States are beginning to re-open their economies, albeit some will move slower than others. The weather is warming and optimism is on the rise. While some business sectors—such as retail and tourism—are still suffering from the sudden downturn and the economic lockdown, others saw a surge as a result of the COVID-19 pandemic. Now that we are beginning to re-open the economy, will real estate return to its former state of glory? If it does, real estate professionals around the country may have opportunity zones to thank for it. Here are some ways opportunity zones could pull real estate back up again.
A Brief on Opportunity Zones
Opportunity Zones were created when Congress passed the Tax Cuts and Jobs Act of 2017. In short, these zones were designated as economically distressed zones that provide specific tax benefits to real estate developers in order to revitalize these areas and spur economic development. You can learn more about opportunity zones here.
Fix-and-flip investors have been operating in distressed neighborhoods for years, and fix-and-flip lenders have funded them. The opportunity zones legislation opened the door for alternative lenders to get in on the action. As a result, it opened the door for other real estate developers, including commercial and new construction developers, to operate with more confidence in those areas. Many of these new players were barely getting started, or were in the middle of huge projects when the coronavirus pandemic hit and the economic lockdown began to implement. It left their projects in limbo. The question is, will they, or can they, recover?
Opportunity Zone Deadline Extensions
In March, President Trump declared every state, the District of Columbia, and four U.S. territories major disaster areas. According to Polsinelli, these disaster areas will extend important deadlines for qualified opportunity zone investments.
The two deadlines affected are:
- The 31-month deadline for spending cash or other financial assets held by a qualified opportunity zone under the working capital safe harbor plan; the extension is for an additional 24 months.
- Capital received from the sale of a qualified opportunity zone fund; the extension is for 12 months to reinvest the funds in order to count them in the fund’s 90 percent asset test.
The working capital safe harbor extension can be used for qualified opportunity zones in any federally declared disaster area. That means real estate developers and investors in virtually every state could have some relief with this extension. There may be limitations, so Sharestates recommends you get your tax advice from your tax advisor and legal advice from your attorney. Nevertheless, these extensions could provide welcome relief to some opportunity zone investors.
Is Real Estate Development on the Road to Recovery?
While there are some signs of certain sectors of the economy beginning to open back up, there is still a lot of uncertainty surrounding the economy and COVID-19. For instance, researchers still are not sure how the virus will respond to warmer weather or whether it will return in the fall. Furthermore, will opening the economy cause a resurgence in cases even though many states are beginning to flatten the curve? These are some of the unknowns.
Despite the unknowns, state government is beginning to develop plans that allow people to get back to their normal lives. These include continued social distancing measures, mandatory face masks, and enhanced business practices such as reduced shopping hours, limits set on customers per square foot, and limits on how many cash registers can remain open at one time. The idea is to mitigate the effect of the virus and limit its spread while people are allowed to continue their normal routines as much as possible. The question is, will any of this allow the real estate markets to recover and, if so, how quickly?
One sector of real estate that has taken a huge hit is commercial real estate. CBRE predicts a long recovery. That’s possible since office leasing has slowed, the retail sector has slowed, and certain commercial industries such as travel and tourism have come to a halt.
The Motley Fool reports that rents were down initially, particularly right after lockdowns were implemented and in cities where shelter-in-place orders came early on. However, in April, they started going upward again. That’s likely due to the stimulus legislation that was passed as renters began to receive their direct deposits toward the end of the month. Some employers are also beginning to let at least some of their employees start work again, and unemployment insurance has some workers opting to remain at home instead of returning to work. So paying the rent isn’t as big an issue as it was.
If the virus threat continues, however, unemployment and economic stimulus packages will taper off. Some employees could find themselves out of work permanently as businesses shoulder the burden of lower profits due to limited operations. Renters may want to renegotiate rent agreement with their landlords or seek smaller rental units. Ultimately, the rental market will likely recover faster than other areas of real estate, especially if some homeowners end up losing their homes.
In Michigan, commercial developers and construction will be resume operations, with some restrictions, on May 7. Other states are beginning to open up, as well. Still, lost revenue from ceasing operations will be a factor in how quickly the construction sector can recover.
Invesco portfolio managers predict three areas of real estate that will likely recover more quickly than others. These include:
Multifamily certainly has the potential to come out of the COVID-19 crisis more quickly than other real estate sectors. With office space, leasing is more likely to recover more quickly than new construction. The logistics sector also has high potential because even online retailers and digital businesses need warehouses and transportation centers. That need is not going to go away. However, it’s possible that the sector could adapt to a new reality post-pandemic.
How Opportunity Zones Could Play a Part in Recovery
Since opportunity zones provide tax benefits for developers and real estate investors, recovery from the pandemic could lead to more real estate professionals seeking these benefits. It’s likely that new opportunity zone projects will focus on sectors that recover more quickly, and since the focus is on economic development in distressed areas, multifamily investment seems like a likely candidate for new investment.
It also seems likely that new projects could focus on smaller spaces, and new and creative ways to look at new construction and development could also arise to facilitate “the new normal.”
In terms of the total recovery, the picture is going to look different for each real estate sector and for each geographic region. Some will recover faster while others struggle. Investors will have to scrutinize every opportunity and be discriminatory in which deals they fund. Due diligence will likely require more nitpicking for a while.