Pratima Damani

WASHINGTON, DC—Investors who are interested in the Opportunity Zones program should align themselves with the 10-year horizon offered by this tax incentive program. With healthy returns on investments expected within that timeframe, investors need to avoid areas that are already showing significant signs of growth and seek locations where they are able to buy low and sell high.

A recent analysis by SP Group, a DC-area real estate advisory firm, identifies the top-tier Opportunity Zones for investors. These 70 Opportunity Zones are located in 69 cities in 25 states. More than half of the top tier Opportunity Zones are in the Midwest.

According to its report, the majority of Opportunity Zone investors are strategic real estate professionals who have experience in utilizing various incentives and public financing programs such as the Low Income Housing Tax Credit (LIHTC), the New Markets Tax Credits (NMTC), Tax Increment Financing (TIF), and other HUD/FHA financing or rent subsidies and financing vehicles through the state housing finance agencies (HFAs). These investors are looking to funnel dollars towards projects that can benefit from other incentives, which increases the project feasibility, thus improving their return on investment (ROI).

“There are at least two types of real estate investors in Opportunity Zones – those that are drawn to a particular location for reasons that have little or nothing to do with the fact that the location is in an Opportunity Zone and those who are making strategic choices to invest in one Opportunity Zone versus another,” says Pratima Damani, CEO and Founder, SP Group.

The first investor may have ties to a particular community or simply believe that it is the best place to park her money. The strategic investor recognizes that long-term gain is more likely to occur in locations that have both an attractive current pricing structure for rents and costs and the potential for growth.

As investors determine which areas will recognize the best ROIs, the SP Group’s report concluded there were certain characteristics of the targeted areas they believe are excellent for investments.

“Although we ran some fairly sophisticated models, the core characteristics relate to two things: rent elasticity and potential for economic growth,” says Damani.

The rent elasticity factor is derived from the level of current rents, the degree to which the current rent levels are already burdensome for the existing population and the cost of improvements that may be made in the local housing stock. The potential for economic growth relates to the characteristics of the labor force, education, and other social and macro-economic and quality of life factors. By combining these factors, Damani and her team were able to isolate and rank areas that have the highest potential for an upswing in local market conditions over time, Damani tells

Of course, any in-depth analysis of all 8,762 Opportunity Zones would uncover affinity areas or commonalities. Based on the SP Group’s ranking system, the top tier tracts are those that depicts the most favorable relationship between current rent levels and current housing costs, the composition of the housing stock and the ability to absorb somewhat higher rents without becoming overly burdensome on the existing population.

Many of the top tier Opportunity Zones are in the so called “secondary markets” – the often overlooked mid-west or southern markets or “small city” markets. The one thing that most of them have in common is that people generally don’t think of these locations as particularly attractive from an investment perspective.

For the monies/businesses invested within Opportunity Zones to directly and positively impact area residents and businesses, neighborhoods would have to become sufficiently attractive to be able to support the creation of and sustain small service and/or manufacturing businesses, explains Damani.

The degree of positive effect would also depend on the level of investment i.e., the penetration of new investment in comparison to the size and composition of the overall housing stock or the size of the local market service sector.

“We believe that some investments will have a positive benefit for the area residents and businesses, but it will require active involvement from state and local authorities to ensure that these investments are structured in a manner that provide adequate return to investors while preserving affordability for the residents,” says Damani.

The SP Group also believes that the degree of positive effect will depend on the timing and the effectiveness of strategies for sustaining affordable housing after the ten year Opportunity Zone holding period expires.

“Once the ten year target for maximizing the reduction in capital gains taxes comes and goes, what will become of the properties and businesses that were fostered by the OZ investment? Planning for year eleven should be a part of year zero’s agenda!”