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Thursday, June 20, 2019

Opportunity Zone Investors Get Answers

By Gerry Schauer (Charleston, SC)
Flexibility and clarity are two welcome takeaways from the second set of proposed Opportunity Zone (OZ) regulations. In April, the Internal Revenue Service and Treasury Department issued this follow-up to the first set of proposed regulations, which were introduced last October. Investors, developers, legal and accounting advisors and community leaders now have many of the answers they need to confidently move forward with real estate and business investment in OZs. This second set reads like, and is meant to be, a complement to the first round. It has answered many questions raised since October and provides greater guidance, which will bring investors off the sidelines.

Ever since the OZ program was first outlined in the Tax Cuts and Jobs Act of 2017, the bulk of the conversation and investment has been in real estate, though business investment is equally represented in the legislation. For real estate investment, the foundation was set early on, with modest additions and many clarifications in round two of the proposed regulations. To review, an investor sells an asset, which can be real estate, stocks and even art, that would normally trigger capital gains tax. The gain is rolled into a qualified Opportunity Fund (QOF) within 180 days. Next, those funds are used to purchase real estate in an OZ (low-income areas that qualify for this program.) The initial capital gain is deferred until Dec 31, 2026 and potentially reduced up to 15%. The real estate is held for at least 10 years to avoid capital gains tax on the appreciation of the OZ real estate. The second set of regulations doesn’t change that, but it addresses a number of questions surrounding “original use,” property that straddles an OZ, depreciation, exit structuring, leases and timelines (including the relaxation of some of those timelines). For example, it is now clear that a property that has been vacant for more than five years and is put back into service falls under “original use” and is exempt from triggering the cost of “substantial improvement.”

Since the first set of proposed regulations came out last October, there have been many questions about how to invest in qualified Opportunity Zone business (QOZB) and stay within the lines. For example, one of the initial key requirements for businesses to be eligible was that half of their gross income must be derived from business activities in an opportunity zone. That leaves a lot up for interpretation. After conducting public comment sessions and gathering feedback, the Treasury listened and responded. In response, it created three safe harbors that clear up the confusion and provide flexibility. Essentially, businesses qualify if half of the hours worked take place within the OZ, half of the compensation paid is for services performed within the OZ or if significant management and operational functions are in the OZ. Answering another question, businesses may use the working capital safe harbor to use cash for business development. That can range from obtaining a fast-food franchise to paying software engineers in a new technology company. The upside for businesses in OZs is substantial. No question: business owners are turning to their advisors and considering the move.

The first set of proposed regulations laid the initial groundwork. The second set, enhanced by community feedback and comment, has addressed many questions, added flexibility and provided needed clarity. Treasury has another public hearing set for July 9 and, perhaps, another set will follow this summer, but there will likely to be tweaks rather than significant new material. The good news is that the guidance is here now. That’s good for investors and good for communities.

(This story was originally published in the Charleston Regional Business Journal on June 10, 2019. Gerry Schauer is a vice-president in Avison Young’s Charleston office. He specializes in office and investment real estate leasing and sales.)

Monday, June 17, 2019

Effective affordable housing delivery offers solution to crisis

By Patrick MacMahon (London, U.K.)

A major housing crisis grips the U.K. and is set to have dramatic social and economic consequences for generations to come. 

In response, cabinet ministers are targeting the construction of 300,000 homes per year by 2025. After just 184,000 were constructed in 2016-17, the target remains a formidable challenge to overcome. 

In 2018, the Letwin review, an independent review of build-out rates led by MP Sir Oliver Letwin MP, highlighted the need for a variety of housing tenures to drive delivery rates, putting a particular emphasis on affordable housing. With private developers struggling to meet government targets alone, the key to unlocking the housing crisis lies in the delivery of more affordable homes and an increasingly interventionist approach from government at both a national and local level. Indeed, in a country with an abundance of empty homes (635,000, according to the U.K. government’s Ministry of Housing, Communities and Local Government ), the crisis is one of affordability, not just supply. 

Let’s discuss what defines the term affordable housing, how it can maximise delivery and consider what role garden cities may have in unlocking the delivery of homes that communities can afford.

