OPPORTUNITY ZONES:
DECEMBER 2018
NAVIGATING A PATH TO INVESTMENT
Introduction
Legislation Timeline
Opportunity Fund Requirements
Real Estate Requirements
Opportunity Fund Business & Equity Interest
Tax Benefits by Investment Term Length
5 to 10+ Years Simplified: Investment Example
Advantages, Challenges, Uncertainties
1031 Exchange and Opportunity Zone Comparison
Historical Investment in Opportunity Zones
Opportunity Zone Buyers & Opportunity Fund Targets
United States Opportunity Zones
Select United States Cities: Opportunity Zone Interactive Maps
New York City: Bronx Opportunity Zone Map
New York City: Queens Opportunity Zone Map
New York City: Brooklyn Opportunity Zone Map
New York City: Staten Island Opportunity Zone Map
Boston Opportunity Zone Map
District of Columbia Opportunity Zone Map
San Francisco Opportunity Zone Map
Los Angeles Opportunity Zone Map
OPPORTUNITY ZONES are likely to serve as a powerful vehicle to defer capital gains, receive tax breaks and ultimately increase after-tax IRR. While aspects of the program remain to be sorted out by the Treasury Department, investor appetite is gaining momentum.
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© NEWMARK KNIGHT FRANK | 2018 Opportunity Zones: Navigating a Path to Investment
Current institutional investors and developers who have raised opportunistic and value-add funds will have a significant advantage—both their experience with ground-up developments, and possible experience in the neighborhoods that have now qualified as Opportunity Zones, make them natural first movers. Large owner-users and long-term holders of commercial real estate also stand to benefit from the tax plan, primarily because the maximum benefit occurs at the 10-year hold mark and their longer investment horizon lessens the impact of changes in Opportunity Zone law or even local events that might negatively impact short-term investment yield.
The advantages are not constrained to the real estate community—any individual or corporation, from a local businessperson to a high net worth individual, with a recent or upcoming capital gain also can benefit by rolling their gains into an Opportunity Fund or Opportunity Fund Business (via equity interest). By qualifying as an Opportunity Zone Business, local businesses such as retail shops or distribution facilities within Opportunity Zones can raise capital by receiving direct investment from Opportunity Funds or by issuing equity interest to various classes of investor.
INTRODUCTION
Prevailing market forces have redirected investments to many of the areas that now qualify as Opportunity Zones—some of the largest and most active foreign and domestic institutional groups are coincidentally the largest current investors in Opportunity Zones, such as Blackstone, Brookfield and Greystar. As the cycle has progressed, investors have grappled with lower returns across all asset classes, from equities in the S&P 500, which have averaged just above 12% annual return over the past three years, to commercial real estate yields, which have compressed in major markets to approximately 4.5% for office properties in markets like San Francisco and Manhattan.
Institutional groups have chased yield into developing submarkets in close proximity to major metros, and also into thriving non-gateway markets. Value-add and opportunistic fund strategies have grown in importance as the supply of core and core-plus product in these developing markets is inherently low. Therefore, for groups already developing product in Opportunity Zones, the legislation will reinforce their existing investment strategy and will almost certainly boost demand, without imposing costs related to strategy development and the identification of product. The lower return environment has also made debt and tax-deferral strategies more important to funds seeking to meet return benchmarks and deliver satisfactory performance to their investors, which could increase adoption of the Opportunity Zone program.
