Where is the next opportunity? It's the million- or (multimillion-) dollar question.
Here's our snapshot of the current multifamily real estate investment situation:
The market continues to escalate, and it is getting harder to make the numbers work at current prices. Most recent multifamily real estate purchases have been completed by sponsors (general partners) who are fee-driven, using high levels of debt to finance project at sky-high valuations that do not reflect the real risk. Rent growth is slowing and expenses are increasing. These factors could bring new opportunities in the next few years, if sponsors are unable to hit their pro-forma projections and cannot refinance their high leverage loans upon maturity.
Admittedly, this isn't the prettiest picture for the investment business. Our goal is to buy properties that will appreciate in the future and bring a reasonable cash flow in the present. There will always be one-off deals that make sense, but it's proving more difficult to make investments work, particularly with escalating interest rates.
That being said, we see a new opportunity within the new "Tax Cuts and Jobs Act" (TCJA).
A key part of the TCJA, which garnered bipartisan political support, is the Investing in Opportunity Act, which provides special benefits for investments made in geographies designated as "Opportunity Zones." Opportunity Zones (OZs) are areas that each state and city have nominated for redevelopment, with the approval of the federal government. These zones are in low-income areas that are to be reenergized by practical investment. Under this new law, investors can obtain tax relief by investing in a qualified OZ property.
Below we will discuss in detail what OZs are and the benefits of the unique opportunities for future wealth appreciation that we believe are offered by investment in an OZ.
In March 2018, the US Treasury agreed to designate certain census tracts throughout the country as Opportunity Zones (OZs). This was done to generate private investment in distressed areas, stimulate economic revitalization, and boost job creation. Over 8,700 OZs were created in the US. In Texas, there are more than 600 OZ census tracts across 145 counties.
In order to qualify as an OZ, a census tract must meet the following requirements:
OR
According to these requirements, the downtown and urban areas of most major cities qualify as Opportunity Zones. For instance, in Houston, all of Downtown, Midtown, and parts of the Medical Center are OZs.
These above income requirements sound fairly bleak, but like most investments the details are important. For example, an area where many students live could be designated as an OZ, because student incomes are frequently very low. Or an industrial area could be deemed an OZ, due to the small number of residents, and the fact that those who do live there have low incomes. Often the edges of an OZ lie alongside a thriving economic area. For example, in Las Vegas, one side of Las Vegas Boulevard (the Vegas Strip) has been designated as an OZ, while the other side of the street has not. While one needs to be selective, there are some excellent potential investment opportunities within Opportunity Zones.
When an investor sells an appreciated asset that they have held for more than one year, such as stocks, bonds, or real estate, they realize a capital gain. This is a taxable event. But under the Opportunity Zone program, if an investor reinvests any part of that capital gain into an Opportunity Zone Fund, the payment of the capital gains tax that is invested is deferred until 2026, and could be reduced or eliminated entirely.
There are 3 federal tax benefits available when investing in a qualified Opportunity Zone Fund:
The concept of deferring and reducing capital gains tax is similar to that of a 1031 like-kind exchange, but it has significant advantages. Here are some of the ways that investing in Opportunity Zone Funds is better than a 1031 exchange:
In order to invest in an Opportunity Zone and enjoy the tax breaks that come with it, investors have to use a qualified Opportunity Fund.
An Opportunity Fund must:
The Barvin Group intends to take advantage of this tax break by buying raw land and building new area-appropriate multi-family projects in Opportunity Zones. Currently, we are under contract to purchase a piece of land in the Texas Medical Center which is within an OZ, and we will build our first new multifamily development project. It’s located close to another property we own, the future Texas Medical Center-3 campus, and is in walking distance to the light rail.
We plan to finalize the purchase of that land in January 2019, and then reach out to Opportunity Fund investors shortly thereafter. Depending on permissions, our plan is to start construction later in 2019, with completion of the project projected for 2020. We will send more information in the near future. Note that, at this point, we will be raising Opportunity Funds on a property by property basis rather than creating a single fund to own multiple assets.