What is affordable housing?
Affordable housing has become a somewhat dirty phrase in the residential development industry, lamented by some developers as the barrier to viable projects and by others as not being truly affordable at all. Affordable housing is defined by the government through three broad strata:
•  Social Rent – Well below market rent levels and set using an established formula based on local incomes, property values and the size of the property (on average c. 50% of market levels). 
•  Affordable Rent – Subject to rent controls keeping rent at a maximum of 80% of market rent (60-65% in London). 
•  Intermediate – Housing for rent or for sale which is above social rented levels but below market levels. These include shared equity and low-cost homes.  

It remains to be seen whether these tenures in isolation provide sufficient breadth to meet the needs of the population. Affordable rent was introduced in 2010 to stimulate the delivery of affordable housing; the increased rental income designed specifically to fund further development in lieu of government grants. However, occupants of affordable rented housing often required extra state support through housing benefits to pay the higher levels of rent compared to social rented housing. As a result, the veritable saving on the public purse was limited. In fact, the graph below shows that overall affordable housing delivery actually declined since affordable rent was introduced:   

Affordable housing and delivery rates
Diversity and affordability of housing product are widely accepted as the principle answers to accelerated housing delivery. Both the 2014 Lyons review, a report based on the findings of an independent group of 12 housing experts chaired by Sir Michael Lyons, and the Letwin review support this idea, stating that there is virtually limitless demand for affordable housing. However, a pertinent question remains: who is going to build it? 

Traditional volume homebuilders have increased total housing output by 55% in the last five years and have a big role to play in reaching the federal government’s target. However, developers will not deliver housing in excess of absorption rates to ensure their profit margins remain healthy. Furthermore there is little incentive for developers to deliver more affordable tenures than government policy requires.

Housing associations have reverted to a cross-subsidy model (i.e. market housing subsidises the affordable) which, aside from the social criticisms, exposes them to a cyclical housing market slowdown. Given the pressure that these organisations have come under, it is hardly surprising; the average cost to build an affordable home has risen 42% in the last 10 years, whilst simultaneously government grants have dropped by two thirds.  More grant funding is required to enable counter-cyclical sub-market rented homes to be built – which not only de-risks the housing associations’ position but also ensures that homes continue to be built during a market downturn. Homes England’s recent announcement that it will expand its range of interventions over and above grant funding provides encouragement that this trend can be reversed. 

Local authorities have a growing role to play. The recent abolition of the Housing Revenue Account (HRA) debt cap removed one of the biggest constraints on council house-building, with local authorities now able to borrow more money to invest in large-scale development. Collaboration and joint-ventures with the private sector can help to ensure that local authorities have the skills to capitalise on this situation. 

A garden city-based solution 
The garden city principle embeds well-planned sustainable communities with a mix of housing for all. The concept dates back to a vision by Ebenezer Howard in 1898 to combine the energy and dynamism of town life with the serenity of the countryside. This seemingly utopian vision led to a number of garden city experiments and, subsequently, to the New Towns programme in 1954, which was a groundbreaking achievement in large-scale planned development.

The Town and Country Planning Act’s garden city principles today require “mixed-tenure homes and housing types that are genuinely affordable, as well as a range of sustainable and community-stewardship priorities. Alok Sharma, the former housing secretary, estimates that the new garden cities can deliver around 220,000 homes and will be crucial to long-term housing delivery. With garden cities and new towns firmly back on the political agenda, they represent the opportunity to deliver affordable housing on a large scale, maximising the delivery of quality housing that people can afford to live in.  

In the current climate, crucial to the success of the new garden cities and the delivery of affordable housing as a whole is significant government funding. It is imperative that this funding is combined with intelligent intervention – and incorporates sustainable and social values which enable new communities to thrive. Unless such an approach is taken, the target of delivering 300,000 homes per year by 2025 will remain extremely difficult to achieve. 

(Patrick MacMahon is a Development Surveyor based in Avison Young’s London, U.K. office.)

