The Dark Side of Opportunity Zones

The Dark Side of Opportunity Zones

A panel of Opportunity Zone experts recently gathered at Connect Bay Area to provide the most up-to-date information on the hottest movement in commercial real estate today. The annual conference, held in San Francisco, drew an audience of more than 300 commercial real estate professionals. In addition to four deep-dive panels, keynotes were delivered by San Francisco City and County Treasurer, Jose Cisneros, as well as the Oakland Athletics’ Lydia Tan.

Moderator Kevin Wilson, a partner at Novogradac, kicked off the session with an overarching explanation of Opportunity Zones. He said the fundamentals of OZs include two important features: One is to incentivize investors to place capital and purchase identified distressed communities via deferring the payment of taxes through 2026. The other is to encourage long-term capital investment in these identified properties by allowing investors to circumvent any additional, generated gains from being taxed if the property is retained for at least 10 years.

These can be complemented with state income tax incentives however, “California is one of about five states that does not provide conforming state tax incentives,” Wilson explained, although the governor of California has announced he will soon provide incentives for those who invest in affordable housing and clean energy property. With the state legislature currently working through this, Wilson believes this will be enacted by the end of fall, if not the end of summer.

A key theme over the past two years is that many companies are slow in gaining traction due to the state of the tax reform bill being put together in a way that created ambiguity. The Treasury Department and IRS have been working on addressing the many issues that have come up, and are taking comments and suggestions from companies.

“The information that came out in 2017 was very unclear,” panelist Paul Monsen, vice president at George Smith Partners noted. The regulations information has been slowly improving, but it continues to be less than transparent. This limited amount of information, along with no track records or history, has made financing difficult.

Exit issues and capital raised that is regulatory are two issues that JP Walsh, director of finance at Panoramic Interests, a local Bay Area developer specializing in high-density, infill investments, has come across. “It’s difficult for an investor to make the decision to invest when the regulations are not final,” he said. Additionally, there needs to be a lot of due diligence conducted which will slow the process even more.

With a new investment strategy taking an average of 18 months to obtain significant capital, along with the second round of regulations that just came out four months ago, is counterintuitive for the OZ timelines that exist, panelists said. “We’ve only known about the designated areas for about a year,” Wilson said, “however, investors need to be placing capital by the end of 2019 for maximum benefits.”

Monsen said he uses this as leverage to encourage investors, however it also works as a disadvantage a because it doesn’t give investors much time to evaluate the prospect. “It’s a very short window as it pertains to real estate.” To that end, the aspect of OZ regulations that seems to be moving the needle is the 10-year hold.

Another concern of Opportunity Zones is that the capital will be placed into low-income communities and drive out existing residents which could cause adverse impacts. “Because of this,” Wilson said, “California is being very cautious with how to proceed to provide similar state income tax incentives.” This is one reason the state is considering incentives that are targeted toward affordable housing and clean energy.

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Fed Cuts Rate for the First Time Since 2008

Fed Cuts Rate for the First Time Since 2008

As expected, the Federal Reserve acted Wednesday to reverse course from the interest-rate increase of recent years, cutting the federal funds rate by a quarter point to a range of 2% to 2.25%. It was the first such reduction since 2008, when the Fed cut rates to essentially zero in the wake of the financial crisis.

At a news conference following the announcement from the Federal Open Market Committee (FOMC), Fed Chairman Jerome Powell called the rate cut “a mid-cycle adjustment,” and implied that it wouldn’t necessarily be followed by further cuts.

In a statement, the FOMC said the quarter-point reduction supports its view that “sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2% objective are the most likely outcomes, but uncertainties about this outlook remain.

“As the Committee contemplates the future path of the target range for the federal funds rate, it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2% objective.”

Commenting on Wednesday’s action by the Fed, Spencer Levy, CBRE’s chairman of Americas research and senior economic advisor, noted that “the current state of the U.S. economy remains supportive of CRE fundamentals.” He added that the Fed move “reduces upward pressure on cap rates.”

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Amenities vs. Services: Property Managers and De-escalating the Amenity War

Amenities vs. Services

For the last several years, developers have been pushing the envelope in terms of physical amenities and coming up with new and innovative features that make their communities stand out amongst the competition. That is, until recently.

Today, we are seeing a shift among developers and property owners away from the physical amenity war that’s been going on for the last several years to a focus now on services.

