EPISODES
Episode 12.
Chris Knoppe, President of CBUS O-X Funds
Partner at New City Homes
Dalton Elliott (Speaker 1)
Death and taxes the good old truism laying out the two certainties in life. I promise we only talk about the taxes part. Chris Nabil joined me for his second appearance on the podcast number two to unpack opportunity zones really dive into the nitty gritty of the benefits, timelines and gotchas of the program. And I already spoiled it. But taxes play a huge role in the incentive part of the opportunity’s own program. I feel like every real estate investor has at least heard about opportunity zones, but I really think the real benefits are the best kept secret in real estate. Thanks for listening.
Welcome to the Real Estate of things podcast. I’m your host Dalton Elliott. I am joined today by our first repeat guest. Very excited we have Chris Knoppe of C-BUS O-X Funds, Chris, great to see you again. Hey, Dalton, thanks so much for asking me back. Good to see you. Absolutely. I just could not get enough and for those watching, you know, just catching up beforehand. I don’t know if my lighting has gotten more white or if I have gotten more Casper the Friendly Ghost. I like absolutely pasty white in this video. You’re over here looking like a Greek god suntan on Mount Olympus. That’s not a good look for me. So hopefully everybody’s just listening and not hitting up the YouTube video this week. That’s okay. It’s just it’s this balmy Ohio weather we have here at the south beach of the North. That’s right. Was a speaking of Ohio. The last time I was on, you’re trying to hit me up for some Ohio football tips for your fantasy football league. So how’s that going? Yeah, it was going well, that was being the operative word there. So I eked out a win last week. I had kind of my first loss in a while. I’m going to make the playoffs for the league, which is good. You have a ticket to the game, which is the important thing. Anything can happen at playoff time. So I’m not stressing, but I had Derrick Henry and Aaron Rodgers the week that Aaron Rodgers was out there who was out. I’ve had I’ve had some trials and tribulations this this season. So I’m happy that I’m making it to the playoffs. But I don’t know. I don’t I don’t have that gut feeling I did years ago when I ran the tables. It’s dicey. I did make it up to Ohio for the first time. The conference center that we were at was directly across from the brown Stadium, which is beautiful right there on the water. So when they opened the blondes Oh, was it at the Hilton? Yeah, the what’s the name of the Huntington Convention Center? Okay, I was up in Cleveland, not not just a few weeks ago for a NovoGradac opportunity zone conference. And it was at the Hilton which overlooks Lake Erie and the brown stadium there made it to a Browns game. So yeah, pretty decent venue they have there. Yeah, it was really pretty. One of the few stadiums where the stadiums actually downtown in the city that it’s named, right like my I’m a Cowboys fan. I visited the stadium. I’ve seen them play but not at the new Cowboys Stadium. I guess it’s not that new at this point. But my sister’s in Dallas. So in last August, we went on the tour, and right Dallas Cowboys, but the stadium is like in Arlington, which is you know, on a good day a 45 minute drive away. So it was cool to see a stadium that was in the actual city downtown. That’s just a rarity. So yeah, definitely. We just in Columbus, we just build a new MLS stadium right in downtown and it’s it’s a game changer. It’s pretty cool. It’s right next to the the hockey arena as well, the NHL team, the blue jackets. So we got the crew in the blue jackets downtown. That’s one thing I played soccer for one year when I was a kid, maybe third grade or something I was like as too much running. And we have the Atlanta Atlanta united, right two and a half hours away from where I’m sitting now in Greenville, South Carolina. And it’s at the they play at the Mercedes Benz dome. And I’ve heard nothing but great things about kind of like there are a couple of MLS games that like you don’t need to know like about soccer. Just go there and it’s always a party. I need to make it to an MLS game. They’re fun. Yeah, they’re fun. It’s even if you’re not a soccer fan. It’s like the one thing about soccer is they never stopped the clock and there’s just constant action is continuous. So it’s yeah, it’s pretty neat. I like it. I have to get up to your neck of the woods, go to a game. Show me the way. Beautiful. So last time you were on we really dove into your investing background and business. And after the episode we kicked around the idea of you coming back to really do a deep dive on opportunity zones. What is the strategy behind that look like? Taxes, right? That’s a huge benefit of the opportunity zone or lack lack There is a huge benefit on the opportunity zones. And the normal disclaimer, neither of us are attorneys. So nothing in here should be construed as, you know, official ironclad legal or tax advice. You know, consult your attorney or accountant for that, that piece out of the way. Talk to me about the tactical actionable piece about if I’m a real estate investor. And you know, I have some experience, but I hear about this opportunity zone opportunity and all of the benefits around it, but like, where do I start? And what are the biggest differentiators between just doing a normal transaction and doing something that’s classified in the opportunity zone?
