The new tax incentives for Opportunity Zones have made a big splash. The smart money predicts cash inflows of at least $100 Billon in 2019. If you are a developer or investor, you’ll want to evaluate your property purchases carefully to see if they are eligible to benefit from the new government incentives. 

What Exactly Are Opportunity Zones?

An Opportunity Zone is an economically-depressed community that provides preferential tax treatment under certain conditions. To receive the Opportunity Zone designation, the state must nominate the community and the U.S. Treasury Secretary must approve it. These nifty tax breaks were added to the 2017 Tax Cuts and Jobs Act, but it took a while for them to catch on. All 50 states, Washington DC and the five U.S. territories each have at least one Opportunity Zone.

What Are Qualified Opportunity Funds?

QOFs are investment vehicles, either corporations or partnerships, that facilitate an investor’s investment in eligible properties within a Qualified Opportunity Zone. There are two major tax benefits related to investing in one of these zones:

1. Tax Deferral: You can defer taxes on any prior gains invested in a QOF until the earlier of the investment’s exchange/sale and the last day of 2026. If you hold the QOF investment for more than five years, you get a 10% exclusion on the deferred gain, or 15% if your holding period is seven or more years. 
2. Basis Step Up: If you hold your investment in a QOF for at least 10 years, you can step up your investment cost basis to the property’s fair market value as of the date of the investment’s sale or exchange.

You can get the tax benefits of a QOF without living or working in the zone. QOFs are designated by census tract numbers, or GEOIDs. You can form your own QOF for specific Opportunity Zones by filing IRS Form 8996, Qualified Opportunity Fund, with its federal tax return. You then can defer a capital gain on your current income tax filing using Form 8949.

Investment Considerations

You will want to hold your Opportunity Zone investment for at least 10 years, so you’ll need a well-conceived hold/disposition strategy for each deal. It makes sense to figure your cash-on-cash return rather than your internal rate of return, since the latter is sensitive to the time value of money. A 12% to 14% cash flow should be sufficient to generate income over the entire 10-year holding period. You must use invested capital gains to substantially improve the property or business in the Opportunity Zone. You can do this several ways, but the most straightforward is to start with raw land. Returns decrease as time goes by, from 3.08% in 2018 to 1.74% in 2025, so don’t wait – jump in now! Speak to us at SLG for financing options to help you take advantage of this opportunity. 

If you are a fan of real estate investing for building wealth, you know that market intel is the key to making the most profit from your investments. A recent survey from Real Estate Express has identified six of the hottest niches in the real estate market, as determined by salaries earned by real estate agents:

1. Luxury Residential Properties: The hottest niche is the one for luxury properties. It is so lucrative that there is even a specialist designation for real estate professionals who focus on the luxury market. The upper-tier residential market is characterized by high-quality luxury homes that offer generous dimensions and top amenities in the most desirable neighborhoods.
2. Commercial Properties: These include offices, retail stores, restaurants, and mixed-use properties. Small commercial properties are often very affordable, and can offer an appealing profit profile to flippers. The ideal property is one that has recently been vacated in a busy commercial area. Often, stores go out of business for poor sales that have nothing to do with the underlying property – these can be excellent investments.
3. Relocation Services: An interesting real estate niche deals primarily with relocation service rather than property ownership. Typically, relocation involves homes owned by executives, providing a solid floor for service pricing. Relocation service providers are involved with two properties within one deal. If you provide this service as a realtor, you have a chance to reap two commissions.
4. Foreign Investment: A riskier but lucrative niche is passive investing in the foreign real estate market. Before you invest in it, make sure you understand the gap between list and sale prices, the average number of days on market, and the amount of supply overhanging the market. If you have the time to do the research, you have a good shot at an excellent return on investment.
5. Investment Properties: Some rehabbers are interested in long-term rental income rather than fix-and-flip capital gains. Both strategies provide lucrative opportunities for wealth accumulation. You might favor a buy-and-hold strategy where you snap up inexpensive properties in gentrifying neighborhoods and holding the properties until their prices rise. If you have little capital, you might consider wholesaling, in which you profit from the difference between the seller’s contracted price and the buyer’s purchase price.
6. Eco-Friendly Properties: LEED-certified properties are one of the hottest segments in the real estate market. These properties are the gold standard for green housing, and usually sell at a premium. Eco-friendly properties are a good choice for developers who build rather than acquire, because they can construct a green property from the ground up. 

