There are many Qualified Opportunity Funds that encompass multifamily real estate and are well worth any investor’s consideration. Investing in multifamily property offers a wide variety of advantages for investors, such as leverage, cash flow, equity growth, and, tax savings. So what’s the forecast for these golden investment opportunities in 2022?

Scott Hawksworth is a co-founder of MultifamilyInvestor.com and an entrepreneur based in Chicago. MultifamilyInvestor.com covers trends and opportunities in multifamily real estate investing and helps High Net Worth investors, family offices, RIAs and financial advisors, and industry service providers navigate the ins and outs of the multifamily landscape.

Click the play button above to listen to our conversation with Scott.

Episode Highlights

• Financial features of a multifamily real estate investment.
• How do Opportunity Zones offer multifamily investing in tax-beneficial ways.
• What is the location criteria for investing in multifamily real estate and what are other considerations when searching for multifamily properties.
• What the future holds for multifamily investments in Opportunity Zones.
• What are the different forms multifamily real estate comes in.
• How can investors access institutional-quality real estate in the multifamily sector.

Featured On This Episode

• Scott Hawksworth on LinkedIn
• MultifamilyInvestor.com

Industry Spotlight: MultifamilyInvestor.com

MultifamilyInvestor.com covers trends and opportunities in multifamily real estate investing and helps High Net Worth investors, family offices, RIAs & financial advisors, and industry service providers navigate the ins and outs of the multifamily landscape.

Learn More About MultifamilyInvestor.com

• MultifamilyInvestor.com
• MultifamilyInvestor.com on LinkedIn

About The Opportunity Zones Podcast

Hosted by OpportunityDb.com founder Jimmy Atkinson, The Opportunity Zones Podcast features guest interviews from fund managers, advisors, policymakers, tax professionals, and other foremost experts in opportunity zones.

• Subscribe on Apple Podcasts
• Subscribe on Spotify
• Subscribe on Google Podcasts

Show Transcript

Jimmy: Welcome to The Opportunity Zones Podcast. I’m your host, Jimmy Atkinson. Multi-family residential real estate is the single most popular asset class for qualified opportunity funds and investors in opportunity zones. Novogradac estimates that $15.56 billion out of the $20.28 billion that they’re tracking, or more than 75% of the funds that they’re tracking, have at least some component of residential development. Here to join us today to discuss multi-family as it pertains to opportunity zones but also overall multi-family sector is Scott Hawksworth. Scott is co-founder of MultiFamilyInvestor.com, a property that I am co-owner in, and he joins us today from Chicago, Illinois. Scott, how are you doing, buddy? Welcome to the podcast.

Scott: Thanks for having me, Jimmy. I’m doing great, how are you?

Jimmy: Good. I’m doing very well, Scott. Always a pleasure to speak with you. We’ve known each other for quite some time, and I’m excited about the new property that we’re building together, MultiFamilyInvestor.com. So, we’ll talk a little bit more about that toward the end of the episode today, but first, let’s talk about multi-family real estate in general. And for most of our listeners, I’d imagine you’re kind of preaching to the choir here. I think a lot of people who listen to The Opportunity Zones Podcast probably have quite a bit of familiarity with real estate investing, and in particular multi-family real estate investing. Certainly, there’s some listeners who do not, but I would guess that the majority have some familiarity, but anyway, let’s talk about multi-family a little bit here. And why don’t you give us, Scott, your case for multi-family and why you think it’s a good investment?

Scott: Absolutely. So, I mean, you said it at the top, there’s clearly tons of interest in multi-family, specifically as it pertains to opportunity zones, some big numbers you mentioned there. But for me, you know, even looking outside of just in opportunity zones, multi-family investments I just find to be so exciting for a number of reasons. The first is just that opportunity for an attractive total return. And, you know, and this return includes ongoing cash flow and, of course, the potential for multiple liquidity events, which is always exciting. And then when you just kind of look at real estate itself, and you look at multi-family, you get this exposure to residential real estate, and we’re in a time where there are housing shortages across the United States, and that’s not changing anytime soon. There’s a little factoid I like to share here, construction of new housing in the past 20 years fell 5.5 million units short of long-term historical levels. This is according to the National Association of Realtors report. So, what that means is we are in this period of housing shortage where people need homes, and we’re just not building enough to meet demand, and that creates opportunity.