© NEWMARK KNIGHT FRANK | 2018 Opportunity Zones: Navigating a Path to Investment | 1
DECEMBER 2017 Program is released as part of the Tax Cuts and Jobs Act
MARCH 21, 2018 Governors’ deadline to nominate up to 25% of the qualified census tracts in their state as Opportunity Zones
OCTOBER 19, 2018 The Treasury Department released guidance on the initially proposed regulations, including clarification of the 70-30 rule and requirements for the improvement period
JANUARY 10, 2019 Public hearing will be held to discuss proposed regulations and provide further clarification and guidelines
DECEMBER 31, 2026 The date when Opportunity Zone investors must pay the deferred capital gains tax on their invested capital gains
DECEMBER 31, 2028 The Opportunity Zone designation for qualified census tracts expires on this date
LEGISLATION TIMELINE
2017
2018
2026
2028
2019
DECEMBER 31, 2019 Deadline to maximize the deferral benefit on invested capital gains, assuming the investment is held for 7 years (see page 6 for further information)
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Must be organized as a corporation or partnership for the purpose of investing in Qualified Opportunity Zone property
LLCs can organize as a Qualified Opportunity Fund as long as they choose to be treated as a partnership or corporation
Individuals and corporations can self-certify through the IRS by filling out Form 8996 with their federal income tax return
Opportunity Funds are the required investment vehicle to invest in Opportunity Zones
Investors have 180 days to invest a capital gain into a Qualified Opportunity Fund that invests in Opportunity Zones
Opportunity Fund investing does not require the use of a qualified intermediary
Qualified Opportunity Zone Property is property that is:• Stock• Partnership Interests• Business Property
Hold at least 63% of their assets in Qualified Opportunity Zone property (applying the 70-30 rule to the original 90-10 requirement)
Lending activity on an Opportunity Zone project does not qualify as an OZ investment
Opportunity Fund investments in real estate are subject to a substantial improvement or original use requirement
There are carveouts for non-qualified businesses, i.e., casinos, golf courses, racetracks, etc., and for financial companies that invest and lend as their core business
OPPORTUNITY FUND REQUIREMENTS
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For real estate property to qualify as Opportunity Zone property, the real estate property needs to have been acquired after December 31, 2017, and meet one of the two requirements below:
SUBSTANTIAL IMPROVEMENT A property is substantially improved when capital improvements in the 31-month period following the acquisition exceed the purchase price of the property, land value excluded
Qualifying Example: Property is purchased for $1.0 million with land value of $200,000. Within 31 months, the OZ investor must improve and invest at least $800,000 to qualify as substantially improving the property
ORIGINAL USE This requirement has not been fully clarified by the Treasury Department, and therefore caution is advised for developers attempting to meet it
The Opportunity Fund must prove that it is the first to use a property, during the property’s existence
If interpreted similarly to “empowerment zones,” this rule would also apply to real property that has been vacant for more than one year, that is put to a commercial use by an Opportunity Fund
In the case of unimproved or vacant land, it has been interpreted that the original use provision commences with the development/improvement of the land into a property type (industrial, retail, etc.).
REAL ESTATE REQUIREMENTS
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OPPORTUNITY ZONE BUSINESS Substantially all (70%) of tangible assets of the Opportunity Zone Business must be owned or leased in an O Zone and at least 50% of the gross income earned by the business must be from the active conduct of the business in the Opportunity Zone
If the business is newly formed, it doesn’t need to hold Opportunity Zone investments at the time of purchase, as long as it is established and organized as an Opportunity Zone Business
With the exception of various leisure businesses (such as golf courses and gambling facilities), most businesses would qualify and can range from industrial distribution facilities to retail shops
It is unclear whether the Treasury Department will allow technology firms, or other businesses that can conduct business globally from a location in an Opportunity Zone, to qualify
Opportunity Funds may hold interest in an Opportunity Zone Business directly or through a subsidiary partnership or corporation
OPPORTUNITY ZONE EQUITY INTEREST Equity issued by any domestic corporation that is a Qualified Opportunity Zone Business
Capital gains reinvested in Opportunity Zone equity are subject to the same tax benefits as direct investments into Opportunity Zone Property
The issuing corporation (O Zone Business) may not redeem a “significant” amount of its own stock one year before or after it issues its Opportunity Zone equity
The issuing corporation (O Zone Business) may not redeem any equity from an Opportunity Fund, or related party, two years before or after it issues Opportunity Zone equity to that Opportunity Fund
OPPORTUNITY FUND BUSINESS& EQUITY INTEREST
© NEWMARK KNIGHT FRANK | 2018 Opportunity Zones: Navigating a Path to Investment | 5
<5 YEARS
7 YEARS
5 YEARS
10 YEARS
Deferred payment of invested capital gains
until the date the Opportunity Fund
investment is sold or exchanged.