Across all demographics, the most in-demand amenities are those that ease the lives of residents through service-based items that provide a sense of convenience. Offering a competitive amenity package today does not necessarily only mean physical amenities and property managers should be taking note.

As more and more apartment communities shift away from over-the-top physical amenities and consider services as a top driver in leasing, what do property managers need to know and how can they prepare for this shift?

Western National Property Management has more than 160 properties under management, many of which incorporate service-based amenities. Here are our top three tips for property managers to begin implementing service-based amenities in their apartment communities to deliver what today’s residents truly demand.

Services that de-stress residents

There is a growing trend, especially among millennials, towards a focus on health and wellness. Renters today are looking for ways to be active, de-stress, meditate, get better sleep, and eat healthier foods, too.

This is creating a significant opportunity for property managers to implement programs and services at their properties that support this.

For example, a prospective resident can find a gym at almost every multifamily community, including luxury style gyms with high-end equipment. That said, what they can’t find in every community are saunas, on-site massage therapists, and fitness classes with rotating trainers, etc.

Property managers should reassess their facilities to determine what types of services they can add to their properties or on-site gyms that will enhance residents’ overall health and wellness.

If offered, residents would likely cancel their gym memberships and utilize a conveniently located fitness center that includes a host of services and has numerous benefits to their health.

Another service-based amenity that properties are implementing are trash valet services, such as Trash Butler. By implementing this type of service, property managers are saving residents from carrying garbage down flights of stairs and nighttime walks to dumpsters, which improves safety but also improves the property’s curb appeal.

These types of amenities provide residents with a convenient experience that they can add onto their everyday routine while saving time, decreasing stress, and increasing their likelihood for lease renewal.

Pet priority

Renter’s ideally want their pets to be as well taken care of as themselves. In addition to pet parks, service amenities for pets are on the rise, including on-site pet spas and grooming services. By incorporating these types of services, residents can reduce the amount of time they spend on everyday errands by bringing these services closer to their door.

In-house dog walking services have also been on the rise and caught prospective residents’ attention. This service is extremely valuable to pet owners, especially to those who work or for pets who do not do well being inside all day. This reduces the cost a resident may potentially spend daily and monthly on off-site pet daycare services, increasing their likelihood of renewing and increasing retention at the property. This service is also a draw for prospective residents as the needs of a prospective resident’s pet are always a consideration factor when selecting a new home.

Ultimately, making pets a priority in a community simplifies residents’ lives by providing more convenience, which results in happier residents, higher retention and bottom line profitability for owners.

Flexible “experience-based” community space

Developers and property managers have become smarter about the way they use up free space. Developments that would have once featured large tennis or racquetball courts now include flexible and open community spaces that can be used to host a variety of events and deliver experiences to residents. Property managers are able to encourage interaction and engagement among residents by organizing community events, such as movie nights, social hours, wine tastings, rooftop barbecues and more. Many property managers have begun to realize that excessive amenities might not be as large of a driving force behind leasing as many once thought, and have now hired outside companies to manage resident events. Events leave a lasting impression on residents and sell an overall experience.

These events can aid in creating new relationships between residents and building a stronger sense of community, which is a key factor in resident satisfaction. This results in residents who are more likely to stay put because they know their neighbors, reducing turnover and the costs associated with it. A sense of community is a timeless amenity that is proven to increase resident retention.

Overall, there is a significant shift underway in terms of amenities and services in demand by today’s residents. Sophisticated property managers understand that it is a mix of both unique physical amenities and convenient services that will attract and retain residents over the long term.

Scott Wickman serves as regional vice president of Western National Property Management, the residential real estate management arm of Western National Group. Headquartered in Irvine, Calif., Western National Property Management currently oversees the management of 23,600 apartment units in 162 communities.

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SEC Considers Expanding the Accredited Investor Definition

SEC Considers Expanding the Accredited Investor Definition

The Securities and Exchange Commission issued a concept release on Tuesday, seeking public comment on possible changes aimed at expanding access to private securities. It includes a number of questions around growing the pool of accredited investors, such as whether to allow clients of registered financial professionals to be accredited and whether to include education and job experience as a qualification.

The current definition of an accredited investor—based on an individual’s net worth—hasn’t been modified in any meaningful way since it was enacted via the SEC’s regulations governing the sale of unregistered investments in 1982.