Chris Knoppe (Speaker 2)
Yeah, that’s right. So last time, like you mentioned, we just really talked about the evolution of my real estate journey, which the more recent years has been spent doing urban redevelopment projects, and in a lot of opportunity’s own neighborhoods. And, of course, we have our opportunity’s own funds, si WSOC funds, is actively raising, raising our third fund right now. So I think you’re right, we just, we just scratched the surface last time on the topic. And that is really what I, what I’ve seen, the general public’s understanding of opportunity zones is very surface level. So I would love to spend some time today really going into a deep dive on opportunity zones, what they are, how they were created, what the purpose was, and really the mechanics of how one goes about investing with to receive the tax incentives that’s really meant to drive investment into low income communities that have been starved of really investment capital for decades. So yeah, without further ado, I think just for some general background, and like you said, we will touch on a lot of tax stuff, some accounting stuff, and some legal as far as fun formation and fundraising and how those mechanics work. So like you said, not an attorney, not a CPA, consult your advisors. This is informational, only. But we’ve been doing this for several years now and have a pretty good knowledge base that I’m excited to share today.
Speaker 1
So where does one start like opportunity zone? Do I go to opportunity zone.com and see a map of you know, where these zones are? How do I figure out where the opportunity zones are?
Speaker 2
Yeah, there’s two easy resources for that the HUD hud.gov does happen, an opportunity zone map, and I’ll probably say O Z a bunch of times today. So that’s the abbreviation one, and the HUD map is sufficient. The I like a map. It’s ESRI is the company in the website, they do all kinds of maps. And they have an opportunity zone map. And that one to me is a little more functional. So on a very basic level, yep, Google opportunity zone map, you will find one of those sites, you can plug in most of them are searchable. So you can plug in an address and see if you’re in a zone zones are usually highlighted some color. So what the opportunity zones are, it’s their census tracts. And they’re they this all came about in December of 2017, there was a piece of legislation called the TAT tax cut and Jobs Act, which was a very thorough piece of legislation, several 100 pages. And really the small section, I think it’s only a few paragraphs, introduced the concept of opportunity zones. And that’s all it was, and it that it had bipartisan support. So it made it in that final final bill, and it was signed into law. And then in but it was, you know, it was the concept of it. And that laid out next steps. The next step was for each state governor to actually select the census tracts that would be come opportunity zones. So that’s what happened in 2018. And in our state, I know it was Governor John Kasich at the time, had all the all the zones selected in that first quarter of the year. And they published their the state opportunity zone map in April of 2018. And that’s really where I first took notice, because before it was just theory, and without really knowing where the zones are and how you can apply them to your investment strategy. There wasn’t much to pay attention to. So 2018 these zones started being rolled out state by state. And the way that they’re selected is first they have to qualify as low income census tracts. And then out of each state’s low income census tracts, they can designate up to 25% of them as opportunity zones. So it’s fairly selective in because if it wasn’t it really if it was spread too thin across too many census tracts, it wouldn’t direct the concentrated type of investment that it was intended to do. So nationwide, it’s about 11% of all census tracts are opportunity zones. So that number may seem insignificant to some people, or it actually may seem significant because it’s 10% of our total country is an opportunity zone. And when you get when you get into your local detail, you’ll see that there’s some rural opportunity zones, and a lot of urban opportunity zones and everything in between. So each Governor tried, I think, their best to spread it out between urban and rural. In some cases, it’s just the communities that have been starved for investment. In other cases, it might be areas that are primed for investment, and they want to encourage it, because there may be there’s, there’s certain infrastructure projects that are coming coming through, and they want to encourage and ancillary investment around those areas. So I think most of the governor’s were pretty tactical about it. And they also worked with local municipalities to get down into the details when deciding what to zone and what isn’t. So that’s how that came about. And then the the Treasury Department is actually responsible for