Deferred payment of invested capital gains and liability is reduced
by 15%.
Deferred payment of invested capital gains and liability is reduced by 10%.
In addition to deferred payment and 15% reduction in liability of invested capital gains, accrued capital gains generated from the Opportunity fund investment are 100% tax exempt.
TAX BENEFITS BY INVESTMENT TERM LENGTH
© NEWMARK KNIGHT FRANK | 2018 Opportunity Zones: Navigating a Path to Investment | 6
5 to10+ YEARS SIMPLIFIED INVESTMENT EXAMPLE
SCENARIO: A CAPITAL GAIN OF $100 REALIZED AND REINVESTED IN 2018
NON-OPPORTUNITY ZONE PROPERTY OPPORTUNITY ZONE PROPERTY
HOLDING PERIOD
TAX LIABILITY
FUNDS AVAILABLE POST-TAX
POST-TAX ANNUAL RATE OF RETURN
TAX LIABILITY
FUNDS AVAILABLE POST-TAX
POST-TAX ANNUAL RATE
OF RETURN
POST-TAX ANNUAL RATE
OF RETURN DIFFERENCE
5 Years $30 $96 -1.12% $29 $104 0.86% 1.97%
7 Years $33 $106 0.99% $32 $118 2.41% 1.42%
10 Years $38 $122 2.58% $20 $159 4.74% 2.16%
*Assumes long-term federal capital gains tax rate of 23.8%, no state income tax, and annual appreciation of 6% for both the O Fund and alternative investment.
$200
$160
$120
$80
$40
$0
Standard Portfolio Investment Excess Returns Offered by an O Fund Investment
5 YEARS 7 YEARS 10 YEARS
SCENARIO: A CAPITAL GAIN OF $100 REALIZED AND REINVESTED IN 2018
$8$12
$37
$96 $106 $122
AFTER-TAX VALUE OF INVESTMENT
Source: NKF Research
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Unlike 1031 exchanges, capital gains from any investment (whether it be the sale of a business, or of stock) can be rolled into Opportunity Zones, within 180 days of sale. This opens up real estate investment to individuals and groups far beyond traditional real estate investors.
The inherent difficulty and risk involved with investing in impoverished and low-income neighborhoods; some areas might not be able to recover or appreciate as predictably as more established areas.
If the tax plan is not extended past December 31, 2026, investors could begin paying taxes on the accrued capital gains from the O Zone investment after this date, regardless of hold time. This is referred to as the “phantom” income date and is an inherent tax risk.
Opportunity Zones favor unrenovated class B/C product and raw land/development sites in emerging areas, which might already be targets by opportunistic funds, and even certain value-add focused funds.
Local regulations and permitting varies on a neighborhood basis.Some neighborhoods might be more accommodating to development than others.
Whether the “improvement” period can be extended past the 31-month requirement, due to delays caused by permitting, natural disasters, financing, labor shortages, and all other delays outside of the fund’s control.
The stated goal of Opportunity Zones is to improve and encourage development of qualified communities; if successful, value can be created throughout the community and have a compounding effect on the original investment.
Securing financing, especially for construction loans, could potentially prove difficult, and will be highly dependent on the experience of the Opportunity Fund and their development plan.
Construction and rehabilitation may take much longer than 31 months and may occur in several build phases; Opportunity Funds might need a longer runway to fully develop their O Zone site. However, it is unclear whether the IRS will be accommodating of this reality.
A business currently can lower its tax basis by using depreciation, and still receive benefits of Opportunity Zones.
Finding investors, particularly less sophisticated retail investors, could be a challenge; most of the industry has not caught up with the legislation, and the legislation continues to evolve.
Whether the IRS will continue to allow the depreciation of assets within an Opportunity Zone, which lowers your overall tax basis, in combination with complete accrued capital gains deferral after a 10-year hold period.
