Feb 07, 2019

Bringing concept to reality: more thoughts on Opportunity Zones in Chicago

It is no secret that everyone in the real estate industry is excited about the potentials that Opportunity Zone investments bring for future years. Though federal guidance is limited in certain aspects of Opportunity Zones and the deployment of taxable gains into them for shelter, there are some areas that we know to be true and useful as Opportunity Zone Funds begin to grow and deploy their capital.

Many recent articles have focused on defining what Opportunity Zone investing entails and detail the basic features at issue with deferral and potential shelter of capital gains tax. This article focuses on key tips for those who own properties in Opportunity Zones and provides some food for thought for sellers in this soon-to-be burgeoning marketplace.

Selling property in Opportunity Zones

For sellers, Opportunity Zone Funds present a moment in time where there will be a glut of potential purchasers of real estate located in designated zones. Opportunity Zones, presently, depend upon a governor’s decision to grant the Opportunity Zone designation to an area. Investors are loading their taxable gains into these Opportunity Zone Funds in order to seek reinvestment and shelter from some or all of the capital gains tax and funds are sourcing suitable properties for investment.

As of yet, federal guidelines have not suggested that suitable properties fall into particular categories, so multifamily, commercial, mixed-use and industrial properties are all up for consideration.

Sellers should consider that the market is currently focused on the formation of Opportunity Zone Funds. To some extent, this approach is different than routine investor-based property syndication models where a group of investors and developers determine that a property is suitable in an investment strategy and thereby recruit funding to close the deal. With today’s major focus driven by enthusiastic investors, large real estate investment outfits are gathering hefty sums of money for eventual deployment. This may mean that a host of ready, willing and able buyers are ready to proceed to the market to meet the present December 31, 2019, investment deadline. This likely signifies that savvy sellers are preparing their properties for sale.

There are key factors that contributed to closing properties quickly, including a fully documented leasing history and complete lease diligence documents, resolution of any encroachments or exterior easements necessary, abatement of any dangerous and hazardous conditions, and compliance with local government requirements.

For leased properties, owners should review their files to confirm that they have all leasing documents, extensions and that they consider fresh estoppel certificates from each tenant. Properties with easements or encroachments that are not documented should consider obtaining appropriate (and recordable) easements from neighboring properties.

If municipal violations or dangerous conditions exist, those should be corrected immediately. While many Opportunity Zone Funds may not be as selective as an average buyer’s lender, the fund managers still have fiduciary responsibilities to the fund investors to deploy their money reasonably. A well-documented property meets their expectations and can close much faster than one that is in need of work or lacks proper documentation.

Time is of the essence

Sellers should consider that closing time may become vitally important and should be expedited. With the end of year deadline and anticipation that many buyers may face time crunches, it is anticipated that a flurry of closing activity will occur in the third and fourth quarters of this calendar year.

Further, Opportunity Zone Funds do not have to invest exclusively in Opportunity Zone properties. Though Opportunity Zone properties must make up a percentage of the fund’s deployment, there is flexibility. This may lead to a last-minute need to balance a fund’s portfolio, requiring the acquisition of more Opportunity Zone properties within a short period of time. Potential sellers with all of their “ducks in a row” will likely stand to benefit when the year-end rush approaches. This may also mean that smaller unique properties may become excellent candidates for sale.

For sellers’ brokers in Opportunity Zone areas, we predict that there will be a great enthusiasm for new listings as owners take advantage of the potential rush of interest in these areas. For the most part, listing fundamentals remain the same. However, it is important to ensure that the seller client has good legal representation on at the onset of interest in the property. We would anticipate that savvy purchasers will present competitive offers with very buyer-favorable contract terms, in many cases including significant diligence burdens and exacting contingencies that create more of an option rather than an invitation to close. 

Key takeaways

For potential Opportunity Zone sellers, the key concepts to take away are that properties should be in a sale-ready state as soon as possible. This does not mean that everything looks structurally pretty, it means all of the property’s documentation necessary for due diligence and quick closing are in order and ready to review. Buyers are looking for good investments so leased properties need to have organized files, active and assignable leases and proper documentation. Vacant or owner-occupied properties, especially in commercial properties, need to be free of problems such as unrecorded easements and municipal violations. Offers must be scrutinized carefully to avoid pitfalls that create options instead of actual transactions.

While there is much opportunity and excitement surrounding Opportunity Zones, the fundamentals remain – be prepared, be thorough, be ready to deal, and seek legal representation for real estate transactions.

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.

Client alert authored by James R. Stevens, Principal

This alert originally appeared in Real Estate Focus: Winter 2019.