And then the third thing I always like to mention is that specifically when you’re looking at real estate, multi-family has proven to be the property sector that is most resilient to recessions, and that is according to a CBRE study. So, I know there’s so many people out there that 2008 is still on the mind and maybe they’re on the fence about it, but when you’re looking at resiliency, I think that’s really exciting. And then the other things I would add would be significant tax advantages. And I know, Jimmy, you would have a lot to say about that specifically when we’re talking about opportunity zones. And then, they can even function as a potential inflationary hedge as real estate asset appreciation can outpace inflation. So, those are kind of my why of multi-family investments.

Jimmy: No, I think that’s great, Scott. Yeah, I’ve always described multi-family as a very resilient and durable asset class. It’s the most essential real estate property type. You can do without retail, probably, you can do without hotel and hospitality, as we’ve seen through the pandemic, especially at the beginning of it, but you need a roof over your head. You need residential real estate and multi-family adds that density component that is much-needed throughout this country, as you mentioned, the housing crisis that we’re facing all over the country, and in particular certain areas of the country are hit worse than others.

I want to lock in on the tax benefits though because I’m a tax benefits guy, I started The Opportunity Zones Podcast and I’m a big OZ guy, so just to quickly review the OZ benefits for a qualified opportunity fund that invests in any type of asset, whether it’s multi-family real estate, or other real estate, or operating business, or maybe something else. Two big tax benefits now that we’re out of 2021, the 10% basis step-up benefit has expired, but still, two huge benefits are outstanding. One is a deferral of capital gains until the end of 2026, and two, as long as you hold the Opportunity Zone investment for at least 10 years, you get to eliminate capital gains tax liability on your opportunity zone appreciation, which I refer to it as probably the greatest tax incentive ever created. So, that’s the qualified opportunity fund wrapper, of course, and its tax benefits, which my listener are no stranger to. But, Scott, are there other tax benefits to owning multi-family residential real estate, or are there other wrappers similar to qualified opportunity funds that you can package multi-family properties into? Give us the lay of the land in terms of tax benefits as you see it.

Scott: Sure. Well, in terms of tax benefits, if you are a direct owner, and even if you’re an investor, of course, there’s depreciation that multi-family investments provide, which is nice to do that.

Jimmy: No, I’m glad you brought up depreciation. Sorry to interject. Because I forgot the hidden benefit of opportunity zone investing, which is…I’m up on my opportunity zone soapbox now. I love this wrapper, of course, Scott, you know that. Depreciation is fantastic until you go to sell a property, right, because that depreciation gets recaptured. But that is not the case with opportunity zones. Depreciation recapture is eliminated for opportunity zone investors, which is another benefit that doesn’t get talked about a lot, and I, frankly, almost forgot to talk about it until you mentioned it. But, anyway, go on, Scott, continue, please.

Scott: So, depreciation, and then, of course, if you are the direct owner of a multi-family property, you get those nice direct expense write-offs that you can take there. But then you were talking about wrappers, and there’s another wrapper here, the Delaware Statutory Trust, or the DST, which for those unfamiliar is an investment vehicle that’s organized as a trust that generates this passive income from real estate, and it allows investors to see the same capital gains tax benefits that they would get from a 1031 exchange without actually having to actively manage that replacement property. So, that’s really attractive for folks who maybe don’t want to go through all of the hoops to directly manage a property, which can come with some challenges. You can still see some tax benefits there.

Jimmy: Yeah, if you’ve been a 1031 investor and you need to 1031 out of a property but you’re kinda tired of the active management part of being a real estate property owner, you want to get away from the three Ts, right? Toilets, trash, and tenants, right, Scott?

Scott: Mm-hmm.

