As far as real estate investments in San Diego and San Diego county go, it’s been getting harder and harder the last few years to find properties that make sense.  Most investors have been seeing returns of 3.5%-6% on apartment buildings and even lower returns on single family homes and condos. 

Because those numbers aren’t very exciting, we’re just seeing a lot less mom & pop type investors.  We’ve been seeing more institutional type investments from hedge funds, REITs and private investment firms in the way of apartment buildings which you can see sprouting up all over downtown like weeds.

With the tax reform President Trump rolled out in January by way of the Tax Cuts and Jobs Act, there are a few major changes that will have an impact on neighborhoods throughout the United States.  The most impactful reform for lower income or blighted neighborhoods comes in the way of Opportunity Zones. 

Opportunity Zones are geographically designated areas where the government wanted to try to bring those areas up quickly.  Think of it as an accelerated renaissance for neighborhoods that have potential, but need a nudge to clean up and improve.  In San Diego, we are fortunate to have some great areas that were included in these opportunity zones.  This areas include, but are not limited to select areas in:

• North Park
• South Park
• Sherman Heights
• Golden Hill
• Barrio Logan
• Logan Heights
• City Heights

What is So Special About Opportunity Zones?

The big win on opportunity zones if you are an investor is three fold.

1. The opportunity zones are ideal for high net worth individuals or even mom & pop investors.  If you are coming in with monies from another investment, you can essentially avoid the capital gains on the sale of that other investment if you hold the property in the opportunity zone for 10 years.  This is essentially a 20% discount on Federal Taxes.  It does not need to be from a like kind sale (like a 1031 exchange).  This means you could sell stocks, bonds, mutual funds, real estate, crypto currency, and other forms of investments and avoid the cap gains.
2. If you hold the property for a period of 10 years or longer, you can essentially wipe away all gains.  This includes the gains you had on the funds coming in and the gains you make by way of improvements and property appreciation over the 10 year period.
3. To qualify for the Opportunity Zone program, an investor must make substantial improvements to the property.  This means that the investor must add improvements equal to or greater than the amount of the value of the physical improvements on the property.  Here’s an example to illustrate.  Let’s say you purchase a 4 plex for $1m and the land is valued at $600,000 and the structure at $400,000.  Then you would have 30 months (or thereabout) to put $400,000 of improvements into the property.  The good news for you is that if the program works as it is intended to, then the neighborhood should come up quickly which would therefore improve rents and property values.

Example of an Opportunity Fund Deal

Source of Funds – you sell a property for $1,500,000 and you purchased this property for $500,000.  You essentially have a gain of $1,000,000 that would be taxed at 20% so you’d have $200,000 of tax liability.  You decide to purchase a property for $1,000,000 in Golden Hill within the opportunity zone.  The property has 3 units, but is zoned for up to 4 units and the property has an alley behind it.  You could essentially add four 1 car garages with a 2/2 over the garages to meet the improvement qualifications.  By doing this, you now have added parking and can raise existing rents, have added another 2/2 unit that could rent for +/- $2300 per month and you could even add laundry if the units didn’t have their own washer/dryers.  Even if the rate of return on the investment were at a mere 5% and you take the 20% tax saved, that adds 2% per year and let’s suggest the property appreciates at 3% per year for 10 years – $1.4m with annual compounded interest would leave you at an exit value of  $1,881,483 so you’d be saving capital gains on another $481,483 which at 20% would be another $96,297 saved in taxes which would be added back to your bottom line.  

There are a lot of things to take into consideration on Opportunity Zone Investments so it’s best to reach out or give us a call to answer your questions.  Keep in mind the Treasury Department is still finalizing some of the tax code so we may not have all of the answers, but the underlying theme of the program certainly presents some great opportunities to invest in San Diego real estate.