Yesterday I attended Bisnow’s event exploring projections on 2019’s industrial and logistics view in the Philadelphia area, and the unique tax incentives available for owners and developers in the region who choose to clench them. As space becomes increasingly limited in Philadelphia, questions raise on where the next industrial hub will lie and how can construction cater to that presence.
The panel shared background on the beginnings of some of the current programs available deriving from the ambition of two senators, belonging to polar ends of the political spectrum. Corey Booker and Tim Scott both grew up in poor areas, however Booker experienced the urban end and Scott a more rural setting. These men developed a government program revolving around the thought that as investment dollars are driven into an area, the value will follow, especially in extremely deprived zones. The idea of opportunity zones was developed to spur development in areas not advanced economically, influenced by both their rural and urban view of underutilized regions.
Their vision involves the ability to drive capital gains through reinvesting in an existing property or business through harnessing value of:
• Tax Deferral
• Tax Reduction
• Appreciation Accumulation
Similar to a 1031 exchange where the sale of a property has proceeds rolled into a similar investment, the “opportunity zone” tax act presents a reduction in capital gain taxes dependent on how long the investment has been held in an opportunity fund (the incentives increase with time). For example, if you leave capital gains in a fund within an opportunity zone for 5 years, you’ll be granted a 10% reduction of capital gain tax. 7 years receives a 15% reduction, and after 10 years if you sell your business or real estate and there is appreciation, federally all capital gains are 100% tax free. Investors can defer tax on gains in a qualified opportunity fund (QOF) until December 31, 2026 or when the investment is sold or exchanged – whichever is sooner.
This initiative is focused within 8700 underutilized zones in the US, District of Columbia, and five US territories. What’s remarkable is there is no cap on the magnitude of the appreciation. However, there are rules that surround the suitability of an investor to receive this benefit:
1. There is a 180 day period to take the gain and put it into an opportunity fund following its realization
2. The investment must be of its “original use” and be “substantially improved” within the opportunity zone. These investments can be stock, an LLP/LLC, or business property, etc.
3. Certain “sin businesses” aren’t allowed to be the target of these investments by law:
• Golf courses
• Country clubs
• Massage parlors
• Hot tub facilities
• Tanning salons
• Racetracks or casinos
• Liquor stores
4. Several other provisions are dictated by the US Treasury Department overseeing certified funds to provide necessary guidance.
The panelists shared that since some of the recent legislature is so new, cannabis is not listed as a prohibited “sin business”. This means many dispensaries or growers with an approved application are able to take advantage of the benefits available.
There is also a strong opportunity for e-commerce within industrial spaces considering all the need for fulfillment and return centers. Research shows that 75 million square feet of industrial space will be needed for uses relative to e-commerce in suburban markets, and the concept of “last mile” and speed to market is heightening demand. In more urban areas like Philadelphia, the last mile is a difficult goal, especially considering the low inventory of real estate available that meets size criteria. This is one of the main challenges that large-scale retailers see, and continuously work toward optimizing by growing increasingly closer geographically to their consumer. With the vast cost pool presented from analytics around “the economics of the last mile,” it has become a continuous goal that I’ve heard mentioned frequently within industrial real estate conversations.
With e-commerce and diverse organizations fueling industrial usage in the Philadelphia market, the future is far from flat. There are some powerful tools for investors to leverage recent legislature to yield a more substantial investment in industrial spaces, while also causing some good in underserved communities. Since inventory is somewhat limited for new industrial construction, the opportunity to repurpose existing buildings within opportunity zones presents both an interesting fiscal and social impact. Although there’s quite a bit of clarification needed on many areas, regions of Philadelphia and neighboring areas fitting the opportunity zone status will likely see a new demand stemming from this act’s implementation.