ADVANTAGES CHALLENGES UNCERTAINTIES
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Like-Kind Property Required Not Required
Property Type Real, tangible property only Can be real or personal property as well as unimproved land, so long as a plan exists to improve the property in an O Zone
Finding the Replacement Property
Replacement property must be identified in 45 days, with limits on numbers of properties
180 days; deferred capital gains do not need to be managed by a qualified intermediary before they are deployed
Amount Invested Both principal and capital gains from the sale
The capital gains from any qualified investment or business sale
Partnership Interests, Stock, or Personal Property
Not allowed Allowed
Recognition of Deferred Gain Upon sale of replacement property unless further deferred in another like-kind exchange
December 31, 2026, or sale of property, whichever occurs first
Income Tax Basis Step Up for Holding Property Five or Seven Years
None 10% if five years before December 31, 2026, 15% if seven years before December 31, 2026
Sale to Related Parties Two-year holding period required Retention of less than 20% interest stake required. If over 20% is retained after sale, owner is considered a related party and the deal does not qualify
Improvement or Use Requirement
None Substantial improvement of the property; if property is owned by an O Zone Business, use is limited to the O Zone where the property is located
Future of Program Program nearly limited to $1 million per taxpayer per year in an early 2016 tax bill that did not pass
Program is guaranteed until December 31, 2026. The Opportunity Zone designation for census tracts is valid until December 31, 2028
1031 EXCHANGE OPPORTUNITY ZONE BUSINESS PROPERTY
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• Demand for product has steadily risen in Opportunity Zones, even before the legislation was enacted; the past three years have attracted nearly $150 billion dollars in investment volume nationwide.
HISTORICAL INVESTMENT IN OPPORTUNITY ZONES(Inclusive of activity in areas prior to designation)
Source: NKF Research, Real Capital Analytics
• As yields have compressed in coastal gateway markets, particularly as the current cycle progresses, investors have chased yield into smaller non-gateway markets. This trend has benefitted Opportunity Zones, which are predominantly located in non-gateway metros.
• While the largest markets; such as NYC and Los Angeles, continue to attract the most investment volume, the majority of investment occurs in other non-gateway cities, which have accounted for $34.7 billion dollars, or 67%, of investment volume in the past 12 months.
$47$51$49$49
$38$31$29
$22
$60
$50
$40
$30
$20
$10
$0
$18
2008
$8
2009
$13
2010 2011 2012 2013 2014 2015 2016 2017 2018 YTD
Billi
ons
157.8%2008 vs. 2018
UNITED STATES TOTAL SALES VOLUME | ANNUAL TOTALS
© NEWMARK KNIGHT FRANK | 2018 Opportunity Zones: Navigating a Path to Investment | 10
TOP BUYERS
24 Months Opportunity Zones
$3.8 billion $771 million
$1.3 billion $608 million
$1.8 billion $659 million
$1.2 billion $505 million
$930 million $504 million
Blackstone Greystar
Wind Creek Hospitality TH Real Estate
Brookfield Morgan Properties
Fireside Investments DivcoWest
Gaming & Leisure Properties GIC
1 6
3 8
2 7
4 9
5 10
$75 millionViceroy Equities
<$100M
$468 million
PNC Financial Services Group Inc
$250 million
Enterprise Community Partners
$250 millionNormandy
$200 millionRubenstein
$200 millionVirtua Partners
$100M –$499M
$500 millionRXR Realty
$500 millionFundrise
$500 millionEJF Capital
$500 million
Youngwoo & Associates and EquitMultiple
$500 million Caliber
$500 millionBridge Investment Group
$500M–$999M
$3 billion
Skybridge Capital(EJF Capital will act as subadvisor)
$1,000M+
Source: Real Capital Analytics
Source: NKF Research, Bloomberg, WSJ
$100 millionHeritage Equity Partners
SELECT OPPORTUNITY ZONE FUND TARGETS
© NEWMARK KNIGHT FRANK | 2018 Opportunity Zones: Navigating a Path to Investment | 11
UNITED STATESOPPORTUNITY ZONE MAPDespite the low-income community requirements for Opportunity Zones, many well-known emerging markets have made the list, from census tracts in Bushwick and Bed-Stuy, Brooklyn to the South End in Boston. As these neighborhoods have already begun to attract the attention of institutional funds and are transitioning into vibrant live-work-play neighborhoods, the location risk for prospective investors is substantially less compared with investments in less well-known areas, further away from urban cores.