If you need help financing a real estate investment in the Greater Washington D.C. region, you want Specialty Lending Group. We have expertise in many different niches. With affordable rates and flexible terms, SLG is positioned to help you get your deal done! Contact us today for personal, experienced service.

Real estate, like every other markets, goes through up and down cycles. We’ve been in a strong market for several years now, and, as a result, many investors have gotten wealthy. While there is by no means consensus, some pundits are predicting that the U.S. will be entering a recession some time before the next election. We can’t see the future, but we know how commercial real estate investors should prepare for it.

Commercial Real Estate Differs from Residential

The 2008 economic meltdown was a huge event, not at all like a typical down cycle. The biggest losers were folks who could no longer pay the mortgages on their homes. Millions lost their homes through foreclosure and were forced into rentals.

This is an important distinction. While an economic downturn puts downward pressure on residential real estate, it simultaneously creates new demand for rental units. This is an unfortunate fact of life. It should guide the behavior of investors who own rental homes and apartment buildings. The extra demand caused by foreclosures might not be enough to drive up rents, but it should cushion any softness in rental rates. 

Buying Real Estate While It’s on Sale

The best time to buy stocks is when they are selling at a discount, which often happens during a recession. Real estate is no different. Whether you are a flipper or a long-term investor, smart investors use recessions to snap up highly desirable properties at discount. For example, suppose a small apartment building was valued at $2 million at the top of the market and generated an NOI of $200,000. That’s a cap rate of 10%. If the property goes on sale for $1.6 million during a recession, the cap rate rises to 12.5%. That’s a healthy increase in expected return. 

The tax benefits of commercial real estate continue through up and down markets. We recently wrote about the tax advantages of long-term investing in Opportunity Zones. Then there is the 20% qualified business deduction that favors the real estate industry. Of course, the long-term capital gains rates for properties held for at least one year continues to cut a huge chunk of tax stemming from property sales. 

Also remember that carrying costs on CRE is tax-deductible. This makes it much easier to hold CRE compared to one’s own residence. Another factor that takes some sting out of a real estate downturn is that mortgage interest rates drop. This is a vast incentive to purchase commercial properties at a discount, financed at a low rate, which will allow you to collect rents as you ride out the recession. You can then sell at a profit after the market recovers. 

Specialty Lending Group provides hard money loans in the Greater Washington DC region. We know first-hand how all phases of the real estate cycle present unique opportunities. If you’d like to learn more, contact us today.

When you consider buying a mixed-use property, its important to consider key factors that help determine the value of the property. It’s well known that mixed-use properties add vitality to a neighborhood, providing ease of access and after-hours activity. Check out these five important factors.

Space Efficiency

The hallmark of a good mixed-use property is efficient space utilization. Vertical design is a popular motif, as it consumes less land and allows denser packing of tenants. Vertical design helps control costs such as utilities, parking, maintenance and landscape when you compare it to horizontal design. A good project can anchor a neighborhood, reduce car traffic, and promote better energy efficiency and sustainability.

Zoning

You need to know whether the local zoning rules encourage or discourage new multi-use development that will compete with the property you buy. On the one hand, barriers to competition can support higher rents. However, you must also consider the positive effects of higher population density in terms of gentrification and demand for amenities. In the long run, additional properties lift all boats.

Government Partnerships

Local governments frequently hook up with real estate investors and developers to help improve run-down neighborhoods pockmarked with dilapidated or abandoned buildings. Often, you can buy a derelict building from the municipality for a token amount. These might include warehouses and loft buildings ready for mixed-use repurposing. New York City’s Soho neighborhood is a prime example. Forty years ago, the city rezoned the area and subsidized redevelopment. Today, it is a thriving, high-rent district with cutting-edge art galleries and gourmet restaurants.

Adding Value

Renovating a single-use building to multi-use can enhance its value. Converting ground floor apartments to retail spaces completely changes the property’s vibe, enhances its value and reduces vacancy rates. You also might be able to boost rents by at least 10% after completing the rehab. You can then sell the property or keep it for rental income. 

Better Management

Run-down properties are usually poorly managed. You can swoop in, snap up a mixed-use property, rehab it and introduce a professional level of management. This type of project often has a great risk/reward tradeoff that will produce attractive results. You also can reconfigure a multi-use property. For example, suppose your city has a weak office market but a strong retail one. You might buy an office/residential mixed-use building and replace the office component with retail stores.

