21st Century Gold Rush: Opportunity zones attract new investors

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Hospitality Tax Shelters

Investing in Opportunity Act opens new ways reduce government’s take on capital gains

An aerial view of the qualified opportunity zone in Avondale, Arizona, a suburb of Phoenix. Opportunity zones follow the New Market Tax Credit’s definition of a distressed community in need of jobs and economic development.

Midas Hospitality of St. Louis, Missouri, has raised $35 million for its new Opportunity Zone fund.

Virtua Partners of Phoenix, Arizona, and Hotel Equities of Atlanta, Georgia, celebrated a Feb. 1 groundbreaking for a hotel in an opportunity zone in a Phoenix suburb.

Peachtree Hotel Group of Atlanta has two hotels under construction in an opportunity zone in Plainfield, Indiana.

These are just a few of hotel investors and developers moving on a new federal program called Investing in Opportunity Act.

The act is born from the 2017 federal tax reform. It paves the way for governors to designate areas in their states as opportunity zones – tracts of land on which business developers can build projects that are rich with promises of tax-deferment for those who invest their capital gains.

It has the power to connect private capital with projects in urban, suburban and rural areas that for the most part have been left out of America’s post-recession recovery. Opportunity zones are opening up commercial real estate development in forgotten-but-promising communities nationwide.

The act also has created a 21st century gold rush, and hotel developers are among the prospectors.

Midas Hospitality raised its money in just four months.

Virtua Partners launched a $200 million fundraising project last summer and teamed up with Hotel Equities in the fall after funneling $500,000 to the hotel management company toward developing hotels in opportunity zones.

U.S. Sen. Tim Scott, R-S.C., second from left, poses with investors, developers and local officials at a Feb. 1 ceremonial groundbreaking for a SpringHill Suites in Avondale, Arizona. The state designated the tract an opportunity zone. Scott is primary sponsor of the Investment in Opportunity Act, which paved the way for the opportunity zone investment program. Also pictured Quinn Palamino, fourth from left, of Virtua Partners, which is managing the opportunity zone fund, and Fred Cerrone, second from right, founder and chairman of Hotel Equities, the hotel and project manager.

Though the program rolled out with overall tax reform, it finally got legs in the fall when the U.S. Department of the Treasury released some investment and taxation guidelines.

Many prospective investors, fund raisers and business developers are still waiting on the IRS to publish clearer rules. The IRS held a public hearing in February but has yet to come out with fresh guidelines.

Meanwhile, all 50 states have designated more than 8,700 Census tracts as opportunity zones.

What Is It?

The Invest in Opportunity Act is the brainchild of Republican U.S. Sen. Tim Scott of South Carolina, and Democratic U.S. Sen. Cory Booker of New Jersey.

Scott via email declined repeated requests from Lodging Leaders for an interview and Booker did not respond to an email request.

Scott told Bloomberg news in September the goal of the program is to “bring private sector dollars to harmonize with public sector dollars” to fight poverty and fuel economic growth in struggling areas throughout the country.

WATCH: U.S. Sen. Tim Scott, R-S.C., talks to Bloomberg about Opportunity Zones.

LOOK: Check out the opportunity zone map posted on the Economic Innovation Group website.

During a Senate Finance Committee hearing last year, Scott said the goals of Investing in Opportunity Act is to spur economic growth, increase business competitiveness and create jobs by attracting “more private sector capital back into distressed communities,” where more than 50 million Americans live.

Douglas Holtz-Eakin, an economist testifying at the hearing, supported Scott’s comments by noting “sharp differences” in job creation and economic improvement across the country. He said the post-recession recovery over the past 10 years has been uneven, leaving many distressed communities and their residents devoid of any progress.

The Economic Innovation Group, which helped lawmakers craft the act, said certified opportunity zones have a poverty rate above the 20 percent eligibility threshold and an average median family income of 59 percent. Residents in these communities are job ready and the areas have a fair measure of business vitality.

The big draw for investors is temporary tax deferment.

To take advantage of the benefit, an investor has 180 days to place the newly realized capital gain into an opportunity zone fund.

The fund must invest at least 90 percent of the capital into real estate or businesses in opportunity zones within six months.

The current tax deferment schedule goes like this:

If an investor holds the original investment for five years, the investor receives a 10 percent reduction on the capital gain’s tax.

After seven years or more, the reduction is 15 percent.

Taxes (at 15 percent less) on the original capital gains invested are due when the property is sold or on Dec. 31, 2026.

After 10 years or more the tax hit is zero on the ROI resulting from the fund’s investment. The exclusion only applies to gains from the sale or exchange of an investment in an opportunity fund.

READ: Got questions? Find answers on Economic Innovation Group’s FAQ page.

WATCH: Tune in to U.S. Sens. Tim Scott and Cory Booker with John Lettieri of EIG at National Association of Counties.

Sense of Urgency

Proponents of the program say there is little time to waste. The program is timed to sunset in 2028, and there are holders of trillions of dollars in unrealized capital gains just waiting for the right reason to cash out and re-invest.

The opportunity zone designation enables developers to raise money from new sources.

