The Opportunities and Risks of Opportunity Zone Projects
May 30, 2019
Investments are now coming into federal “Opportunity Zones.” The Opportunity Zone program, ushered in by the Tax Cuts and Jobs Act, allows various benefits for investors who reinvest capital gains in these federally designated zones throughout the country. The effect (in theory) is that investment will flow into these areas, which are typically low-income or underutilized, and new projects and growth will be spurred. There is a caveat important to the construction industry: the investment must coincide with the “original use” of or “substantially improve” the subject property. This can only mean one thing: new projects.
The benefits for the developer are obvious in the lower cost of capital for new projects. The program also lessens completion risks, as there are incentives not to foreclose that a lender for a typical project may not share. Risks can also be balanced out by careful diligence and greater community support for such projects.1
But what does it all mean for contractors? While the direct effect on how contractors might handle such a project may be minimal, there are secondary risks in contracting for these jobs that should be considered.
First, projects are often renovations, as Opportunity Zones may encompass historical (and oftentimes rundown) buildings. If you have such a project, you should be clear from the outset on who takes the risk of project slowdowns or losses caused by the condition of the building. Negotiate for an unforeseen conditions clause broad enough to cover structural defects when uncovered. Demand clear and unequivocal rights to stop the work if potentially dangerous defects are found. Closely scrutinize indemnity obligations. For example, does “arising out of the work” include loss caused by the dilapidated condition of the building? If the answer is yes, or even maybe, you may be in a fight over paying for claims you did not and could not have caused—and that the owner probably should be indemnifying you for.
Second, many Opportunity Zone projects involve demolition. This may pose issues of regulatory or other legal liability relating to construction and demolition debris. For example, is asbestos-containing material or mercury involved? Has the developer done an asbestos survey? Closely scrutinize hazardous materials clauses to be sure who is responsible for remediation costs (and in what circumstances) or regulatory reporting requirements. Additionally, there may be legal requirements on how construction and demolition debris can be handled. For example, materials might need to be segregated and disposed of differently—and at higher cost—depending on what’s in them. To avoid delays, consider discussing a waste management plan with the owner before the contract is signed.
Third, watch for clauses making you responsible for tax benefits missed out on by the owner. Other tax incentives may overlap with the Opportunity Zone program and be available for the project. Owners commonly insert a clause in the contract asking the contractor to cooperate in tax documentation and accounting (e.g., for materials or supplies). While reasonable cooperation may be acceptable, avoid clauses that make you responsible if the owner does not ultimately reap the tax incentives or benefits expected.
Opportunity Zones are an exciting new tool in the toolbox for connecting private capital to areas that most need new infrastructure. But, as always, anticipating the risks in these projects and being prepared to allocate them appropriately is an important step in finding the right opportunity for you as a contractor.
1 See Michael Schiffer and Walter Calvert, “Opportunity Zone Fund’s and New Market Tax Credit’s Impact on Construction Contractors, Construction Executive, Dec. 3, 2018, https://www.constructionexec.com/article/opportunity-zones-and-new-markets-tax-credits-impact-construction-contractors.