Earlier this year, the Senate Committee on Banking, Housing and Urban Affairs announced it was considering a bipartisan package of bills, colloquially called the JOBS Act 3.0, meant to spur capital formation, prompt more initial public offerings and generally expand the public’s opportunities to invest. That package passed the House of Representatives last July. One bill in that package, the Fair Investment Opportunities for Professional Experts Act, would expand the definition of an accredited investor to include education and job experience. It also directs the SEC to update its definition in Regulation D.

According to the concept release, the SEC may revise the financial thresholds required to qualify as an accredited investor and the list-based approach for entities to qualify. One option could be inflation-adjusted income and net worth thresholds with no investment limits, while another could be indexing financial thresholds for inflation on an ongoing basis. The agency may allow spousal equivalents to pool their investments in order to qualify.

For entities, it may replace the $5 million assets test with a $5 million investments test and include all entities, “rather than specifically enumerated types of entities.” It may also expand the types of entities that may qualify.

The agency is also considering grandfathering in issuers’ existing investors under the current definition.

It may also expand the criteria for individuals beyond income and net worth, considering such things as minimum amount of investments, certain professional credentials, experience investing in exempt offerings and an accredited investor examination. The SEC may even allow individuals to opt in to being accredited investors, having received a risk disclosure. It’s also considering allowing knowledgeable employees of private funds to qualify for investment in their employer’s funds.

Another idea under consideration would be to qualify clients of registered financial professionals as accredited investors. And if the agency were to allow that, those financial professionals may be subject to educational or other qualifications and additional disclosures. Related to this, the SEC is exploring whether the financial professional would be required to assess the appropriateness of the investment on a transaction-by-transaction basis or by looking at the client’s portfolio as a whole.

Currently, about 16 million American households qualify as accredited investors under the existing criteria, the SEC found.

Comments are due to the SEC within 90 days of the concept release being published in the Federal Register.

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U.S. Multifamily Market Remarkably Consistent, Remains Top Investment Class

New research by Yardi Matrix and NKF reveal a host of interesting trends within the multifamily sector. Not only has the U.S. multifamily industry exhibited remarkable consistency, it remains a darling asset class for investors.

Rents increased by $5 in April 2019, as robust job creation continued to drive absorption of about 300,000 new units per year, reports Yardi Matrix. The average rent increase represents year-over-year and year-to-date growth of 3% and 0.8%, respectively.

NKF’s first quarter report showed annual effective rent growth increased 10 basis points to 3%, led by above-average growth in Las Vegas, Phoenix, Orlando, Jacksonville and Tampa. Rent growth was particularly strong in the Class B space, which increased 3.4% year-over-year.

Meanwhile, on the investment front, NKF says investment sales volume totaled $36.4 billion in Q1 2019, up 1.3% year-over-year, with more than 70% invested in non-major markets. Trailing 12-month sales volume rose 8.1% to $175.2 billion. NKF writes, Q1 2019 marks the eighth consecutive quarter in which multifamily represented the highest sales volume of all property types.

NKF researchers indicate cap rates decreased 2 basis points quarter-over-quarter to 5.39% nationally, with major markets increasing 3 basis points and non-major markets decreasing 7 basis points. Yields between major markets and non-major markets compressed to 85 basis points, representing the tightest spread since Q1 2013, according to NKF.

Researchers at Yardi Matrix write in the report, “With the prime rent growth season just starting, it remains to be seen whether this year’s gains will be stellar or merely average, but in any event there seems to be no reason to think the multifamily juggernaut is going to hit the pause button.”

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Fed’s Interest Rate Position Could Help CRE Sales Volume

 

Fed’s Interest Rate

The Fed’s shift to a neutral position on rates could keep CRE transaction activity on par with 2018 levels.

The current Goldilocks economy—not too hot and not too cold—is helping to keep the bears from emerging in the commercial real estate sector. In a move aimed at holding on to that warmish balance, the Fed confirmed during its May 1 meeting that it would not change rates. That move is expected to fuel another strong year of transaction activity. At the same time, it is stirring speculation about what action the Fed might take in the fourth quarter.

The Fed has become more dovish on rates, essentially changing its policy from one where it was likely to raise rates two or three times in 2019 to a more neutral position, and capital markets have gained confidence from that shift. “December and January were tough months for the economy and the commercial real estate business, because consumer confidence tanked and business confidence tanked along with the stock market,” says Spencer Levy, chairman of Americas research and senior economic advisor at real estate services firm CBRE.

The rebound in the stock market has strengthened both consumer and business confidence. “We would expect that as rates stay low, that confidence is going to remain,” adds Levy.

