You may already be well versed in all of the reasons why OZs are intriguing investments. The program is so aptly named that the opportunity cost of sitting on the sidelines is too great to consider, but the prospect of getting started can be a little daunting. Investors only have 180 days from the time a capital gain is realized to re-invest into an OZ fund. That is a very narrow window to find and fully vet projects. To this end, data can be a powerful tool to alleviate concerns about unknowns and provide critical insights to validate potential investments.
There are three simple steps that can help you mitigate risk and make informed data-based decisions:
ALIGN YOUR SEARCH TO YOUR INVESTMENT STRATEGY
With over 8,700 OZs across the country there is something to meet the needs of every investor, but the key is to determine expectations and appetite for risk up-front. Formulating a strategy ahead of a project search will naturally create a rubric of data points, against which any potential investment can be evaluated. It also makes it easier to compare apples to apples when deciding between a handful of projects or locations.
Let’s explore an example. Jane Doe and John Smith will each realize $15 million in capital gains this year. They are both interested in investing in OZs, but John is very cautious and prefers a low-risk scenario with steady returns. While Jane wouldn’t put all of her money on a single number at the roulette table, she is open to calculated risk when there is strong potential for a high return.
Since the OZ designation was partly based on old census data, some neighborhoods included in this legislation have undergone substantial change and development in the past decade. For those that have already experienced major growth, there is less room for appreciation and competition for remaining property in the area can be fierce. Investors with a similar strategy to John are drawn to these “established” OZs because they have an existing track record of growth and may be lower risk.
Whereas “up and coming” areas are more likely to suit Jane. This segment can be characterized as communities that have been historically underserved but have the potential for significant economic growth and job creation over the next few years. Investors that accurately predict which OZs are on the cusp of growth may earn a greater ROI.
If you don’t have a crystal ball handy, researching the right data points can offer compelling insights about the likely trajectory of a given market. Both John and Jane should look at the same metrics including: income, rental prices, home values, education, occupancy rates, unemployment, proximity to employment, market health etc. However, John’s analysis will be through the lens of evaluating an OZ’s current fundamental data points, while Jane’s attention will be drawn to the data trends. John wants to see a location that already has high income, as well as strong home values and rental prices. On the other hand, Jane is comfortable with an OZ that currently has a low income per capita, as long as there are recent positive growth trends in those key data points.
OPEN GEOGRAPHIC PARAMETERS
Jane is from Los Angeles and John is from New York, but that doesn’t mean their investments need to be limited to their home cities. One of the most attractive parts about the OZ program is that there are eligible areas all over the country. Data can provide investors with local insights about the socioeconomics and market trends of any location without having to board a plane. Opening up your search geographically can unlock hidden gems, and possibly increase your potential returns.
Since many of the OZs in the Los Angeles area are already established, Jane might find that there are parts of Cincinnati, Oklahoma City, or Pittsburgh are more suited to her investment strategy. Now that she knows which metrics are important to her, comparing and contrasting OZs is easy. Jane has decided to look at the current data from each of these areas as well as growth trajectories before making a final decision.
Without viewing data from other cities, John feels confident that New York City is the best place for him to invest. While he is correct that there are multiple strong OZs in his hometown and he will likely see stable growth with his investment, had he considered other established markets such as Salt Lake City, Denver or Austin, he might have been able to further lower his risk by diversifying his $15 million investment across two or three projects.
REMEMBER THE BASICS PRINCIPLES OF INVESTING
Opportunity Zones have incredible potential, but stamping “QOZ” on a project doesn’t automatically mean that it will be a win for investors. As with any other investment, the deal has to be solid and the numbers need to pencil out. Does the structure make sense? Do the returns seem feasible based on the market data and trends in that area? Answering these questions and performing due diligence are critical before making any investment decisions.
Additionally, investors should consider the impact of state conformity to the federal tax treatment. While many states have adopted the federal program guidelines, investors would do well to thoroughly research and evaluate state and local tax exposures as a part of their overall due diligence. Effective planning at the deal- and tax-level coupled with the insight of market intelligence data would ultimately help investors maximize the potential of their OZ investment.
NOW IS THE TIME TO ACT
Now that you understand how to leverage data to make informed investment decisions, it is time to get off the sidelines and into the OZ game. Following the release of the second round of regulations, which offered investors increased clarity and flexibility, OZ fund and development activity have started to ramp up and are anticipated to build further traction in the coming months. The laws of supply and demand tell us that increased interest in OZs could result in higher property prices, and it would be advantageous to get ahead of that curve.
Additionally, in order to maximize the capital gains tax deferral and reduction benefits investments must be deployed into an OZ fund by Dec. 31 of this year.
Commit the next couple of months to exploring various OZs and screening projects using data as your guide. You might find a great investment with higher than anticipated returns in an area that wasn’t even on your radar.