A Carve Out for Vacant Properties in OZs Allows Them to Avoid Certain Requirements

If the fallout from COVID-19 continues, there is little doubt that the number of abandoned and foreclosed properties will likely increase.

To show how the CRE environment will change, Newmeyer Dillion Partner Mike Krueger points to restaurants. The ones that are allowed even to open will have fewer customers.

“If you had a big 8,000 square foot restaurant that allowed you to have 150 customers at one time, the most you’re going to have is likely going to be half of that because you’re going to have spacing requirements and you’re going to have certain limitations,” he says. “Then you’re also going to have limitations on how food is going to be prepared. You will no longer have chefs in the kitchen working shoulder to shoulder.”

He says the space equation will be “turned on its head.”

“That is why I believe we’re going to see massive vacancies in commercial real estate,” he says. “Those vacancies aren’t going to be restored anytime soon. They’re going to be repurposed.”

Krueger says an increase in abandoned properties could present an opportunity for Qualified Opportunity Fund (QOF) investors in Qualified Opportunity Zone Businesses (QOZBs). In its third round of guidance, the Treasury Department included a special carve-out for vacant property that could allow investors to avoid the requirement to “substantially improve” properties. That provision could potentially save QOF investors time and millions in development fees.

Combined with the IRS’ recent announcement that the deadline to close on QOZBs can be extended to mid-July, the carve-out could give QOF investors new investment opportunities in today’s COVID-19 landscape.

“The vacancy requirements are easier now,” Krueger says. “The property has to be vacant for three years, or if the property was vacant in April 2018, it just has to be vacant for one year.”

A property actually doesn’t have to be 100% vacant to qualify. It just means that no space more than 20% has been occupied during that time. “You can have a 10,000-square-foot apartment complex,” Krueger says. “As long as no units are rented out that take up more than 2,000 square feet, that’s technically a vacant building.”

Since the building is considered vacant, it can be purchased with an Opportunity Zone Fund. “As long as that apartment building is an Opportunity Zone, you can acquire that even though you’re not making any improvements to it,” Krueger says. “It’s a vacant property under the regulations of a qualified opportunity property.”

After purchasing the property, the fund can rent out all of the spaces without spending money to upgrade it. “It was vacant for the minimum period that now qualifies as original use, and original use is one of the elements to qualify your property as a qualified Opportunity Zone business,” Krueger says.