What does ‘opportunity zone’ mean in real estate?

Homebuyers, developers and investors may be able to find a bargain in an opportunity zone, a distressed, often up-and-coming area that’s eligible for tax incentives. Whether you’re an investor looking for new prospects or a buyer on the hunt for something affordable, here’s what to know about opportunity zones, and the areas closest to you that may be worth exploring.

What is an opportunity zone?

Opportunity zones are “an economically distressed community where private investments” — in other words, real estate development — “may be eligible for capital gain tax incentives,” according to the U.S. Economic Development Administration. They’re sometimes referred to as Qualified Opportunity Zones, or QOZ.

Created by the 2017 Tax Cuts and Jobs Act, the goal of opportunity zones is to boost economic and job growth by encouraging investment in these areas. By making land improvements and purchasing, constructing and renovating properties in these locations, the hope is that they will become more appealing places to live, work and invest.

What qualifies as an opportunity zone are lower-income census tracts designated by the federal government. State governments were also able to choose 25 percent of the eligible census tracts in their states. The overall goal is to create a positive social and economic impact.

— Erik HaydenCommercial real estate developer and founder of Urban Catalyst, an opportunity zone fund based in San Jose, California

Opportunity zones: Pros and cons

Pros

Investing in an opportunity zone can pay off financially. Here are a couple reasons reasons why:

Lower prices and higher appreciation

Simply put, it can be cheaper to buy a home in an opportunity zone, and many of the areas appreciate more in value than national trends dictate.

For example, between the first quarter of 2019 and the first quarter of 2020, 45 percent of opportunity zones had their median home price increase by more than the national trend, according to ATTOM Data Solutions. At the same time, the median home price in 78 percent of opportunity zones remained lower than the national median.

“Because these are distressed areas, opportunity zones represent good bargains,” says Tino Jaimes, owner of Sunrise House Buyers TX in Houston. “Fewer buyers are interested in purchasing in these areas, and with less demand, the prices are lower.”

Tax breaks

Real estate investors and developers in opportunity zones can take advantage of tax incentives, which get better the longer they own the property. “They can be eligible to defer their federal taxes on capital gains,” says Valla Vakili, managing director and head of venture innovation for Citi Ventures in San Francisco. “They’ll get a 10 percent capital gains tax exclusion after holding on to an opportunity zone fund or eligible property for five years, a 15 percent exclusion by year seven and 100 percent exclusion after 10 years.”

Investors can also put existing assets with capital gains into Qualified Opportunity Funds (QOF, the vehicle for investing in an opportunity zone), and the taxing of those existing capital gains won’t happen until the asset is sold or the end of 2026.

Cons

There are also some disadvantages to consider before investing in opportunity zones.

Limitations on tax incentives

Homebuyers generally can’t take advantage of the tax incentives associated with opportunity zones unless they make considerable upgrades to the property they buy there.

“The buyer must ‘substantially improve’ the property during the first 30 months of ownership,” says Rick Sharga, an executive vice president at ATTOM, a real estate data firm. “That’s government-speak, meaning that the owner needs to increase the value of the property by at least the amount he or she paid for the property. So if a buyer purchased a property for $100,000, the property would need to have another $100,000 in improvements to meet the requirements.”

If you plan to buy a house in an opportunity zone and simply move in without taking advantage of the capital gains benefits, you aren’t required to make these expensive improvements.

Investment risks

For investors, there are always risks in a distressed neighborhood, which may contain blighted areas with dilapidated structures, unkempt land and otherwise unattractive properties.

“If, for example, you are considering purchasing a rental property and serving as the landlord, you have to ask yourself several questions,” cautions Jaimes. “Is this area safe enough to invest in? Will my property attract tenants who pay on time and won’t damage the property? Will I be here long enough to realize the capital gains tax incentives?”

Buyer’s remorse

Buyers who don’t do their homework might regret an opportunity zone purchase. For instance, further investigation may reveal that the community lacks infrastructure, public resources or popular amenities, that public schools are lacking or that the area isn’t attractive as an employment destination. All of these can impact an owner’s bottom line.

How to find an opportunity zone

Opportunity zones can be found in all 50 states, plus Washington, D.C., and five territories, including Puerto Rico. In all, there are more than 8,700 designated opportunity zones in the U.S. The U.S. Department of Housing and Urban Development (HUD) has a handy online map of opportunity zones you can explore.

What if I live in one?

If you’ve already purchased a home within an opportunity  zone, it’s smart to keep tabs on your home’s changing value. Knowing the extent to which it may have appreciated can be helpful. That’s especially true if you’re considering selling your home, refinancing your mortgage or tapping into your home’s equity.

“At its core, this program is meant to boost the local economy and enable communities to attract the capital they need to grow,” Vakili says.

How to invest in an opportunity zone

Most anyone can purchase a home or commercial property in an opportunity zone. But to take advantage of the tax benefits, the investment has to be made through a Qualified Opportunity Fund (QOF).

“[This is] an investment vehicle that files either a partnership or corporate federal income tax return and is organized for the purpose of investing in QOZ property,” says Sharga. “This can be a small company like an LLC, a larger corporate entity or a partnership, usually comprised of investors.”

There are specific requirements involved with filing and being acknowledged as a QOF, so to make sure you qualify, it’s best to hire an experienced attorney.

Bottom line

Whether you’re a homebuyer or an investor, opportunity zones can offer an inexpensive way to buy property. There are even tax incentives for those who stay in it for the long haul. However, before you invest in an opportunity zone, take the time to do your homework and understand what you’re getting into. Some of these areas lack infrastructure and amenities, making them a risky investment.