For the first time, those with a capital gain in one investment bucket can invest their surplus in different buckets. New investors include individuals looking for a place to stash gains realized from non-commercial investments such as selling a collectible antique car or cashed-out stock returns.

Scott anticipates the program can unleash more than $2 trillion in private funds over the next few years.

A much, much higher figure is calculated by Economic Innovation Group, which helped craft the Investing in Opportunity Act. The advisory firm figures the amount of pent-up capital available is more than $6 trillion. It counts perspective capital gains from personal investments such as stocks and funds as well as corporate capital gains on the books in 2017.

READ: Read Senate Bill 293 that created the Investing in Opportunity Act Senate bill and its companion bill in the House H.B. 828

Not For Every Hotel

Not every opportunity zone is the best site to build a hotel.

Peachtree Hotel Group recently broke ground on a Courtyard by Marriott in Plainfield, Indiana. The qualified opportunity zone is near the Indianapolis International Airport.

Mitul Patel, co-founder, managing principal and COO of Peachtree Hotel Group, said plans to build the hotel were underway when the state announced the area was now tagged as an opportunity zone.

Although new investors may be available, Peachtree Hotel Group is sticking with its tried-and-true business practices.

Tax breaks or no, Patel said the hotel project has to pencil out.

“We are trying to do deals where we believe in the underlying real estate, the hotel metrics and growth in the area,” he said. “The bonus beyond the tax dollars is there will be other investment in this area due to the tax savings, and hopefully the area expands on top of just our little piece, which is the hotel.”

Peachtree Hotels Group is speculating and putting offers on land in a few opportunity zone tracts throughout the country. “First and foremost the fundamentals have to be strong to support a hotel development,” Patel said.

“We do want to get it right. There are a lot of opportunity zones out there that don’t makes sense for a hotel.”

The opportunity zones might be a wise investment for another CRE asset class such as retail or office, but not every market will support a hotel.

The fact that the act has bipartisan support and President Trump is in favor gives hotel developers faith in its longevity.

Brian Waldman, senior vice of president of investments at Peachtree Hotel Group, shares that sentiment. Though the IRS has yet to answer a lot of questions regarding the program, the developer and investor has “its arms around the majority of it.” The open questions, if answered, will make the program stronger, he said.

WATCH: Brian Waldman of Peachtree Hotel Group explains the taxation rules.

“The most important thing for us is these are projects stand on their own,” Waldman said. “So if something happens in Congress tomorrow and the whole program blows up, we are still doing deal we believe make sense and that we would have done anyway.”

Waldman said being an “early mover” on opportunity zone development gives Peachtree Hotel Group a market advantage where it’s right to build a hotel.

“I think from our perspective we are trailblazing. We are moving quickly and setting a path that others will follow.

“Our biggest responsibility is the company, our investment thesis and our investment vehicle,” Waldman said. “We need to be smart and strategic and make sure we are focused on doing the right deals and all the rest will come along after that.”

Just as an opportunity zone project will draw money from new stream of capital, the program has developers rethinking their business models and joining forces with new partners.

Peachtree Hotel Group is doing more joint-venture projects and it’s teaming up with developers of mixed-used projects.

WATCH: Brian Waldman talks about Peachtree Hotel Group creating JVs to move fast in opportunity zones.

The Courtyard in Plainfield, Indiana, is an example of a type of co-development. Peachtree is building the hotel and Poag Shopping Centers is developing the adjacent Shops at Perry Crossing.

In almost all cases, the local partner has cleared municipal zoning hurdles, a big plus in getting a hotel built and opened.

Greg Friedman, co-founder and president of Peachtree Hotel Group, said the company has a pipeline of about a dozen hotels in opportunity zones. Peachtree is co-developing a little more than half the projects where the fellow developer has already gone through a municipality’s zoning or entitlement process.

“The benefit we get is we are able to partner and work with certain groups who have gone through the entitlement process and it enables us to meet the timeline of the program.”

Multi-Faceted Opportunity

While many builders and investors are focused on new development within qualified opportunity zones the Investing in Opportunity Act includes other channels for tax deferment. They include rehabilitating existing buildings and investing in the operation of a business.

Nicole Ament is a real estate lawyer and a shareholder in Brownstein Hyatt Farber Schreck law firm in Denver, Colorado. She has become well-versed in the tax benefits of opportunity zones and the various ways those with capital gains can defer and reduce the size of the tax when investing in hotels.

She said Investing in Opportunity Zone Act provides more flexibility for investors. Most CRE investors are familiar and have used the federal 1031 like-kind exchange to avoid paying tax on capital gains. But the law demands a like for like exchange.

Not so for an opportunity zone investment.

Apple stock is an analogy commonly used to explain the flexibility of an opportunity zone investment. Say an Apple stock investor who has $1 million in capital gain. The investor can place any portion of that gain in an opportunity zone fund. Thereby reducing and deferring the tax hit. The rest of the gain can be put in another opportunity zone fund or the investor can pay the full tax on that portion and keep the cash.

The Investing in Opportunity Act is not only focused on bricks and mortar.

Another wealth-generating aspect of the program is investment in business operations. The hotel building and land are often separated from the operating business. Capital gain investors can put their money toward the operations of the hotel and realize the same tax benefits as a real estate investment.

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