interpreting how the IRS will, will regulate the rules. And so when these zones came out, the Treasury Department, you know, all they’re going off of, and all investors and attorneys and accountants were going off of was were these few paragraphs that describe opportunity zones, and what they were that were within the tax cut and Jobs Act. So then the Treasury Department had to actually draft the regulations. And the regulations is the basis for you know, how people can act and invest within the zones and the true mechanics of it, and how the IRS would then enforce it. So those those first set of regulations were published in October of 2018. So really, nobody was actually taking action, investing in opportunity zones until those regulations were proposed. And they answered a lot of the questions, a lot of the low hanging fruit out there. But in some cases, it was really just the tip of the iceberg, because there was additional questions that remained, and they had a lot of Public Comment Commentary period. So a lot of trade groups submitted feedback. And they went on to publish a second set of Proposed Regs. And that was in April of 19. And then the final set of regulations for opportunity zones wasn’t, wasn’t published until December of 2019. So for people that were operating kind of plain vanilla straight down the fairway, they could start investing after the first set of regulations, and certainly after the second set in early 2019. And then for some people that were operating more in the gray area, or looking to do something more creative, they may have wanted to wait until the final set of rigs in December 2019, republished, and actually even after that, they amended them later on. So that’s kind of the legislative side of things. So if people haven’t heard a lot about them, that’s why because really 2019 was the first year you could start investing. And we formed our first fund, we started forming it, we started conceptualizing it, as soon as the first set of regs came out. And then you know, we we were doing an internal fun with our own capital gains, to test out the mechanics of how this would all work and make sure we could apply it to our business model of doing a whole lot of small projects. Because this is, as we’ll get into today, I mean, it, it’s set up as a fund structure, you can’t Joe Smith can’t go buy one property in his name and call it an opportunity zone investment. It has to be a fund, which is a multi member entity. And then there’s rules for how the assets are deployed. And so we wanted to work all that out before we invited outside capital. And so we did that in 19. And then our second Fund, which was the first with outside investors, formed in 2020. So that funds been operating for it’s been buying property for about 18 months now. And we’re on the fun three, but a lot of progress in a really short period of time. On the fun side of the fence. I want to talk about that for a minute.
Speaker 1
So first fund was kind of you and very close acquaintances, right. And then the second question was, was it still kind of a, you know, calling friends and family or was it? Was it beyond that in terms of your relationship? To the investors?
Speaker 2
Yeah, so it was it was mostly word of mouth. So we certainly had folks investing that had known us for a long time, there was secondary introductions, and then people that may have been familiar with us just from being in business for a long time, but we didn’t know and they, they caught wind of what we were doing and they wanted to be a part of it and they join and so it kind of grew organically from there, you know, to where you get referrals and introductions or somebody hears about you. And in the last few years, I’ve I’ve attended a lot of conferences all over the country specific to opportunity zones, and so your network grows and you become known know, for us. We were fairly early on raiders in the opportunity’s own space. And also what we do is fairly unique in that we are accumulating a lot of smaller assets within our funds, as opposed to the more traditional development model of having one fund for one large project. So I think people like that factor of us. And really, the intent of the program is to revitalize neighborhoods. And so you don’t revitalize neighborhoods by building a 20 story tower, you usually need to go in and buy boarded up properties and clear out the blight and bring residents back into the neighborhoods and then bring some retail business back into the neighborhoods and really go grassroots with it. And that’s what I love about what we do.
Speaker 1
So on the fun side of the fence, what are some of the biggest stressors, pain points, differences, however you want to attack it from really an extended relationship fund model? So you said, you know, a lot of secondary introductions, well, above and beyond the friends and family model, versus kind of fund one and that set up? What are some of the biggest things that stick out between the two?
