- Houston’s Opportunity Zones
- What Are Opportunity Zones?
- 3 Things To Know About Houston’s Opportunity Zones Locations
- Check out the Ultimate Opportunity Zone Guide for Houston Commercial Real Estate Investors Here.
- Current and Upcoming Houston Area O-Zone Projects
- 3 Important Things to Know about Investing in Opportunity Zones
- Opportunity Zone Qualifications
- What’s In Store for Houston Opportunity Zone Investing in 2021?
- Giving Houston a Boost with Opportunity Zones
- Learn More About Investing in Houston’s Opportunity Zones
Houston’s Opportunity Zones
By now, most commercial real estate investors have heard of Opportunity Zones. However, not all investors understand the program and how it can benefit them. Below, we outline Opportunity Zones, specifically focusing on the Houston area. You will learn more about these strategic investment areas and their incredible tax incentives.
What Are Opportunity Zones?
Briefly, Opportunity Zones (a.k.a. ‘O-Zones’) are designated investment areas included under the 2017 Tax Cuts and Jobs Act. The overall objective of these Zones is stimulating economic growth in designated areas.
Many designated O-Zones are distressed areas, economically depressed areas, or both. The goal is to stimulate local economies and increase access to affordable living options for those living in these areas.
When utilized properly, real estate investors could potentially transform economically stagnant and struggling areas of Houston. This is especially true for places impacted by Hurricane Harvey in 2017. While investors can dramatically improve the quality of life for residents in these areas, investors will enjoy incredible potential tax benefits from these investments.
Currently, Opportunity Zones already designated by the U.S. Treasury Department will remain part of the program until December 31, 2028. So there is still plenty of time for investors to benefit from the tax breaks associated with O-Zones.
3 Things To Know About Houston’s Opportunity Zones Locations
Even if you’re familiar with Houston real estate investment, you might not have all the details you need to invest in O-Zones. Below are three things you should know about Houston’s Opportunity Zones.
1. There are 150 Opportunity Zones in the Houston Area
All around Houston, many neighborhoods and areas have the ‘Opportunity Zones’ designation. In fact, Houston proper has 99 O-Zones. Harris County has 150, offering investors throughout the Houston area plenty of opportunities.
Texas Governor Greg Abbott submitted eligible areas to the Department of Treasury not long after the Tax Cuts and Jobs Act passed. The intention was for Opportunity Zones to boost local communities in and around Houston, especially those hardest hit by Hurricane Harvey.
Under the program, Houston city leaders rely on O-Zone investing to attain the following community improvement objectives:
- Create communities where all residents have access to amenities and tools to help each individual community thrive.
- Provide affordable housing. Houston is one of the top 5 faster-growing cities in the nation. However, rising housing costs leave many Houstonians unable to keep up. Opportunity Zones can provide affordable housing solutions for those most in need.
- Manufacturing and distribution jobs. By building industrial and technology centers within these zones, these communities have access to high-paying jobs that would not otherwise exist.
- Build grocery and retail centers, giving all Houstonians access to fresh food and other products. This helps eliminate so-called “food deserts” which are so often common in underprivileged communities.
Several Houston Opportunity Zones could benefit from an influx of investments, including Downtown Houston, New Caney, and East Downtown Houston. O-Zone designations benefit a myriad of industries – real estate development, manufacturing, restaurants, and even service business.
2. There is a Houston Opportunity Zones Map
Per the Treasury Department, Opportunity Zones are designed to spur investment in economically-distressed communities. Using this measurement, many areas of Houston could benefit from Opportunity Zone investment projects. For instance, three years after Hurricane Harvey, many areas continue to experience economic impacts.
Texas Governor Greg Abbott submitted the state’s 628 Opportunity Zone designations to the Treasury Department in March 2018. As outlined above, 150 of these O-Zones are in Houston.
The map’s blue highlighted areas indicate the designated Opportunity Zones. As you can see, it shows numerous blue sections near Downtown Houston and East Downtown Houston. The highlighted areas indicate where investors could potentially invest their capital.