Mezzanine financing is a layer in the capital stack between senior debt and equity. It’s main purpose it to add leverage (debt) to a deal after primary financing has been arranged. With mezzanine financing, you receive additional capital that reduces the cash you tie up in a real estate project, allowing you to use the cash elsewhere. For example, if you take a hard money loan in which you put down 40% cash, a mezzanine loan can reduce your cash commitment to anywhere from 30% to 0%. 

Mezzanine Loan Structure

A second mortgage is subordinated debt with a secondary lien on the property. In contrast, a mezzanine loan is not secured directly by the property. Instead, its secured by a lien on the equity (known as membership interests) of the parent LLC that controls the project. In some cases, mezzanine debt has an equity kicker, such as an option that transforms part of the debt into membership interests through conversion or co-investment rights.

Default Considerations

If a borrower defaults on a mezzanine loan, the lender has an alternative to the standard foreclosure procedure (which can take a year or longer). Instead, the lender can do a rapid foreclosure (usually measured in weeks) on the parent company using the Uniform Commercial Code’s Article 9. In this process, the lender grabs the membership interests of the parent company, after which it assumes ownership of the project property. 

Uses of Mezzanine Financing

Mezzanine financing can be an attractive option for these reasons:

• Extracting equity: You can use a mezzanine loan to cash in on a property’s appreciation. This is a useful alternative when refinancing is inconvenient, perhaps due to a lock-out clause or large prepayment penalty.
• Adding value: A mezzanine loan can be used to enhance the value of an existing property. For example, suppose you have a tired office building that is only half occupied. You bought the property a decade ago using a $12.5 million mortgage (with a prohibitive prepayment penalty) of which $6 million balance remains. You might be able to get a $5 million mezzanine loan and use the proceeds, in part, to renovate the property, thereby reducing the vacancy rate to 5% and boosting the property’s value.
• New construction: You might want to limit the amount of cash you tie up in a new construction project. You use mezzanine debt to reduce your cash commitment and increasing your loan-to-value ratio.

SLG offers mezzanine financing. Contact us today!

Our previous article illuminated how money has a time value, i.e., money in your pocket today is worth more than the same amount to be collected in the future. The time value of money is expressed as interest, the extra amount a borrower pays, or lender receives above the repayment of the original amount. When you take a convenient loan from Specialty Lending Group, you pay a modest interest amount each month until you repay the loan. This is a sensible business arrangement if your project will net you more money than you spend – after all, why would you borrow money for a real estate project if you expected to lose money on the deal?

Two methods that professionals use to evaluate the potential return on a project is the net present value and internal rate of return. Both depend on the time value of money to discount future cash flows, such as the lump sum you’ll receive on a fix-and-flip, or the rents you’ll collect on a fix-and- lease. Let’s see how this works.

Net Present Value (NPV)

If we stipulate that a dollar received today is worth more than a dollar you’ll receive in a, say, a month, that must mean that the future cash flow is worth less than $1.00. That difference is expressed as a discount factor, which is just an interest rate — in this case, the rate that would express all cash flows as if they occurred on the first day of the project. The discount factor reduces the value of future cash flows as an exponential function of time – the later the flow, the less its value. You can use the Excel function NPV to calculate net present value. If you end up with a negative number, then the project is a money loser.

In a fix-and-flip project, you typically have an initial series of outflows, culminating with a large inflow at the end representing the net proceeds from the closing. In a fix-and-lease project, you assume a perpetual series of cash inflows once you start leasing out the property. If you plan to collect rent for five years and then sell the property, you would have 60 cash inflows, followed by a single inflow representing the sale of the property.

Internal Rate of Return (IRR)

The IRR function lets you find a rate of return (the “annualized effective compounded return rate”) that will exactly equate cash inflows and outflows. All things being equal, the higher the IRR, the better the project. IRR is useful when you are considering two or more mutually exclusive projects. All things being equal, the one with the highest IRR is the winner, although considerations other than return might sway the ultimate decision.

You can calculate IRR use the Excel function of the same name. With both NPV and IRR, the higher positive value wins, but many folks feel that IRR is more intuitive. While this is debatable, what’s not debatable is the importance of accurately estimating future cash flows. The old saying “garbage in, garbage out” applies here, so it often pays to run best, worst and most-likely scenarios to get a better feel for the risks and rewards of each alternative.