Speaker 2
Yeah, and I’m happy to go into that and talk about our funds. But I do also want to, you know, this is I want to provide some educational material for people listening so that if they decide to go form their own fund, you know, they can do that. Or if they want to go invest in someone else’s fun, they can do that. Or if they just want to work within their their business model with opportunity’s own funds, they understand how they work, what their, what their incentives are, what their priorities are, and how how they could be worked into everybody’s business. So with that, I think I’ll, you know, I want to first say that these aren’t just the tax break, the tax break is meant to drive investment dollars. And in order to do that, you have to incentivize it. And so the whole point is to some communities out there have had been starved of investment and have suffered for for decades, and private capital and want to touch it, because that’s once you once you on that kind of that train of downward decline and a lot of blight, it’s snowballs, it kind of gets worse. And it’s hard to turn that train around, unless you get a whole lot of capital committed to that mission. So that’s what he’s trying to accomplish. So that’s the purpose of it. And in order to get that much capital excited to reverse those trends, you have to dangle out some pretty nice carrots. So that’s where the tax incentives come into play. So specifically, they’re geared towards capital gains. And the thought process behind that is, alright, the stock market has been on a 10 or 12. Year boom, the certain real estate markets have also been on a boom, what do we need to do to have people take some of that off the table? And you know, which is a gain? So some of those appreciated assets? How do we motivate somebody to sell their stocks or to sell the building in the in the nice neighborhood, and reinvest those proceeds into a community that hasn’t fared so well. And so the only real way to do that is to is to require capital gain investment. So it moat, and it’s very interesting, as I talk to investors, or potential investors for our fun, some of them have a gain, and they’re just trying to decide what to do with it. And they’ve heard about opportunity zones, and they decide to invest it in Ozy fund rather than whatever else they may have done. So it’s capturing investment that way with people who, who already had the gain regardless, but now just want to decide what to do with it. But then there’s also people who intentionally realize their gain. And so they can invest in opportunity’s own funds. And that to me means that it’s a powerful incentive. And it’s working. Because if you if you’ve got appreciated Apple stock, and normally you would just let it sit there, because for one, you don’t want to sell it and have to pay tax on it. And two, you got to figure out what else to do with it that money. But here you have this program that can offer you some nice incentives encourage you to sell that stock and reinvested into a low income community. That’s pretty powerful. And so specifically, the incentives are threefold. The first is if you have a capital gain, and you invest it into a fund, you can defer your tax on that gain. And the deferral period as a Tritan now goes through the end of 2026. So instead of realizing again on your 2021 tax return, you invested in a fund and you don’t have to realize your gain until tax year 2026 Which means you file your return sometimes in calendar year 2027. And you your tax would be owed at that time. So right now we’re looking at a five to six year deferral of that tax. And that that part of it, that’s not the best incentive, but it’s a big one. And it’s probably unappreciated, because not only are you delaying the tax, but in the meantime, the money you would pay in tax is being invested in growing for that five or six year period. And if you’re investing that at a decent rate of return, call it eight to 12%, you’re basically doubling your money over that period of time, if you’re if you’re getting a compound annual compounded return. So if you look at it that way, the tax you would pay today, when invested in the Fund grows and doubles in a five or six year period, it pays for itself, because you’ve doubled your money and you pay your tax, and you still have everything you put in. So the deferral is powerful. The second benefit, which is particularly timely right now, is that when you do pay your tax in tax year 2026, instead of paying your full tax, you get a reduction in tax, and the tax jargon with it is actually you get a step up in basis. But what that results in is essentially a discount on the tax you pay. And that discount is 10%. So if you’re in the 20%, capital gains bracket, and you have $100,000 gain today, rather than paying 20,000 in tax, five years from now, your you’d pay 18,000 in tax. So it’s not huge, but it’s something and actually that started out as not a 10% discount, but a 15% discount, and they’re tearing it down as time goes on. The reason for that was they wanted to put an extra carrot out there to get people to take action early when the program was first introduced. So really to reward the early adopters. And that the way it actually is written is that if you were invested for seven years, before the deferral period ends, you get a 15% discount. And if you were invested for five years before the deferral period ends, you get a 10% discount. So if you do the math from the end of tax year 2026, take your backup five years, that’s the end of this year, you have to be invested by to get that benefit. So those are the first two. And the third one, which is the most powerful is it doesn’t have to do with your current tax, but it has to do with your new investment in the fund. And if you hold that investment in the Fund for 10 years, when you exit that fund, your capital gain at that time is 100%. tax free. So again, the power of compounded investing over a 10 year period, if you’re earning a reasonable return, your money can triple and that gain is tax free.