3. There Are Tax Benefits for Investing in Houston O-Zones
Opportunity Funds (O-Funds) are the primary vehicle for investing in Opportunity Zones. In particular, new investments in these areas could qualify for tax benefits under certain conditions. Qualified O-Funds offer the following tax benefits to investors:
- Deferred Capital Gains Tax —Sell current assets and invest the taxable capital gains in Opportunity Funds. Do this within 180 days of selling the assets to avoid paying capital gains tax (until the fund is divested or until December 31, 2026).
- Basis Step—Ups – Increase rolled-over capital gains:
- 5-year O-Funds holding produces a 10% basis step-up
- 7-year O-Funds holding produces 5% more (15% total)
- Tax-Exempt Potential — Hold Opportunity Funds for 10 years – they grow tax-free and are exempt from capital gains
- Fewer Limits — O-Fund investments have fewer limits than other investments. There are no limits on:
- The amount invested
- How much tax you avoid
- The type of taxes you avoid
- The amount of time that gains compound tax-free
Current and Upcoming Houston Area O-Zone Projects
Over the past few years, Downtown Houston has made a concerted effort to attract more residents. Because of this push, the number of Downtown residents grew from about 3,800 residents in 2013 to over 10,000 currently. Downtown Houston would like to see this number continue to rise, with possibly as many as 30,000 residents by 2040.
Below are five current projects located in one of Houston’s 150 O-Zones:
Hines is currently building a 46-story, 373-unit luxury tower originally named The Preston (Hines changed the name to Brava in November 2020). Once completed, Brava will be Downtown Houston’s tallest residential development. Construction began in March 2019 and is slated for completion in Q3 2022. Due to its location in a Houston Opportunity Zone, Hines will receive favorable tax benefits from this project.
The Cameron Ironworks
Acquired by Kaldis in November 2018 along with two adjacent parcels, this renewal project revived a historic 1930s Art Deco-style building. At 60,000 SF, The Cameron was originally built for
Cameron Ironworks. The space will incorporate mixed-use offices, housing both professionals and creatives. Original plans to open in 2020 were delayed due to the pandemic, but Kaldis plans to complete the project in early 2021
East River/ Midway Sites
Midway’s five-phase 150-acre East River redevelopment project will create a walkable live-work-play community. Located along 6,000 feet of the Buffalo Bayou waterfront, the finished project will have a wide range of amenities. Specifically, the completed development will have almost 9 million SF of Class-A office space, about half a million SF of retail, over 475 single-family homes, 1,400+ multifamily units, and 12 acres of green space.
While the project could take decades to reach total completion, phase one begins in 2021. Midway is already deeply invested in this site and is staking a lot on this project’s future. In addition, the Houston-based developer owns two other nearby properties (on Canal Street and Navigation Boulevard).
This 1.8-acre tract of land at 2929 Navigation previously had a warehouse, which is now demolished. In April 2018, Houston-based Ersa Grae Corp. broke ground on a single-story, two-building retail development. The group has already signed two tenants:
- Memphis-based Corky’s BBQ – This location will be Corky’s second in the Houston-area.
- Allegiance Bank – A 4,500 SF space with a two-lane drive-thru.
Yet Navigation Place still has 9,000 SF of leasable space, including retail and restaurant areas. The area is growing fast, attracting young families to the neighborhood. And with downtown Houston’s rapidly growing population, Navigation Place might be the ideal location for investors.
Valley Ranch in Porter, TX
Not all of Houston’s Opportunity Zones are located near the urban core. About 25 miles northeast of Downtown Houston is Porter, an ideal North Houston Opportunity Zone. Many people consider Porter and the surrounding areas to be the third-best Opportunity Zone in Texas, behind only Downtown and East Downtown Houston. Located at the intersection of I-69 (US-59) and the Grand Parkway, the area is a straight shot to Downtown Houston.
At the moment, the main development taking advantage of Porter’s Opportunity Zones is Valley Ranch. This 1,400-acre master-planned community is a new ‘village’ being developed by The Signorelli Co., one of Texas and Oklahoma’s leading real estate developers. Once completed, Valley Ranch will have residential areas, retail, offices, healthcare facilities, and entertainment, all within walkable distance.
