder & CEO of Primior, about his take on the policy update on Opportunity Zones, as well as the effects on California’s real estate investment sector. His company is a strategic real estate development and investment management firm headquartered in Los Angeles, which earlier this summer broke ground on a mixed-use OZ project in Orange County.

Part I of the story included the insights of Bilzin Sumberg’s real estate practice group leader Suzanne Amaducci-Adams into this topic.

What is your general opinion on this recently revised Opportunity Zones initiative?

Zhang: After reviewing the latest guidance issued on the Opportunity Zone program, it’s clear that the IRS is taking serious steps to help provide the clarity the investment community has been seeking. While there are still a few unanswered questions, we are hearing from many investors that they have a better understanding of the program and its benefits.

Wasn’t this tried before? Many point out to a similar plan launched in 1993, the Empowerment Zone, Enterprise Community and Renewal Community initiative.

Zhang: While all these programs share similar goals, from a development perspective, the Opportunity Zone program is better suited to attract investors. Previous programs targeted employers with employment wage credits or allowed for elimination of capital gains on assets sold. The Opportunity Zone program is directed specifically towards savvy investors who are seeking to offset their current capital gains liability, as well as realize strong long-term earnings.

Who do you see as the main beneficiaries of OZs—investors, communities, or is it an equally divided gain?

Zhang: We believe the Opportunity Zone program benefits both investors and communities in many ways. The projects funded by this program will provide excellent return on investment and significant tax advantages for investors.

At the same time, local communities will enjoy new or substantially renovated structures that better serve the community. Generally, these new or improved facilities will be cleaner, better maintained and will benefit the community for many years to come.

One of the most pervasive concerns around Opportunity Zones is that they will accelerate gentrification and contribute to the displacement of low-income residents. What are your thoughts on this matter?

Zhang: While the issue of displacement may seem initially concerning, it’s important to remember that the Opportunity Zones generally represent a relatively small subsection of any given city. These neighborhoods were identified and selected as areas that can greatly benefit from substantial developments.

It’s also important to note that analyses done on similar programs, like the Empowerment Zone program, show substantial increases in employment and increased wages that were not accompanied by dramatic changes in the local cost of living.

Each project will create short-term and long-term jobs opportunities for the community. Starting with their initial development, there will be a need for architects, engineers, draftsmen, skilled and unskilled labor, as well as local services to meet the influx of those working on the project. After completion, each new development will provide additional jobs servicing the local community.

Another pressing question is related to timing. Given the length of negotiating and closing property transactions, and then performing the capital improvements (while also taking into account the shortage in labor workers), how feasible is the process?

Zhang: Excellent question. This is key to the development process for Opportunity Zone land. A developer needs to perform the evaluation and due diligence very thoroughly to ensure the process moves quickly and smoothly. If a property has any “hidden” pitfalls, they could delay the project and possibly move it outside of the capital improvement requirements window.

Let’s talk about LIHTC and OZ pairing, one that could generate high investment yields. When and how is this combination possible?

Zhang: We generally recommend investors to first review investment yield without factoring in benefits from the Opportunity Zone program or other potential incentives. Any investment deal should make financial sense without needing these added benefits. Any added returns from these programs should be looked at as bonus earnings. If a deal can’t stand alone without them, investors should walk away.

As for pairing programs, each individual property is analyzed to determine its maximum potential return. This includes federal programs like New Markets Tax Credit, Low-Income Housing Tax Credit or other local and state programs.

Is there need for additional oversight of the OZ initiative?

Zhang: Well-drafted policy is essential to giving investors peace of mind and providing clear guidelines for developers to work under. As we saw with the first round of tax guidance, there were still many unanswered questions that caused investors and investment firms alike to move cautiously into the Opportunity Zone space. As more guidelines have been released, we see confidence in the program rising significantly.

How high is the level of (un)certainty when it comes to investing in OZs in California?

Zhang: This largely depends on the investor. Forward-thinking investors who can see a 10-year picture of the real estate landscape have confidence that their investment will provide the returns they are seeking. At Primior, we strive to find Opportunity Zone investment opportunities that will provide an excellent return, even without the added tax benefit. This is important because a project cannot rely solely on the tax advantages to make it sustainable.

Which areas in California have seen a steady flow of new investment capital over the past year and to which degree the OZ boundaries are a factor in these investments?

Zhang: Both Los Angeles and Orange County have seen excellent growth rates in the past year. In 2018, Los Angeles added 28,600 jobs, while Orange County added 23,700 jobs. Construction was the largest growth sector at 6 percent. We see this as a strong indicator of investment capital on the rise.

Are OZs affecting land prices? If so, is it purely speculative or are these valuations realistic?

Zhang: We are seeing the average land price in Opportunity Zones rise across the country. According to recent surveys, Opportunity Zones land prices have risen about 20 percent since the program was announced. While some of these increases may be considered speculative, it appears to be an indicator that investors and developers alike see the value this program offers for return on investment and to local communities.