Speaker 1
So 10 years is better than forever. In any book,
1
Speaker 1
23:08
that math adds up a 100% tax free, those are words that just you don’t hear about anything ever. And as you I loved the 123 breakout that you gave in any one of those is a material incentive and to stack all three of those together, really the first two on a medium term horizon and short slash medium term horizon. And then the third one on a slightly longer but not really that long term horizon makes it incredibly compelling to me this is the opportunity’s own program is a prime example of kind of a government incentive program that has run exceptionally well, by most relative standards. It’s really tough to properly incentivize activity around investment in dollars. And there’s so you know, now to literally today more than ever before, you have more options, no matter how much money you have to invest that money, whether it’s real estate, crypto, fractional real estate, they’re all different kinds of things, even within the real estate space, but above and beyond that limitless options and this program, the opportunity’s own program. It’s just one of the few things that I look at, like the the nail was hit on the head with with the incentive structure around this compelling sell. Yeah, yeah, definitely. And there was just a second study released that was commissioned by Congress back in 2019. And, and the point was to measure it’s a new program, right? So nobody really knows what’s going to happen if it was perfectly designed, and they wanted to there’s certain checkpoints and really the results were a the incentives are working There’s been $29 billion invested in opportunity zones. And to the zones that were selected our low income zones that need the money. And three, the there are the local, local municipalities. They overwhelmingly rated the program from good to neutral. You know, it’s it was either, yes, this is driving investment in projects that really matter, or this is looks like it’s working. But it’s still a wait and see thing. There was very few that responded saying, No, this isn’t doing what it was intended to do. So that was good news. The other good news is I mentioned earlier, it had bipartisan support. So whenever there’s a new program, particularly, that involves tax reporting, and you know, the federal support, people are a little weary of getting involved until they know it’s gonna be around. But you know, this was passed originally under the Trump administration, but it had congressional leaders on both sides of the aisle that supported it. And early on Biden expressed support of the opportunity’s own program, as have other Democratic leaders. So that is a real positive thing for you. If you’re going to get involved in something, you want to make sure it has lasting power or staying power, the study that was released, the one thing is it’s that there’s some challenges from an IRS perspective on compliance and how to enforce that and make sure people are following the rules. And so any calls for change to the program thus far have been around that you how do we make sure we’re measuring investment into the communities and into the projects? And what’s that? What’s that translating into? So that it’s not just a tax break for for people with a lot of capital gains, that it’s actually doing what it was intended to do. So I think, eventually, we can expect to see at the fund level, some more detailed reporting requirements. But that’s a good thing. Because if you’re involved in a program that’s doing positive things you want, you want people to see that and be able to measure it. And if you can’t measure it, then people will become skeptical. So having the reporting tools in place to show those results will ultimately be a positive thing for everybody. Yeah. Last time, you were on the podcast, you mentioned that you live in work in the area that you invest, right. What have you seen, just over the few years that you’ve been in opportunity zones side of the fence? What have you seen tangibly in your neck of the woods?
Speaker 2
Yeah, so for us, we were doing projects, pre opportunity’s own fund with our own money, with bank financing with institutional private rehab lenders. And we were able to make an impact. But the introduction of the Ozy program and outside capital has allowed us to just exponentially increase that impact that we’re making. And so from that perspective, I think that, you know, any given investor can make a small drop in the lake when it comes to neighborhood revitalization. But if you align larger amounts of capital with these incentives, you’re driving a lot more dollars of investment into more concentrated areas. And so the results are quickly tangible. So for us, specifically, the area, we located our office into what is now an opportunity zone, back in 2018. I moved into that same neighborhood in 2019. And I’ve seen after every season that goes by there’s there’s noticeable change, there’s less boarded up houses, there’s more homeowners, there’s more residents, there’s more renters, and now new businesses are popping up as well. And so even though it’s a short period of time, it is helping change the tide. That neighborhood in particular was it peaked, population peaked in the 1950s. It was once a vibrant neighborhood outside of downtown Columbus. But ever since then, for six decades, the population has declined. And the most recent census numbers that came out this past year that we’re measuring from 2010 to 2020, showed that it had declined some more. But my guess was that Yeah, from 2010 to 2020, there’s a net decline. But I think the decline, hit rock bottom and started turning the tide in that rug right at the end of that measurement period. So the 2020 measurement, I think that we’re now turning the corner in that neighborhood in particular, and I think when the next census numbers come out, 10 years later that’s Wow, you’ve had a full fun cycle of investment here. It’ll tell a different story. So there’s just there was a lot of vacant properties. There was a lot of torn down properties. Those are all coming back to productive use and then that fuels other anomic activity in the neighborhood. So, yeah, just in a few years, I think we’re seeing tangible results. Beautiful the program working as intended. Nice thing to see. Yeah, I think it’s worth mentioning too. So the three, the three benefits that I highlighted, those are federal tax benefits. And then it’s up to the states, whether they want to mirror those benefits, modify them, or not offer them at all, most states have gone the mirror route where they have adopted the same tax treatment, or a close variation of that certain states, namely California and New York said, you know, what, we’re not going to give the tax break. So that’s something for investors to be aware of Ohio in some states went above and beyond to try to attract the capital. So Ohio not only mirrors the federal benefits, but also added a state tax credit. And that’s for investors that invest in funds that exclusively invest in Ohio. Opportunity’s own projects. So, so our investors in our fund are beneficiaries of that. And it’s interesting to see that work as well, because we do work with some investors out of state who just they love that tax credit, they get that and if they can’t use it, they can sell it, they sell it to another Ohio taxpayer. And we help them do that. And it’s a it’s a nice incentive it gives them especially for a 10 year investment timeline. So rather than waiting 10 years to get everything back that tax credit allows them to get some liquidity back within the first year of investment.