Jimmy: You can make this passive investment into a Delaware Statutory Trust, DST, yeah. That’s another great wrapper that I like as well. Not as much as opportunity zones, but it’s a good one, I’ll admit. Not for everyone, you have to be a 1031 investor, but if you are, it’s definitely worth looking into. What about some trends, Scott? Let’s move away from tax benefits for a minute. Let’s talk about trends that you see in the multi-family sector and your outlook for the rest of the year. 2022 has just kicked off. Where do you see this year and beyond taking the multi-family real estate asset class?

Scott: Sure. The overall outlook is very, very good. I’m so excited for it, and so many multi-family investors are excited because this housing shortage that I alluded to earlier is not going away, and in fact, it’s impossible to fix in the short term. We just can’t build enough homes to meet that demand. I have another statistic here. On average, the U.S. built 276,000 fewer homes per year than between 2001 and 2020 compared to the period between 1968 and 2000. So, we’re actually getting worse with it. So, again, that creates opportunity. So, look to the housing shortages to continue to exist.

And then when you look at that, you have to also look at population migration. And this is gonna continue to be really, really big in the multi-family space. When you’re looking at where are people moving? Over the past year and anything before that, we’ve had a lot of regions in the country that are benefiting from significant population influxes in really a variety of ways, and real estate has been part of that. So, there’s so much activity happening in the Southwest specifically as people look for warmer climates, maybe areas where there’s, you know, more friendly to business or lower taxes and these types of benefits. So, when you’re looking at trends and outlook on multi-family, a lot of these areas are seeing lots of builds, a lot of investment activity, and then these multi-family properties are filling up really quickly, and that, again, creates a lot of opportunity.

I’ve got another statistic for you here. So, there are low-vacancy rates in a lot of desirable locations that are across the United States. So, as of 2020, 9.7% of housing was vacant, which was down almost 2% from 2010. So, what that means is that there are actually these desirable areas where there are vacancies, so then there’s going to be prices rising. So, that’s really interesting there. Then you have metro-area growth. We’re looking, as I mentioned, we’re talking maybe Southwest, you’re looking at sort of Phoenix, cities like that. Lots of metro-area growth, which, again, creates more demand for housing, jobs, all of that, which kind of affects it.

And I want to talk about COVID-19 a little bit because this is really upended a lot of things, and it’s kind of shifted things. You know, even now, a lot of offices are allowing more work from home, they’re going remote again. This has really changed a lot about the way people are even thinking about their homes because they’re spending more time at home, their homes are needed to serve not only as a place where they can live but as a place where they can work. In fact, I’ve got a little statistic here on that. So, more people than ever before are working from home, and this recent industry report predicts that 36.2 million workers, or 22% of Americans, will be working remotely by the year 2025, and that is an 87% increase from before COVID-19. So, what that means is that, again, more people are reevaluating where they’re living. They’re wanting more space, they’re wanting nicer space. If I’ve got to sit at home and work eight hours, you know, you kinda look at your four walls and think, “Can these be nicer?” You know? “It sounds a little loud here, I can hear the kids in the next room. Can I get something…?”

Jimmy: Yeah, it makes multi-family even more essential, really. Or residential…

Scott: Exactly.

Jimmy: …as a larger asset class group more essential.

Scott: Exactly, exactly. So, I think that’s a really…when we’re talking about trends and outlook, that just is not showing signs of slowing down, and many people have really started to embrace the work-from-home lifestyle, and they like it, and they don’t want to give it up. So, I think what that means is residential real estate, and specifically multi-family, especially when you’re looking at population centers, places where there’s a lot of jobs and business activity, that’s gonna continue to increase and be a factor. And then also, I think that it’s created a lot more flexibility and movement, kind of tying back to that migration I was talking about. So, now there’s folks that can have…maybe they can have a Chicago-based job, but they only have to fly there a few times a year, and now they’re looking, “You know what? I want to go to a sunny place. I want to go to Arizona.” I keep hitting on the Southwest, but that, again, creates opportunity there.