Opportunity Zones Program
Opportunity Zones are covered by IRS Code Subchapter Z. As outlined by the IRS, these regulations promote real estate investments in certain areas. Furthermore, one of the program’s main goals is long-term economic growth in these communities and neighborhoods.
The Opportunity Zones program enables investors to invest capital into low-income and/ or distressed communities. In exchange, investors in a qualified Opportunity Zone fund may be eligible for the following tax benefits:
- A. Tax deferral for capital gain
- B. Eliminating up to 15% of the tax on capital gains
- C. Possible elimination of tax when exiting the investment
In addition to the program’s original regulations, the Treasury Department released additional guidance on October 19, 2018. Some of these proposed regulations include:
- A. Almost all capital gains qualify for deferral.
- B. At least 90% of and Opportunity Fund’s assets must be held in qualified Opportunity Zone property.
- C. To qualify for deferral, the capital gain must be invested in a Qualified Opportunity Fund. Also, the investment entity will be considered a corporation or partnership.
Additionally, if a taxpayer holds their Qualified Opportunity Zone Fund investment until December 31, 2026, the gain subject to tax will be either:
- the original deferred gain OR
- the lesser of the property’s fair market value at the time of sale
3 Important Things to Know about Investing in Opportunity Zones
Below are three important technical aspects of Opportunity Zones that all investors should know:
1. Forming a Qualified Opportunity Zone Fund
Investing in O-Zones requires a Qualified Opportunity Zone Fund (QO Funds). These funds must be either partnerships or corporations. Once formed, QO Funds can invest in Opportunity Zone property. However, with a QO Fund, 90% of the assets must be QOZ Property (qualified opportunity zone property). In addition, the property should have been acquired after December 31, 2017.
2. O-Funds Have Fewer Limits
O-Fund investments have fewer limits than some other investments. For starters, O-Funds have no limits on the amount you can invest. What’s more, there are also no limits on the types of taxes you can avoid, how much tax you can avoid, and the amount of time your gains can compound tax-free.
3. O-Funds’ Tax-Exempt Potential
If you hold O-Funds investment for at least 10 years, they will grow tax-free. On top of that, during that time period, you are required to pay capital gains.
Opportunity Zone Qualifications
In order to be Qualified Opportunity Zone property, commercial real estate must meet one of the following criteria:
- It was not in use within the five years previous to its acquisition OR
- It becomes a substantially improved property within 30 months of it being acquired (rehab expenses = cost plus $1)
However, the taxpayer must have a documented plan of rehabilitation before the IRS will consider real estate (and cash used for rehab) as qualified property during this 30-month rehab period. This plan should include:
- Construction drawings for the planned rehab
- A timeline for project completion including milestones
- Other written materials to support the intention of rehabilitating the property into a qualified opportunity zone property.
The taxpayer must have a documented plan of rehabilitation
Without a clear rehab plan, any of the QOF’s cash which is intended for property rehab won’t be considered as a qualified asset. Furthermore, it is possible that the property itself also wouldn’t be considered a qualified asset.
Penalties for Unqualified Assets in an Opportunity Zone Fund
The IRS charges a penalty for an unqualified asset in an Opportunity Zone Fund. This penalty is equal to the underpayment rate for estimated taxes (this changes monthly). If assessed, the entity must pay the monthly penalty for each period that the 90% qualified business property test isn’t met. Overall, the IRS bases this penalty on the amount by which you miss the 90% test.
For example, if a QOF has $1,000,000 of total assets, yet $300,000 of those assets are qualified opportunity zone property, then the IRS levies the penalty on $600,000 of the “miss”. Currently, the underpayment rate is 5% (this changes every three months based on Treasury rates). In this example, the penalty would be about $2,500 per month (or $15,000 for a 6 month testing period).
Effectively, the investor loses the initial tax benefit after paying about a year of penalties.
