Commercial Mortgages: Getting Maximum Benefits From Opportunity Zone Financing need to be taken in 2019

Like the 1972 hit song by Paul and Linda McCartney and sung by Wings, most in commercial real estate spent last year worried about how rising interest rates were going to get "Hi, Hi, Hi." Now, the fear of higher rates has been replaced with lingering anxiety that the current economic expansion can't last forever.

Overall rates are up from last month and are currently in the 4.25 percent to 4.45 percent range for 5- and 10-year loans offered by life insurance companies, according to the John B. Levy National Mortgage Survey. Conduit pricing is more expensive and ranges from 4.75 percent to 5 percent for 10-year loans depending on leverage.

Even though the 10-year Treasury yield is about the same as this time last year, long-term rates were about 0.50 percent to 0.60 percent lower in January 2018.

And what is true for long-term rates is even more pronounced for floating rate pricing. The 30-day LIBOR was sitting at about 1.55 percent a year ago, nearly 100 basis points lower than today. As a result, many banks are offering new floating rate loans that price higher than a 5- or 10-year loan from a non-recourse lender.

When the difference between 30-day and 10-year yields is small, it's called a flat yield curve. When the yield on 30-day money is higher than 10-year money, it's called an inverted yield curve.

Investors are nervous about an inverted yield curve because generally it is predictive of a recession.

As the economic expansion navigates its 10th year, investors are worrying about what creates an inverted yield curve, and those concerns have led to great volatility in the bond and stock markets.

Commercial real estate is well-positioned as an attractive alternative to stocks and bonds, particularly for investments into the new federal opportunity zones.

Opportunity zones were created as part of the federal tax reforms enacted by Congress in late 2017. About 8,700 zones have been set up in all 50 states to lure investors and developers with tax breaks.

Investments allow deferral and potentially reduction of capital gains by up to 15 percent. There also is a more interesting advantage on the new investment, which is the abolition of capital gains taxes on a sale if it is held for 10 years.

This obscure tax code benefit is essentially giving commercial real estate a turbo boost of energy in the form of dollars just at the point when everyone thinks the party should be winding down. The maximum benefit requires investors to get dollars to work in 2019, which also creates an immediacy that should benefit certain areas and projects.

In the Richmond area, opportunity zones have been created in areas in and around Manchester, Scott's Addition, Shockoe Bottom, North Church Hill, Libbie Mill, Reynolds Crossing and Regency mall.

Developments planned for the area north of Broad Street in downtown Richmond - including those in Jackson Ward and around the Richmond Coliseum - are potential beneficiaries because of the area's location in an opportunity zone.

If the developers behind the $1.4 billion plan to redevelop 21 acres of city-owned real estate around a new Richmond Coliseum want to attract private investors interested in taking full advantage of the opportunity zone tax benefit, then the project should get underway this year.

The maximum benefits to investing in an opportunity zone project can only be captured by investing in 2019.

The capital gains tax can be deferred for up to seven years, but must be taken in 2026. The step-up in basis to 15 percent can only occur with a seven-year hold. That means that in order to get that 15 percent step-up, the investors need to make the investment this year.

A debate will rage on about the projections associated with this project, but one thing is certain. The fact that this project is in an opportunity zone makes attracting private money easier and more likely - at least in the coming year.

If the debate rages on for too long, however, the opportunity zone benefits start to fade.

John B. Levy & Co. partner and investment banker Andrew Little can be reached at [email protected].