And then the last piece, and I alluded to it before, is this is sort of inflationary landscape protection. We’ll talk about some of the episodes that I’ve had in a bit here, but when you look at consumer price inflation in the U.S., just an example here, it was 13.5% in 1979, which was the worst year since 1947, and dividend income from REITs traded through the stock exchange averaged 21.2% that year, and total returns amounted to 24.4%. Just throwing a bunch of numbers here, but the point is is that it can…real estate, and specifically multi-family, can help act as that sort of hedge with inflation. So, those are kinda the trends and the outlook and where things are gonna continue to go as we look to 2022 because I don’t see any of this slowing down. I see this activity only increasing, and I know, Jimmy, you can speak to the opportunity zones side of things and what’s happening there, of course.

Jimmy: Yeah, as I will throughout the course of the year and in the years to come as well. But, yeah, like I mentioned at the beginning and you did as well, Scott, this is a resilient, durable asset class. That’s why we like it so much. What about cap rate compression? We had a lot of cap rate compression in 2021, you know, what effect did that have on multi-family real estate investors, and are you expecting more of the same in 2022?

Scott: Yeah, the surprising thing is there’s been this cap rate compression, but it really is not slowing investors down. Yeah, you’ve got to pay a little more to get in, but kind of tying back to what you were saying, Jimmy, it’s resilient, and investors are looking for safe investments that can offer opportunities for greater return and they’re not shying away. They’re saying, “Well, this is what it’s gotta be.” We’ve had also some trends in terms of new builds. You know, it’s a bit more difficult to get materials and things for builds, but again, that’s not slowing down the activity because I think you just look at, yes, okay, we’ve got inflation, we’ve got prices going up, but that main aspect of the housing shortages, and the fact that no matter what the environment is, people need homes, is really not deterring investors. I don’t anticipate that will change over the next year.

Jimmy: Yeah, and with bonds and treasuries where they are, you know, probably I would say the next best alternative to get income, current income, is real estate. And I think that helps push up those prices and those values in not just the multi-family sector, but across the real estate asset class, but particularly the multi-family sector for some of the reasons we discussed. Right, Scott?

Scott: Yeah.

Jimmy: Well, let’s pivot now and tell us a little bit more about your story, Scott, and about MultiFamilyInvestor.com, which, you know, I disclosed in the beginning, I’m a co-owner in that property, you’re a business partner in that property, Scott. Give us the story behind that.

Scott: Yeah. So, obviously, I’ve worked with you for a number of years, and if you can’t tell, I’m a bit of a multi-family evangelist. I really do think that investor portfolios can benefit so much from really significant allocation to multi-family. And I’ve had a lot of experience over my career in hosting podcasts and really interviewing experts about a wide variety of topics. Most recently I’ve been the host of “PayPod,” which is a payments and FinTech podcast about financial technology. And I looked at the multi-family sector, and Jimmy, you and I had conversations, and I just realized what an opportunity it was, and I was excited to start a podcast, and a video podcast nonetheless, where I could really speak to folks making this industry run and doing exciting things in the multi-family world. And so, that kind of was the impetus for co-founding this with you, of course.

Jimmy: Good. Well, Scott, it’s been a pleasure catching up with you and learning a little bit more about multi-family and chatting multi-family with you, but before we go, where can our listeners go to learn more about you and MultiFamilyInvestor.com and the multi-family investor podcast?

Scott: Sure. So, MultiFamilyInvestor.com, you can go there. We have all of our show notes posted up there. We’re available on all the major podcasting platforms, of course, and it is a video podcast, so we do have a YouTube channel, and we’re gonna continue to release videos as companions to our podcast. And we’ve got some exciting episodes coming up where we’re gonna be talking all kinds of multi-family topics. We’re gonna talk about workforce housing, we’re gonna be talking to sponsors who are developing properties in some of those exciting up-and-coming and growth areas. And then we have a backlog of episodes, which have been fantastic. We’ve talked about tax lien investing in multi-family, we’ve talked about the macroeconomic case for multi-family covering that inflationary landscape that I was talking about earlier. And, of course, Jimmy, fans of you, if they want to hear more from Jimmy, you were on a couple episodes where we talked opportunity zones in multi-family. So, there’s a lot to cover there, and it’s all at MultiFamilyInvestor.com.