The Fed would like to keep raising rates in an environment where unemployment is extremely low and wage growth is accelerating. Yet core inflation is not moving. On the other side, GDP and job growth put the economy in a strong position where the Fed doesn’t see the need to cut rates either, says Ryan Severino, chief economist at real estate services firm JLL. “So, they’re just sitting there for the time being looking for a little more clarity on either a more pronounced slowdown in the economy, or a re-acceleration in inflation,” he says.

Impact on CRE

Volatility and uncertainty on rates did weigh on investment activity during first quarter, with sales volume that dropped 11 percent, according to Real Capital Analytics, a New York City-based research firm. The latest Fed decision is giving commercial real estate investors more confidence in the economy. Underlying property fundamentals remain strong, the cost of capital remains low and investors still have a lot of capital that needs to be deployed. “So, I would expect there to be a re-acceleration of transaction activity in the back half of the year,” says David Bitner, vice president, Americas head of capital markets research for real estate services firm Cushman & Wakefield.

The 10-year Treasury has dropped by nearly 75 basis points since November to hover between 2.45 and 2.55 percent this month. CBRE expects the 10-year Treasury to top out just shy of 3.00 percent this year.

“I think we’re going to have about the same amount of transactions this year as we had last year, because the capital markets remain deep and liquid,” says Levy. In addition, while certain parts of the commercial real estate market may be near the peak, there is still a lot of momentum and opportunities that exist in newer markets like Nashville, Tenn., Orlando, Fla. and Kansas City, notes Levy.

One question is how the Fed position on rates and the recent decline in the 10-year Treasury could impact cap rates. Overall, cap rates have been on a plateau for the past couple of years, moving only about 20 basis points. Even with the recent dip in the 10-year Treasury, there is not a lot of room for cap rates to move lower, notes Bitner. People generally don’t have the risk tolerance that would be needed for rates to compress further, he adds.

Will the Fed cut rates?

JLL’s outlook for this year is that the Fed will likely remain neutral on rates through 2019. Core inflation could accelerate a little as the year progresses, but likely not enough to trigger a rate increase, notes Severino. “At the same time, I don’t see the economy deteriorating enough where the Fed would have to cut rates,” he says.

GDP growth improved to 3.2 percent in the first quarter and JLL is predicting that growth will slow throughout the year as stimulus from tax reform starts to fade to end the year at GDP growth around 2.0 percent. However, there are some factors that could push the Fed out of that neutral position, such as acceleration in core inflation, wage growth and other signs of overheating in the job market.

What is interesting is that the Fed Funds Futures market and the equity market both reacted negatively to the recent Fed decision as both expected the Fed to cut rates. Those expectations to cut rates don’t appear to make a lot of sense when the economy is growing at a rate that is above trend and unemployment is at a 50-year low, notes Severino.

“I think the Fed has been very dovish, but at the same time, they have been careful to make sure the market understands they are not immediately planning to cut rates,” says Bitner. However, that has not deterred growing sentiment that a rate cut may be in the cards for later in the year. According to CME FedWatch, expectations for a Fed rate cut rise to 26 percent for the September meeting, 42.2 percent for October and 60.1 percent for the December meeting. Growing sentiment in favor of a rate cut is due to concerns about trade tariffs and elevated recession risk.

Looking out over the 12- to 18-month horizon, Severino believes it is more likely that the Fed will raise rates again before they make any moves to cut rates. “I’m not saying they will raise rates necessarily; I just don’t see as much risk to the downside of the economy as I see a chance that the Fed think rates need to be higher going into the next downturn,” he says. Either way, the Fed is likely close to the end of its tightening cycle, he adds.

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“Steady on Interest Rates” Says Federal Reserve

The Federal Reserve’s Federal Open Market Committee unanimously voted to leave the key U.S. interest rate alone Wednesday. The money policy group will maintain the target range for the federal funds rate at 2.25% to 2.50%.

Fed leaders were more upbeat about the economy too, despite its slow start earlier this year.

Federal Reserve Chairman Jerome Powell said after the two-day meeting, “I see us on a good path,” when evaluating the health of the economy.

Part of the reason cited for not changing the rate was the recent decline in inflation, even though the economy continues to grow “at a solid rate” and the “labor market remains strong.” The Fed acknowledged household spending and business fixed investment slowed in Q1.

A statement issued by the Fed noted, “The Committee continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2% objective as the most likely outcomes.” That said, the group promises to “be patient” regarding future adjustments to the target range to keep the economy humming along.

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