The Tax Cuts and Jobs Act1 passed by Congress in late 2017 created a new tax incentive program called the Opportunity Zone program, which has the power to transform real estate investments. Through this program, those who invest realized capital gains into qualified Opportunity Funds may defer and significantly reduce their capital gains tax liability, and potentially pay zero taxes on earnings from their Opportunity Fund investments altogether. Through these tax incentives alone, Opportunity Funds have the power to potentially double after-tax returns for investors.
First things first: What is an Opportunity Fund and what does it invest in?
What is an Opportunity Fund?
A qualified Opportunity Fund is a U.S. partnership or corporation that intends to invest at least 90% of its holdings in one or more Qualified Opportunity Zones. There are now more than 8,700 designated Opportunity Zones in all 50 states.
There are three types of investments that can fall under Opportunity Fund investments in the Opportunity Zone program:
- Partnership interests in businesses that operate in a qualified Opportunity Zone.
- Stock ownership in businesses that conduct most or all of their operations within a qualified Opportunity Zone.
- Property such as factory equipment or real estate located within a qualified Opportunity Zone.
As the first real estate investment platform to create a simple, low-cost way for anyone to invest in real estate, we have a history of embracing new investment options that offer the most promise for our investors. We believe that real estate investments offered under Opportunity Funds can provide new advantages not available in most other real estate investments when paired with the right investment strategy.
The Benefits of Opportunity Fund investing
Investing in real estate through qualified Opportunity Funds offers several tax advantages — immediately and over the course of the next decade. Investors can reap tax deferral benefits immediately at the beginning of their investment. But, the greatest capital gains tax advantages are only available to investors who hold their Opportunity Fund investment for at least 10 years. Those who invest for at least 10 years can defer and reduce their initial capital gains liability, and also expect to receive permanent exclusion from taxable income of capital gains on profits from the sale of their Opportunity Fund investment.
In other words, the longer an investor holds their investment, the more potential income they’re able to exclude from capital gains tax. The graph below demonstrates a hypothetical situation of a $100,000 investment following a traditional investment path of stocks versus a $100,000 investment following the Fundrise Opportunity Fund path, assuming that both investments appreciate at an average 7% annual return. At the end of 10 years, an investor who follows the traditional stock portfolio and pays capital gains tax when gains are realized can end up with $50,000 less than an Opportunity Fund investor who deferred their capital gains tax and reduced their capital gains liability.* Plus, income earned from the sale of an Opportunity Fund investment can qualify for permanent exclusion of capital gains taxes after the 10-year investment mark.
Why Choose Real Estate for Opportunity Fund Investing?
Since real estate is inherently a long-term asset class, it fits well with investment vehicles intended to maximize benefits for investors over longer investment horizons. Traditionally, this has meant that real estate pairs well with retirement accounts, such as a 401k or IRA. Now, however, we believe that real estate also fits well — or even better — with Opportunity Funds.
One of the fundamental long-term real estate investment strategies is the acquisition of properties at a low cost basis in an emerging urban neighborhood. As surrounding popular neighborhoods grow and become more expensive, people begin moving into more affordable adjacent neighborhoods, driving new demand and growth. An important attribute of real estate investing is that, historically, in supply-constrained markets, properties typically appreciate over time. Because land in major metro areas, such as Los Angeles, is inherently limited, thanks to spillover demand, the potential for appreciation of real estate in neighborhoods adjacent to already popular and growing areas can be enormous.
Real Life Examples In Action
To illustrate this point, let’s look at a real-life example of Los Angeles’ Koreatown neighborhood. Much of Koreatown now falls into qualified Opportunity Zones, and the area is growing in value. According to Zillow, the median home price here grew by roughly 47% over the trailing 5-year period that ended in May 2018. According to the website’s forecast, the area still has significant room left to grow. Before the Opportunity Zone program was created, our team at Fundrise recognized the growth potential of this neighborhood. In fact, many of Fundrise’s most notable investments to date, including our Gramercy Rowhomes investment, have been in neighborhoods that are now qualified Opportunity Zones.
The growth potential of Opportunity Zones isn’t confined to one area of Los Angeles. South Los Angeles is poised to benefit from spillover demand due to the city’s affordability crisis. The area is experiencing steady improvements thanks in part to the new Exposition Light Rail Line, which now offers South Los Angeles residents access to both Downtown Los Angeles and Santa Monica.
Like Koreatown, our real estate private equity team at Fundrise saw potential in South Los Angeles before many of its neighborhoods were qualified as Opportunity Zones. In fact, we’ve already deployed millions of dollars across various residential investments in the area. According to Zillow, home prices in South Los Angeles are expected to increase by more than 17% in the next year alone.
Unlike other investment vehicles, Opportunity Funds have the capacity to couple the appreciation of real estate investments with unprecedented tax advantages. Many of the neighborhoods with high-growth potential that now define Opportunity Zone investment strategies have been the primary focus of the Fundrise real estate private equity team for nearly a decade.