Speaker 1
That’s great. What what did we miss on the fund side of the fence? Anything there?
Speaker 2
Well, so I think we talked about how they were formed, what they are, what the incentives are, you know, that’s how they drive investment. But as far as who can invest in how you invest, I think is is what should be, which we should cover next. So any any endeavor, any taxpayer can invest in an opportunity zone fund, and that’s a individual or a bit or an entity. So nonprofits and other entities that don’t pay tax, aren’t the best candidate, because the whole thing is tax incentives. But any tax pain, individual or entity is eligible, there aren’t any there are no income restrictions. So no matter how much you make, or how little you make, you can still invest, which is nice. And there’s also no minimum or maximum investment to participate in the program. I will say, though, that at the fund level, due to SEC rules, primarily, most funds have a minimum investment amount, but from the program overall, there is no minimum or maximum. So that’s nice, too. But there are there are some gotchas, you know, there’s some some this is great, but so it’s always it’s always nice to say these are all the great things, you can triple your money over 10 years and not pay tax on it. You can defer, you can just count that gets people interested so that then they can stomach the gotchas.
So a couple of gotchas are that the it was written, I said, in more of a venture capital or private equity model, where it must be a fund don’t mail it cannot go buy a house in his name, and say, this is my opportunity zone investment, Dalton needs to invest in a multi member entity in order to get that Ozy qualified Ozy investment incentive. And so what that means is from a small investor perspective, you can form your own fund just has to be a multi member entity. And, and then there’s other rules, though, that you have to follow. And the rules, you know, one might think they’re cumbersome or irritating. But we also have to understand why they’re in place. And they’re in place so that the program is not abused. So if I can’t just form a fund, put all my capital gains in there and then not do anything with it, that doesn’t, that doesn’t create the intent of the program of making making positive change in the neighborhoods. So one of the rules is a fund needs to deploy 90% of its assets within six months. So you got to get moving on it. Yeah, if you’re, if you’re forming a nosey fund, you’ve got to put that money to work in a quick period of time. One of the other one of the other rules is that in order to in order for your investment to be a qualified Ozy investment, you have to be significantly improving it. So you can’t buy a beautiful building that happens to be in an O Z, and just rent it out forever turnkey, there has to be a significant improvement aspect of it. So again, the intent is to drive investment into improving communities. So the way they measure significant improvement is that whatever your cost basis is to buy that asset. You You really essentially have to double it. So whatever you pay for it, you have to add that into provements You do get, you know, you do get credit for the land value. So like a real simple example, you buy a low cost house 50,000, maybe you allocate 10% of that to land value, most accountants would say somewhere in the 10 to 20 range is acceptable, or you looking at you get an appraisal or you look at the auditor assessment value, but let’s just say 50,000 purchase. So 5000 is land value that leaves 45,000 of your basis and the actual house itself. So you have to invest 45,000 in repairs in that property in order for it to be a qualified opportunity zone investment. So there’s some strategy there and you have to be selective, you can’t buy a home that doesn’t need much repairs, that that would be a bad asset, you are allowed to have a certain number of bad assets in your fund, but you have to monitor that and measure that and be aware of it. So those are, those are two of the bigger ones, you can also invest in businesses. So it’s not just real estate, a fund can invest in an opportunity zone business. And then that comes with its own set of rules. The business, of course, has to be located in an opportunity zone, it has to have a certain percentage of revenues derived from opportunity zones, employees have to primarily work in opportunity zones and things like that. So startup entrepreneurs can locate their business in an opportunity zone and offer it was the incentives to their venture capital investors or their angel investors or friends and family, whoever is investing in their company. So even if you’re not a real estate investor, there’s other ways to work with opportunities, the opportunities on industry, lenders, lenders are