Owning property has been critical to building wealth for centuries. Not only does real estate tend to appreciate over time, but property owners also generate income by allowing others to use the land and buildings.
The most common choice of investment property is a small residential or commercial building that brings in rent, but some investors have also had success in buying run-down buildings, renovating them, and then reselling for a profit – also known as “flipping”.
Of course, the biggest rewards come from large commercial properties with multiple tenants. Building and managing this sort of real estate brings greater, more reliable returns.
Unfortunately, the amount of capital required for such investments is usually out of reach for individuals. Until fairly recently, participation in large commercial real estate projects was generally limited to institutional investors.
Real Estate Investment Trusts (REIT) were developed in the 1960s to give individuals access to large commercial investments, and the program has been quite popular. However, many were not satisfied with publicly traded REIT shares. They wanted the option to invest directly, without buying buildings outright.
Companies like EquityMultiple have made this possible, through platforms that connect individuals with project sponsors. When the 2017 tax overhaul created Federal Opportunity Zones, EquityMultiple designed programs that give individuals access to these special tax-advantaged investments.
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Federal Opportunity Zones?
Economically distressed areas are caught in a downward spiral.
Those living and working in these neighborhoods lack the necessary funds to maintain and improve real estate, and it loses value. Those who can afford to move their homes and businesses to better neighborhoods do so, pulling money out of the area.
Buildings fall into disrepair, and no new businesses come in. Eventually, the only residents and businesses left are those that can’t afford to leave.
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In an effort to encourage private investors back into such areas, the 2017 Tax Cuts and Jobs Act created Opportunity Zones.
These are defined as “economically-distressed communities where new investments, under certain conditions, may be eligible for preferential tax treatment.”
More than 30 million people currently live in such areas, which include everything from urban environments to suburbs and rural communities.
Each of the 50 states and the District of Columbia nominated zones marked by a concentration of low-income residents, and the zones were then certified by the IRS as Opportunity Zones.
What Qualifies As
An Opportunity Zone?
Now, investors can create Qualified Opportunity Funds for the purpose of investing in these areas. If all criteria are met, fund participants are eligible for preferential tax treatment.
Some of the relevant criteria include:
- More than 90 percent of the fund assets must be in the Opportunity Zone
- Funds must make substantial improvements in the investment properties that are at least equal to the original value of the property
- Improvements must be made within 30 months of purchase
- Investment properties cannot include country clubs, golf courses, hot tub facilities, massage parlors, tanning facilities, liquor stores, racetracks, or gambling venues, even if they are located within Opportunity Zones
The challenge for individual investors often comes in selecting real estate with potential, then arranging for the necessary improvements. Once that is complete, the property must be managed or sold.
These tasks can be a full-time job, making it near-impossible for average investors to participate in the Opportunity Zone program. Opportunity Zone Funds transfer most of this work to real estate experts, so investors can enjoy the benefits without being responsible for the details.
EquityMultiple Opportunity Zone investments combine the benefits of EquityMultiple’s commercial real estate investing programs with the tax advantages of Opportunity Zone Funds.
What Are The Tax Benefits Of
An Opportunity Zone?
Generally, investing in large commercial real estate projects over small rental properties means less risk and more reward.
These are the most common benefits cited by financial services professionals:
- Downturns in the economy, or systemic risk, affects commercial real estate differently than it does stocks and bonds. Historically, commercial real estate hasn’t moved in sync with the global equity markets. That makes commercial real estate investment important for portfolio diversification.
- Rental payments provide a steady source of income, even though the property itself is not particularly liquid.
- Commercial real estate typically has many tenants versus the limited number found in small residential or commercial properties. This reduces the risk of losses should a single tenant fall behind on payments or a single unit stand empty for a period of time.
- Businesses are more inclined to sign long-term leases – three to five years, at least, and 10 year leases are not uncommon. That means less volatility, regardless of events in the larger economy.
In addition to the benefits that come with general commercial real estate investing, Opportunity Zone projects offer potential for greater tax savings. For example, investors can defer federal capital gains tax from these projects until December 31, 2026.
Better still, taxes on gains from previous investments can be deferred if the gains are invested in Opportunity Zone projects within 180 days.