Why Consider the Fundrise Opportunity Fund for Real Estate Investments?
You may be thinking that Opportunity Zone program sounds promising and that Opportunity Funds could offer new tax advantages — but, how does Fundrise fit into this equation? Experienced real estate managers may be considering harvesting gains from asset sales by creating their own qualified Opportunity Funds. For those with the knowledge and available resources and ability to execute their strategy quickly, Opportunity Funds could offer a profitable strategy. But, due to these steep requirements, this strategy is only feasible for some.
Except for the largest institutional developers, most real estate operators are missing the ability to build a truly diversified portfolio of Opportunity Zone real estate investments. While investing directly in a single asset or a handful of assets can offer high return potential, that strategy is accompanied with high risk. This is why we believe that diversification across asset types and by geographic location is crucial for Opportunity Zones real estate investments.
The Fundrise Opportunity Fund intends to invest in a variety of asset types, including residential, mixed-use, and office properties. We believe this type of portfolio diversification is key, because it intrinsically mitigates the risk factors associated with any particular building type. How? If demand for single-family homes diminishes due to rising interest rates, an investor with a diversified portfolio of Opportunity Fund real estate investments may fare better than an investor with a portfolio that is focused solely single family homes.
In addition to risk mitigation, each property type that the Fundrise Opportunity Fund intends to invest in offers unique advantages. A diversified portfolio can enable investors to leverage the advantages of each at the same time. For instance, multifamily properties tend to be countercyclical, meaning that they typically outperform during economic downturns. Mixed-use properties offer multiple sources of cash flow - typically retail and residential tenants. Meanwhile, office developments may offer a compelling opportunity to capitalize on rapid growth in the tech sector.
One primary advantage of our Opportunity Fund is that it can potentially offer exposure to various markets across the country. Given the logistical limitations of smaller real estate operators, a portfolio of multiple assets would likely need to be concentrated within a single market to make the portfolio manageable. In turn, this limits smaller operators’ ability to mitigate portfolio-wide risk through geographical diversification.
Fundrise’s Opportunity Fund intends to acquire dozens of assets in emerging areas throughout the country with high-growth potential. To maximize growth potential in these areas, we intend to pursue a variety of opportunistic, value-add real estate investment strategies. We believe that this strategy will enable Opportunity Fund investors to mitigate risk through diversification, while leveraging the enormous tax incentives of the Opportunity Zone program.
Apart from giving investors access to more investments, we believe that by pooling capital, we can also give investors access to larger and better investments than they would otherwise be able to access on their own. By pooling investments from thousands of investors, we are able to pursue not only one type of real estate development project, but several. Under this model of capital raising, we believe we will be able to pursue not only residential or office renovations, but also large-scale multifamily ground-up development projects.
There’s more to investing in qualified Opportunity Zone property than buying a cash-flowing multifamily asset and improving it through minor in-unit renovations. The Opportunity Zone program was set up in a way that limits the types of property that Opportunity Funds can invest in. The law states that Opportunity Funds may only invest in the construction of new buildings, the revamping of previously unused ones, or the fund must invest more than it paid to acquire the building in property improvements (e.g., renovations) within 30 months of the purchase date.
In other words, investors must develop a property from the ground up, convert it into a new building with a new purpose, or substantially rehabilitate it (e.g., perform a gut renovation) within 30 months of buying the property. Each of these options requires access to both capital and construction expertise.
Our track record includes approximately 50 real estate construction and development deals in both residential and commercial real estate across the U.S. Our real estate private equity team has been pursuing investments that follow these investment strategies since 2012 with strong and steady results to show. However, please note that past performance is not indicative of future results, and all securities include risk of loss.
There are many investors who aren’t real estate developers, and who have no interest in becoming one. These investors still have the ability to invest realized capital gains into an appreciation-focused, tax-advantaged investment through the Fundrise Opportunity Fund. The Fundrise Opportunity Fund essentially offers a combination of the ease of a traditional passive investment, like a REIT, with unprecedented capital gains tax incentives.
Our team of world-class real estate experts with billions of dollars of experience in both commercial and residential underwriting and management invest on behalf of our investors. With our rigorous underwriting process that considers more than 350 data points, we’re able to pursue only the investments that we believe offer the greatest value to our investors.
In addition to our real estate private equity team, have a team of in-house accountants and tax experts, as well as major accounting firms devoted solely to helping structure the Fundrise Opportunity Fund as tax efficient as possible.
The Opportunity Zone program offers a set of capital gains tax incentives that have the power to transform the real estate investment industry. Fundrise has a history of pairing adept investment strategies in areas now designated as Opportunity Zone areas long before the Opportunity Zone program. The new Fundrise Opportunity Fund enables us to pair our existing expertise and strategy with an investment vehicle that offers unprecedented capital gains tax incentives for long-term investors who want to diversify into real estate investments.
Learn more about the Fundrise Opportunity Fund and how you can pay as little as $0 in capital gains on your next decade of investment returns here.