a great partner for opportunity’s own funds. And if a lender does understand that opportunity’s own funds, because of some of the tax detail behind it, the investors themselves the limited partners, the passive investors, they don’t necessarily have basis in the fund. So things like depreciation and other pass through losses can only be allocated to them, if they establish basis in that fund. One way of doing that is to use non recourse financing. So there’s a huge need for non recourse financing, within opportunity’s own funds so that the fund can establish basis for its investors and then can pass through benefits like passive losses from depreciation. And I will touch on depreciation because that’s a huge benefit with Ozs. Because their appreciation does not have to be recaptured after 10 years. So you can take all the depreciation you want. And then there’s never a recapture event at the end. So anyone who’s owned rental property for a long time and sold it can appreciate that because sometimes that tax bill is surprising, when you have to recapture pay tax on all that depreciation you took, that’s all and all the gotchas don’t seem to terrible are the biggest things that stand out in my mind. Or I know if you’re a first time investor sitting on a good, good cash pile looking to really run the operations of a nosy fund. That sounds like a little little rich to buy it off, right? Especially the fact that you have to put in the property value, or improve it by at least the initial acquisition costs, right? That means that none of these projects are going to be light. rehabs, right? They’re all going to be relatively intensive overhauls. And the timeline of six months 90% deployment within six months, that’s, you have to know what you’re doing. This should not be your first rodeo in my mind. So yeah, all in all, the benefits definitely sound like they heavily outweigh the operational stressors, that that are the gotchas of the program that it does that kind of encapsulate your feelings and other folks, you know, who are in the opportunity’s own world. Is that the kind of the take on it? Yeah, well, we obviously feel it’s worthwhile because we’re doing it. So yes, we think that if properly structured and monitored and managed, right, the Ozy fund is well worth the effort.
Speaker 1
Was there anything at the outset? That kind of knocked you in the teeth unexpectedly? Or were you you know, kind of regimented in your due diligence and everything? You know, all the ducks were in a row and everything panned out? How you expected?
Speaker 2
Well, we were we think we knew what we were, we knew what to expect to some extent, but it was a brand new program, so everyone was feeling their way through it. With us, or now, I would say in retrospect, if someone’s gonna form the fun today, you just you really have to, there’s two things that you should evaluate. One is, how much is your game? You would invest in your own fund? And is that worth paying tax and legal advisors to set it up for you? And then is it worth you have enough in there to make material investments to you know, you’re going to be filing these tax returns, you’re going to be following these rules and the timelines. Is that all? Is the juice worth the squeeze? If it is, then then go for it. If it’s not, then you may want to consider investing passively in someone else’s fun.
Speaker 1
We think we hit the nail on the head with this one. Yeah, I mean, think I mean, I’m sure I breathe this stuff day in and day out. So I don’t even remember what was said and what wasn’t. But I feel I feel exponentially more educated on opportunity zones. I remember, for some reason, I remember a guy by the name of Josh Woodward, who’s our chief financial officer. years ago, whenever we first heard the word opportunity’s own at my day job at Lima, one capital, and he sent around this three page PDF that was this ultra high level, here’s this thing that’s coming out. So it’s, it’s interesting in my seven years in the real estate investment space on the lending side, interesting to see something go from concept to execution and hearing from you someone who is really all in on on this concept, being able to see soup to nuts start to finish and all the way through the program get launched, rolled out, you put dollars to work in opportunity zones and see the intent pan out into reality, it’s really a really a great ingenious way that has, seems to be making headway towards accomplishing the goal overall. So that’s a really interesting program. And something that is, is not just a, you know, a quirk in the tax code, it is something that is providing, you know, fair incentives, to incentivize investors to bolster up these neighborhoods. So it’s, it’s an incredible program, I’m really glad to hear your story from it.
