Opportunity Knocks

The new Opportunity Zones present some lucrative targets for qualified investors, but regulatory wrinkles and market dynamics are holding back projects in the Kansas City region.

In his 2012 book titled “The Laws of Opportunity,” Suoyo Aganaba wrote that “opportunity most often presents itself as a problem that demands a solution.” It’s just possible, then, that the economic-development incentives built into the tax reforms of 2017 might better be known as Solution Zones, rather than Opportunity Zones.

In many areas of the country—less so, perhaps in Kansas City—they are already having the desired effect of luring capital investment into areas, urban and rural, that carry the designation of “distressed.” “I had a former life as a real-estate development attorney, and I still do—in the middle of the night—but I’m spending all day now on Opportunity Zones across the country,” Korb Maxwell of Polsinelli, PC, says, only half-jesting. “This isn’t for the faint of heart; it’s not the easiest program in the world, but it wasn’t meant to be. The whole concept was that we needed to spur action and activity in the market, providing that carrot, not the stick, for capital investment. If you meet these standards, you can get this very generous benefit, but we needed to go into low-income areas with that investment.”

The program is a tool to accelerate development by pulling long-term private investment into low-income areas. It offers three main benefits to investors willing to take on projects in what are known as Qualified Opportunity Zones:

  • A temporary, capital-gains tax deferral that can run through 2026.
  • A stair-stepped increase in basis: 10 percent of the deferred gain for investments held five years and 15 percent for those held seven years.
  • And tax forgiveness on all gains for investments held for 10 years. 

The zones themselves fall within 72 Census tracts designated by the Treasury Department as distressed. In the Kansas City region, that includes core parts of older suburbs in Johnson County as well as industrial swaths of North Kansas City and one of the city’s thorniest social quagmires in the ZIP code 64130. 

For investors who have realized recent capital gains, the program presents a nearly unprecedented opportunity to avoid up to 20 percent in federal taxes on their return. While Maxwell has been on a George Jetson treadmill trying to keep pace with deals in other metro areas, investors in the Kansas City region have been more circumspect.

Part of that is because federal implementing regulations from the IRS have been slow to come, and were
delayed an additional seven weeks by the government shutdown to start the year. Part of it reflects some of the more conservative approaches to such deals within the regional investor class. Part of it is simply trying to figure out what types of projects make sense, and where.

For the broader community, the payoff could be economic development that connects the urban work force with more jobs, and not just low-paying service jobs. “I think the most prolific asset classes we’ll see will be office and industrial,” Maxwell said. “The benefits are not only for the project itself and the 
real-estate investors, but there’s also a tenant advantage because the operating companies, when this starts working, are going to get a boost as well.”

On the investor side, “I would say people are interested, but there are a lot of unknowns,” says Jim Williams, chief investment officer for Overland Park-based Creative Planning. “I’m not aware of anyone who has invested in Opportunity Zones and we have a lot of clients, someone could have done one and
it’s just that I’m not familiar with it.”

Investors, though, may be taking their cue from the firm. “Our view is more of a wait and see approach and going with a (development) partner who has long track record in real estate,” Williams said.

Brad Sprong, Kansas City managing partner for the global accounting/consulting firm KPMG, said that
“‘stampeding’ might be a strong word, but there is a lot of interest and activity going on. The challenge is, to get the benefit, you have to have the capital-gain money. If you bought Amazon at $100 and it’s now worth $1,000, then $900 of that is the gain and can roll into the Opportunity Zones. But if you don’t have
that, it’s hard to find enough money to do these deals.”

At this point, he said, KPMG is still trying to connect investor capital with the groups that are aggregating funds to get behind projects. KPMG will be working with noted private-equity firms like Blackstone, Bain Capital and Goldman Sachs, but they’re waiting for a bit more clarity from Washington.

“It seems like regulations around these are complicated and still in flux,” Sprong said.

The main point for investors, both Williams and Sprong say, is that the focus of any deal within an Opportunity Zone must be grounded on the economic fundamentals of the deal itself—its ability to provide a return on that investment, rather than produce a profit solely through the potential tax

“From our perspective, what’s the benefit for our client?” Sprong said. “This can benefit the community, and that’s wonderful, but the community is not the client. Our focus is, is this a good investment for clients?”

The answer to that, on the development side, is a definite maybe. “Most of us in the real-estate development field are feeling like the Opportunity Zone is one of the hottest topics now, and so many people are aggregating funds to buy, but it’s still kind of a work in progress as to what exactly the benefits are,” says Bucky Brooks, of Copaken Brooks. “Second, a lot of properties are in areas that, even
with benefits as understood, are not great spots to be developing.”

The firm is looking into things Brooks says, and is searching for eligible properties to acquire, given the potential. “It feels like we’re on the bleeding edge, but people are still trying to figure it out,” he said. “The incentives might be good enough.”

One thing holding back potential projects, he said, is the restriction on the amount that an owner can invest on projects aimed for land he already owns.  “That’s one of the stranger aspects,” Brooks said. “If you own that property now, it has to be somebody new; the new gains have to come from somebody else,
for the most part, You can only invest 20 percent in those deals. I don’t know why it wouldn’t allow a current owner to develop the property.”

Ryan Brunton, a real-estate expert with Husch Blackwell, said he’s seen a bump in Kansas City activity along the Troost corridor. “We already have a party involved in real-estate development projects, and have identified a project they’re planning to develop in an Opportunity Zone,” Brunton said. At this
point, most of the movement is coming from developers themselves who have recently experienced a capital gain event.

“The more self-contained ones, where the developer makes an investment and uses that capital, those are the deals getting done now,” he said. But it’s clear, he says, that there remains “a lot of uncertainty,” especially as it relates to operating the businesses within the zones, post-development. 

“Until we receive that clarity from the IRS and Treasury, you’re going to see that private equity generally siting on the sideline,” Brunton said.

So . . will this all work as intended? And if so, where will the changes start showing up?

“I think this is going to move in stages,” said Maxwell. “I think the Johnson County zones are really attractive, the Rainbow corridor, and North Kansas City is incredibly attractive. Those are the highlight areas, for sure. As you push farther west, the Wyandotte County zones are attractive, and closer
to Downtown, the west side and west  Crossroads.

“When you push east of Troost, to Prospect, those are going to take longer. I do hear folks interested in those zones. The green shoots are starting to pop up, and Opportunity Zones are only going to
accelerate that.”

One thing to keep in mind for all such projects, Maxwell said, is that they are investments. “For the core to have any value, you have to have an investment that is going to make money. This isn’t charity; it has
to have a for-profit motive to it and has to accrete in value,” he said. “But as the money flows in, you will see it move east, piece by piece. I don’t think it will be an immediate shot in the arm to solve all the
problems there, but it is one more tool to start pushing in the right direction.”