Keep in mind that the QOF only provides a deferral of taxes. As a result, the levied penalty on gross miss isn’t a hypothetical tax. Instead, the effective penalty rate on this deferral is significantly higher.
Continuing with the example above, the tax on $600,000 of gain would be about $144,000. Also, a 12-month penalty on a $600,000 miss would be about $30,000. Due to this, the effective penalty rate on the deferred taxes is approximately 21%.
What is a Qualified Opportunity Zone Business?
As noted above, we can consider an investment by a QOF in a QOZB to be “good assets” for purposes of the 90% test. In order for a business to be a QOZB, it must have at least 70% of its assets in a qualified opportunity zone. Furthermore, it must meet a ‘doing business’ test. Specifically, a certain amount of gross income must come from zone or the investment vehicle pays wages to employees within the zone. Since rental real estate receives rent for property located in the zone, it always meets the gross income test.
So, it is really the asset test that is significant. As noted to be a QOZB only 70% of the assets have to be Qualified Business Property.
If the business does not meet this test then it is not a QOZB and therefore the investment at the QOF level in the business would be a “bad asset”. To determine whether real estate is a good asset in a QOZB, the same test discussed above for the QOF owned property applies. (Note: this is not in use for 5 years or substantial improvement in 30 months).
What’s In Store for Houston Opportunity Zone Investing in 2021?
A pandemic, record unemployment, and a change in administration: 2021 promises to be a year of struggle. And while experts are hopeful a vaccine will bring businesses back to full force, investors can still expect to see changes to Opportunity Zone properties.
In light of the COVID-19 pandemic, the Treasury Department updated the rules surrounding Opportunity Zone investments. While some of the deadlines have passed, there are still special provisions that allow investors more time to improve properties and reinvest proceeds of qualifying properties.
For a more in-depth look at what’s changed for Opportunity Zones as a result of the pandemic, click here.
Changes Under the Biden Administration
With a new administration entering the White House, there remains some uncertainly surrounding Opportunity Zones in Houston and throughout the U.S. However, most experts agree that while the Biden administration may put the program under a microscope and make some changes, he’s unlikely to get rid of the program altogether.
Both President Biden and Vice President Harris have commented on the O-Zone program’s abilities to change struggling neighborhoods. However, the Biden administration will likely make changes to the program that will ensure it’s working for the residents and business owners in each community in addition to the investors. These changes could include more detailed analysis of a project’s impact on the local economy (including housing affordability and job creation rates), creating stricter guidelines for designated a project as an O-Zone, and providing incentives for investors and developers to team up with nonprofits or community organizations to increase maximize community benefit and create jobs for low-income residents.
Giving Houston a Boost with Opportunity Zones
Established by the Tax Cuts and Jobs Act of 2017, the hope is that long-term investments will connect capital with communities. Under these Opportunity Zones, there is the potential for billions of investment dollars to flow into Houston. As Houston continues to grow, many people hope that Houston’s Opportunity Zones will boost underprivileged communities. In the words of Andrew Young (former Mayor of Atlanta):
Too many communities in our great nation feel passed over by economic growth and forgotten by our political leaders. We need a new formula for the public and private sectors to work together to generate new investments, new businesses, and new good-paying jobs in places that have fallen behind. The Investing in Opportunity Act will harness much-needed private capital to flow to more American communities and empower state and local leaders to build a more prosperous future.
Without a doubt, Opportunity Zones are an excellent tool for commercial real estate investment. By investing in O-Zones, commercial real estate investors can help revive and restore Houston, one neighborhood at a time. And not only can investors be a part of real change in Houston, but they can also receive tax benefits.
Learn More About Investing in Houston’s Opportunity Zones
Are you ready to learn more about investing in Opportunity Zones in Houston? To help you better understand this great program and its incentives, we have developed several resources. For more information, read CXRE’s Opportunity Zone Fund Guide for Texas. Then, to get even more details on Houston commercial real estate investments, contact our knowledgeable and dedicated team. We can guide you through the entire investment process, identifying the best opportunities for your portfolio.