This map was produced using reliable private and government sources. This information is provided without representation or warranty.
Source: ESRI
Estimated unrealized capital gains from both American households
and corporations
$6 Trillion 1 Million 18.2% of Total Land Area
in the U.S. that is represented by Opportunity Zones; comprises 5.4% of
major metro land area
Properties across all property types nationwide are thought to be located within Opportunity Zones
Average household income in
Opportunity Zones
$52,694
© NEWMARK KNIGHT FRANK | 2018 Opportunity Zones: Navigating a Path to Investment | 12
SELECT UNITED STATES CITIESOPPORTUNITY ZONE MAPS
CLICK ON CITIES FOR EXPANDED VIEW
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© NEWMARK KNIGHT FRANK | 2018 Opportunity Zones: Navigating a Path to Investment | 13
NEW YORK CITY: BRONXOPPORTUNITY ZONE MAP
Queens
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Port Morris
Soundview
Mott Haven
EastConcourse-Concourse
Village
ConcourseMelrose
South-MottHaven North
CastleHill
Hunts Point
UnionportMorrisania-Melrose
Longwood
Highbridge
UniversityHeights-Morris
Heights
FordhamSouth
Middletown-PelhamBay
Belmont
Claremont-Bathgate
VanCortlandt
Park
Baychester
Eastchester
0.75 mi
Queens
Bronx
Bronx
Bergen
EastchesterBay
LittleNeckBay
LongIslandSound
East River
Hudson River
New YorkNew York
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Tremont
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NEW YORK CITY: QUEENSOPPORTUNITY ZONE MAP
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NEW YORK CITY: BROOKLYNOPPORTUNITY ZONE MAP
Brooklyn Heights
DowntownBrooklyn
SunsetPark
Vinegar Hill
Bay Ridge& Fort
Hamilton
Red Hook
Boerum Hill
Greenwood
Borough ParkSunset Park
Gowanus
ClintonHill
CrownHeights
Prospect Heights
Bedford-Stuyvesant
Gravesend
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Gravesend
ConeyIsland
Coney Island
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Bushwick
Bushwick
EastWilliamsburgFort Greene
Williamsburg
Greenpoint
BrightonBeach
Midwood
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ProspectLefferts Gardens
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BrownsvilleSpringCreek
East New York
Cypress Hills
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NEW YORK CITY: STATEN ISLANDOPPORTUNITY ZONE MAP
New
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Middlesex
Hudson
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Richmond
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BOSTONOPPORTUNITY ZONE MAP
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Norfolk
Norfolk
Suffolk
Middlesex
Essex
Charlestown
South Boston
South End
JamaicaPlain
ColumbiaPoint
HarborIslands-Long
Island
WellingtonHill
Randolph
Quincy Point
DeerIsland
RevereEverert
Weymouth
¤1
1.5 mi
Quincy BayHingham Bay
Broad Sound
NahantBay
Boston Harbor
DorchesterBay
AtlanticOcean
Norfolk
Norfolk
Suffolk
Middlesex
Essex
MaldenMedford
NorthComoridge Somerville
§̈¦95
§̈¦95
§̈¦93
§̈¦90
§̈¦90
UV2
£¤3
UV2
UV16
UV2
UV9
UV203
£¤1
£¤1
UV1
UV90
£¤1
UV3
UV3
UV60
£¤3
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© NEWMARK KNIGHT FRANK | 2018 Opportunity Zones: Navigating a Path to Investment | 18
DISTRICT OF COLUMBIAOPPORTUNITY ZONE MAP
Arlington
Alexandria(City)
Fairfax