Monday, June 3, 2019

Urban enclaves: Massive mixed-use transit-oriented developments taking root in Metro Vancouver, British Columbia

By Andrew Petrozzi (Vancouver)
There has been an ongoing process towards the establishment of what I’ve termed urban enclaves – massive mixed-use transit-oriented developments – throughout Metro Vancouver with the first phases of these projects being delivered in 2019; however, there have been a couple of key junctures in this process that led to this rise of ‘cities within the city.’
The birth of this process locally began with the July 2011 adoption of MetroVancouver 2040: Shaping Our Future by Metro Vancouver, a regional federation of 21 municipalities, one electoral area and one Treaty First Nation. (A Treaty First Nation refers to a First Nation that has signed a modern treaty with the Government of British Columbia.) This regional planning document laid out the details of a regional growth strategy (RGS) that provided recommendations to guide municipal development decisions in order to sustainably accommodate the addition of more than 1 million new residents anticipated to arrive by 2040. Among its many recommendations, the RGS laid out the locations and definitions for what it termed “urban centres (UCs)” and “frequent-transit development areas (FTDAs)” among several other similar designations for the entire region. These designations in the RGS, particularly UCs and FTDAs, provided direction to not only municipalities, but also developers and investors and specified where growth and density would be encouraged in Metro Vancouver’s highly land-constrained market.
The second phase in the evolution of urban enclaves, which ran from 2012 to 2017, was the result of a confluence of factors. Ongoing price increases for all commercial asset types, declining rental vacancy, rising house prices, the increasing pinch of the perennial region-wide shortage of developable land and (at last!) definitive planning direction that specified where higher densities could occur. This planning direction provided greater certainty to developers and investors, allowing them to re-examine retail assets with a large land-use component (primarily, but not exclusively, traditional car-centred regional shopping malls) that were located in many of the UCs and FTDAs outlined in the RGS. This (re)evaluation by developers and investors used different metrics than were previously utilized to determine the value of shopping centres. Developers and investors who understood the potential advantage in unlocking the new value of these sites positioned themselves during this period to acquire building assets or land and/or review their existing portfolio holdings in these areas (although a couple of key sites were acquired in 2010 – while the RGS planning document was in process – by purchasers who, perhaps saw the writing on the wall.)
Concurrently in this five-year period, municipalities in Metro Vancouver were responding to the RGS document that required them to update their respective zoning bylaws or, in many cases, the community or master plans for the UCs and FTDAs identified in their communities to mesh with the goals outlined in the RGS. The earliest of these plans were ready by 2012 and continued to be rolled out through 2017 in communities such as Burnaby, Vancouver and Surrey. Construction had largely commenced by 2015-16 on this first wave of urban enclaves with their first phases set for delivery in 2019. Similar developments in other municipalities, including Richmond and Coquitlam, remain in progress. The idea of building up density on nodes along rapid transit is not unique to Metro Vancouver – it has been occurring in some form or another in land-constrained markets around the world for years – but the scale and number of such developments occurring in such a small geographic area likely represent a phenomenon that is likely unique to the region.
These urban enclaves are the tangible manifestations of the future that Metro Vancouver staff envisioned and planned for back in 2011 in order to keep the region liveable as it grows and expands. As more and more people start to call these high-density nodes home, people’s expectations of how and where they live in the region will change. People moving to, and living in, Metro Vancouver in the coming decades will become more accustomed to tower living, but the expectations of what will be available at their doorstep is also evolving to include not only retail, hospitality and entertainment options, but parks, community centres, medical services and the transit options necessary to get around the city as the cost of owning and operating a vehicle becomes prohibitive. Effectively, these compact communities will evolve into microcities, a trend already present in much larger global cities such as New York, London and various Gulf State cities. Metro Vancouver’s urban enclaves have come to represent the beacons of density envisioned by city planners, progressive politicians and transit advocates alike.   
To learn more, please read Avison Young’s topical report Future Forward: The Rise of Urban Enclavesin Metro Vancouver.
(Andrew Petrozzi is a Principal of Avison Young and Practice Leader, Research (BC). He is based in the company’s Vancouver office.)

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