Speaker 2
Yeah, and I think everyone wants to do good when possible. And but the definition of investment is, you’re looking to make a return on your capital. And so and we’re capitalists first and foremost. So in my opinion, the beauty of this program is that it pairs or levels, the playing field, or even enhances the playing field to do both. So you’re you’re able to achieve your investment goals. And at the same time, your investment is improving communities. And you’re not taking a haircut for that. No, you’re not, you’re not battling uphill, you’re not going against the wind, you’re getting incentivized to do it. So I think a lot of our investors, they want to make a return. But then they also like to feel it’s great to feel good about what the projects are doing too. So it’s not one or the other. It’s pairing those two concepts together, which is great. And I think I’ll need to wrap things up, I would, I would say, two things, I’ll go over a quick timeline of important dates that people should consider. And then also talk about as far as funds go, considerations, whether you’re starting your own or investing in someone else’s. So for fun considerations, there’s all kinds of fun sponsors out there. And so you want to look at track record, you want to make sure that whatever they’re doing, they’ve done it before, and opportunity zones being a new concept. Nobody’s been running an opportunity zone fund for 20 years. But what they’re doing with that fund, have they been doing that successfully? For a while, you know, so that’s first thing to look at? And then secondly, is what is the investment strategy? And again, is this is if you’re starting a fund, or if you’re looking to invest in another one? What’s that investment strategy going to be? What asset classes it and you know, what types of projects are they doing? So is it gonna be more of a commercial fun doing office buildings or hotels or retail properties? Or is it a multifamily fund? Or is it single families, etc. And similar to that, is the fun going to invest in a single asset, meaning one big project, or is it a multi Asset Fund is going to do several medium sized projects or maybe they’re doing several big projects, are they doing a whole lot of smaller projects and The reason that’s important to understand is because they have different risk profiles, a large prize, a single asset fund doing one large project that could turn out amazing, or it could turn out not so great. And it hinges on the success of that one project. So if you really believe in their investment strategy and their asset class, and you really believe in that one project, that might be a great fun for you to invest in, because if it goes, well, you could see an oversized return. But the opposite is true is that if it if it, if it’s something that it’s not going to fare well in an economic downturn, or there’s some risk involved in how that project is executed, then it could be a higher risk project for you. I prefer the multi asset strategy. So we spread our risk over a whole lot of smaller projects. And that gives us some diversification of geography. It gives us diversification of, you know, there’s contractor risk, and there’s tenant risk and lender risk, it just it spreads it all out. So just neither one is good or bad, but they’re just different. And you have to understand be comfortable with that. And then when you when you when you find a fund that you think you’re interested in, you want to obtain their offering documents and review those carefully so that you understand exactly what what the terms are. So an offering document typically be what’s called a ppm or a private placement memorandum that usually comes with an operating agreement of the fund entity and describes the business plan described usually will include disclosures or any conflicts of interest along with risks. A lot of that’s driven by the SEC, they require that you make all those disclosures, and it’s a good thing for the investor to read through those and understand fully what’s going on. It also should spell out the fees being charged by the fund managers, and also the returns and how proceeds are distributed. Typically, there’s what’s called a waterfall where there’s a prioritization of how money is distributed, there might be a preferred return that goes to the outside investors along with the return of capital. And then after that some kind of profit split. So it’s important how to how to understand how that’s happening so that you can compare apples to apples when you’re looking at different funds. And then there’s of course, minimum investment amounts that may be required, and a lot of funds will be restricted to accredited investors only. And that’s because of SEC rules. And what that means just briefly is that accredited investors are considered sophisticated financial individuals that have money that they can afford to lose. So the rules are restrictive to a lot of the population. Unfortunately, the reason for the rules is supposed to be to protect individuals who can’t afford to lose their savings on a discretionary investment. That’s the reason for it, but it ultimately keeps some investors on the sidelines. So it’s good to understand that typically an accredited the most two common types of accredited investors are folks with a net worth greater than 1 million after you exclude the primary residence, or high income earners, which are defined as single taxpayers with income over 200,000, or joint taxpayers with income combined income over 300,000. And then certain people that have securities licenses, for example, or different licenses are also considered accredited because they’re educated on financial instruments, regardless of their net worth or their income. And then employees, of course of the operators are also allowed to invest in the Fund. So and then bigger institutions, and there’s like a list of 10 others that are considered accredited categories, but those are the most common. So that’s a little bit about investment, selecting funds. And then if you got a question shoot Dalton, otherwise, I’ll just cover some important deadlines or timelines, and then we’ll call it a day.
Speaker 1
Thanks for carving out some time to really dive into the nitty gritty of the opportunity zone side of the fence. I think our first episode did a really good background on you and I’m really glad that we have this follow up to dive into opportunity zones I genuinely learned a ton and hope a know our listeners will as well. So thank you so much for joining again, Chris.
Speaker 2
Yeah, great, great to be with you adult and thanks for having me. And tax talk is not always the most exciting but hopefully our the listeners picked up on some good nuggets here. But it may not be the most exciting but everybody loves money especially I assume if you’re listening to this podcast, so very captive audience I think so important things with the old dollars and cents in the tax man so beautiful. Thank you for sharing your wealth of knowledge with us and I will see you out in Arizona at a conference in a couple weeks my friend.
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