Montgomery
PrinceGeorge's
U
U
U
U
U
U
U
U
U
U
U
£
£
£
£
£
V27
V110
V396
V27
V295
V5
V400
V355
V295
V189
V4
¤50
¤50
¤29
¤29
¤1
BrightwoodPark
PleasantPlains
SouthwestWaterfront
HillEast
Hillsdale
Barry Farm
Historic Anacostia
Fairlawn
LowerFairfaxVillage
Hillcrest
Greenway
Central NE LincolnHeights
Deanwood
GrantPark
Carver /Langston
Brentwood
Edgewood
Kenilworth
Mayfair
Benning
Takoma Park
CongressHeights
ShepherdParkway
Arl ington
Alexandria(City)
Fairfax
Montgomery
PrinceGeorge's
Potom
acR
iver
§
§
§§
§
§
§
¨
¨
¨¨
¨
¨
¨
¦
¦
¦¦
¦
¦
¦
395
495
295695
95
66
295
Distr ic t ofColumbiaDistr ic t ofColumbia
Maryla
nd
Maryla
nd
Maryla
nd
Maryla
nd
Distr ic t of Columbia
Distr ic t of Columbia
Virg in ia
Virg in ia
1 mi
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© NEWMARK KNIGHT FRANK | 2018 Opportunity Zones: Navigating a Path to Investment | 19
SAN FRANCISCOOPPORTUNITY ZONE MAP
SanFrancisco
Bay
Golden Gate
PacificOcean
San MateoSan Mateo
MarinMarin
TreasureIsland
Hunters Point
BayviewExcelsior
MissionTerrace
CrockerAmazon Visitacion
Valley
Bayview
Hunters Point
0.95 mi
San FranciscoSan Francisco
§̈¦80
UV80
§̈¦280
UV280£¤101
BACK TO MAIN MAP
© NEWMARK KNIGHT FRANK | 2018 Opportunity Zones: Navigating a Path to Investment | 20
LOS ANGELES OPPORTUNITY ZONE MAP
Pacific Ocean
Pacoima
Sylmar
Canoga Park
Chatsworth Northridge
PanoramaCity Sun
ValleyNorth
Hollywood
NorthHills West
Van NuysResedaCanoga Park
Mount Washington
Elysian ValleyRiverside
HollywoodStudio District Lincoln
HeightsEl Sereno
UniversityHills
Boyle Heights
Boyle Heights
Chinatown
Downtown LosAngeles
RampartVillage
Pico UnionMid City
West AdamsBaldwin Hills University
ParkSoutheast Los
AngelesHydePark
Crenshaw
SouthLos
Angeles
Watts
HarborGateway
South
Wilmington
3.5 mi San Pedro
Long Beach
Norwalk
North Long Beach
Bell Gardens
Bell
NorthwestTorrance
Hawthorne
Central Alameda
Vernon Commerce
Garvey
Compton
InglewoodWestmont
UV118
UV14
UV170
UV134
UV134UV2
UV110
UV710
UV60
UV91
£¤101
§̈¦210
§̈¦10
§̈¦5
§̈¦710
§̈¦110
§̈¦105
§̈¦405
§̈¦10
§̈¦605
£¤101
OrangeOrange
VenturaVentura
Los AngelesLos Angeles
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© NEWMARK KNIGHT FRANK | 2018 Opportunity Zones: Navigating a Path to Investment | 21
Newmark Knight Frank has implemented a proprietary database and our tracking methodology has been revised. With this expansion and refinement in our data, there may be adjustments in historical statistics including availability, asking rents, absorption and effective rents.
Newmark Knight Frank Research Reports are also available at www.ngkf.com/research
All information contained in this publication is derived from sources that are deemed to be reliable. However, Newmark Knight Frank (NKF) has not verified any such information, and the same constitutes the statements and representations only of the source thereof, and not of NKF. Any recipient of this publication should independently verify such information and all other information that may be material to any decision that recipient may make in response to this publication, and should consult with professionals of the recipient’s choice with regard to all aspects of that decision, including its legal, financial, and tax aspects and implications.
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