More importantly, when investors hold their Opportunity Zone investments for more than five years, there is a 10 percent exclusion on the deferred gain when taxes come due.
This exclusion increases to 15 percent after seven years, and after 10 years, no federal income taxes are assessed on the investment’s appreciation.
Opportunity Zone Areas
You might be wondering why invest in an opportunity zone area vs putting your money to work in a publicly traded real estate investment trust, or REIT.
REITs offer individual investors a chance to participate in the commercial real estate market without purchasing and managing a commercial property outright.
Essentially, the trust is a publicly-traded corporation that holds at least 75 percent of total investable assets in real estate, gets at least 75 percent of its income from rent or mortgage interest, and pays at least 90 percent of taxable income to shareholders as dividends.
Those interested in adding commercial real estate to their portfolio can purchase REIT shares, just as they would buy stock in any other corporation.
Historically, share prices have fluctuated with the larger market, and downturns in the economy have equated to declines in REIT value – though perhaps to a lesser extent.
The main concern with REITS is this: as a publicly-traded company, value is determined in the court of public opinion, and REITs are subject to systemic risk. A bit of bad news about a project can decimate stock prices.
Privately-held real estate assets are more insulated from systemic risk, which gives EquityMultiple’s platform an advantage.
It puts individuals in a position to invest in private market commercial real estate, just like institutional investors do.
In addition to the standard categories of commercial real estate – multifamily, office, retail, and industrial – EquityMultiple offers exposure to niche property types that are rapidly gaining investor interest.
Examples include senior living facilities, manufactured home communities, data storage centers, and student housing.
How Much Can You Make
Investing in Opportunity Zones?
It’s hard to pinpoint a specific rate of return for commercial real estate investing in general and Opportunity Zone investing in particular.
The first consideration is the quality of the project selection process. EquityMultiple takes some of the guesswork out of this process by delegating responsibility for project selection to industry experts. The project sponsors and the projects themselves are vetted through rigorous underwriting, and EquityMultiple accepts less than 10 percent of all projects it reviews.
To date, EquityMultiple has participated in 70 transactions across 40 markets, with $1 billion in total capitalization on funded projects. The weighted average internal rate of return (IRR) on fully-realized investments is 17.3 percent.
EquityMultiple investors have three choices when it comes to how they put their money to work.
Syndicated Debt is the safest option, offering maximum protections. However, that also means a capped upside. The target rate to investors is between 7 percent and 12 percent, and the standard term is 6 → 24 months. Typical loan to value (LTV) runs between 50 percent and 75 percent.
Preferred Equity has some downside protection, and investors are entitled to a share of the upside. The target current preferred return is between 7 percent and 12 percent, and the target total preferred return is between 10 percent and 14 percent. The typical term is one to three years.
Finally, there is the Equity option, which has unlimited upside potential. Of course, that means more risk and very limited downside protection. The target annual cash return is 6 → 12 percent, and the target IRR to investors is 14 percent or more. The typical term for this investment is three to seven years.
Of course, these figures include all of EquityMultiple’s projects. Data specific to Opportunity Zones is not yet available, as the program is relatively new.
The biggest factor in Opportunity Zone investment is the tax advantage. By holding the investment for ten years, investors realized gains virtually tax-free.
The result is a 30 percent → 40 percent increase in annualized returns, which puts the upside of this type of investment leaps and bounds ahead of other commercial property investments.
How to Qualify For
Opportunity Zone Investments
EquityMultiple works with investors who meet specific qualifications. However, once the qualifications are met, the investment minimum is fairly low – just $5,000 for certain programs.
The benchmark to be eligible for EquityMultiple programs is at least $200,000 in income for the past two consecutive years, or at least $1 million in net worth, excluding primary residences.
Getting started is as simple as creating an online profile. Once registered, investors can review offerings real-time, select investments, and link accounts from financial institutions to fund the investment and receive distributions.
A dashboard offers up-to-date information on the progress of each investment, including a wide selection of user-friendly reporting and analysis tools. Investment documents are signed on the portal, making the entire process simple and streamlined.
For many investors, EquityMultiple is the easiest way to diversify into commercial real estate and take advantage of the tax benefits available from Opportunity Zone Funds.