Jimmy: Fantastic. Yeah, and I was a guest on Scott’s podcast once, or actually maybe twice now, and I know you’ve got some qualified opportunity funds sponsors stepping up in the coming days and weeks that are gonna fill in and be guests on your show as well, Scott. So, yeah, if you like what we’re doing here at The Opportunity Zones Podcast, I think you’re really gonna like what Scott’s doing at MultiFamilyInvestor.com. Please go check him out. And for listeners of this podcast, as always, I will have show notes on the Opportunity Zones Database website. You can find those show notes at OpportunityDB.com/podcast, and there you’ll find links to all of the resources that Scott and I discussed on today’s show. And, of course, I’ll be sure to link to MultiFamilyInvestor.com as well as his YouTube channel. Scott, it’s been a pleasure, buddy. Talk to you soon.

Scott: Talk to you soon. Thanks, Jimmy.

ADUs (accessory dwelling units) have become more prevalent in recent years. Also referred to as mother-in-law suites, multigenerational units, and in-law units, ADUs offer both environmental and financial benefits for investors and tenants alike. Paired with a Qualified Opportunity Zone project, the advantages of ADUs are even greater.

Adam Stone is a licensed Real Estate Broker, member of the California Bar, and CEO and fund manager of ADU OZ Fund. He has expertise in various aspects of both residential and commercial real estate including acquisition, management, entitlements, litigation, joint ventures, municipal codes, and San Diego zoning and ordinances.

Click the play button above to listen to our conversation with Adam.

Episode Highlights

• Advantages of accessory dwelling units (ADU) and how to go about designing, building and funding ADUs.
• How ADUs can help with today’s nationwide housing shortage and soaring real estate prices.
• Why ADUs are increasing in popularity and why pair ADUs with opportunity zones incentives.
• The different types of ADUs, the benefits of each, and their potential impact on the property value and neighborhood quality.
• Laws around ADUs, specifically in California, and what to know about zoning regulations and restrictions.
• How to achieve the full tax benefits of ADUs and the specific tax incentives they provide.

Featured On This Episode

• Adam Stone on LinkedIn
• ADU OZ Fund LLC
• SB8, 9, and 10

Industry Spotlight: ADU OZ Fund LLC

ADU OZ Fund LLC is a Qualified Opportunity Zone Fund creating new affordable housing in San Diego and other desirable markets that targets and acquires 1–4-unit properties within zoning designations that allow the addition of multiple ADUs for more housing.

Learn More About ADU OZ Fund LLC

• ADU OZ Fund LLC
• ADU OZ Fund LLC on LinkedIn
• Email: info@aduozfund.com

About The Opportunity Zones Podcast

Hosted by OpportunityDb.com founder Jimmy Atkinson, The Opportunity Zones Podcast features guest interviews from fund managers, advisors, policymakers, tax professionals, and other foremost experts in opportunity zones.

• Subscribe on Apple Podcasts
• Subscribe on Spotify
• Subscribe on Google Podcasts

Show Transcript

Jimmy: Welcome to The Opportunity Zones Podcast. I’m your host, Jimmy Atkinson. Joining me today on the podcast is Adam Stone. He is a real estate attorney, broker, and now fund manager of ADU OZ Fund, a qualified opportunity zone fund that uses accessory dwelling units as an option to complete value-adds for multifamily residential projects. Adam joins us today from San Diego, California. Adam, welcome to the show.

Adam: Hey, Jimmy. Thanks for having me. I’m a huge fan of the show.

Jimmy: Awesome to hear. Adam, thanks for joining us today. Pleasure to be with you. This is the first podcast interview that I’m recording in 2022. We’re in the first week of January here. So, New Year, new podcast episode, looking forward to seeing what this year brings for opportunity zones. But let’s turn to you now, Adam, and focus on your fund, which features accessory dwelling units, or ADUs. It’s the first such OZ fund that I’ve come across. So I’m curious to learn more about it during the course of the episode today, during the course of our conversation, but to start us off, a very basic question. What is an accessory dwelling unit exactly?

Adam: Sure. Well, an accessory dwelling unit, ADU for short, is a separate dwelling area on the same property as a primary detached home. Generally, they’re up to 1200 square feet. And I think people are familiar with them. If you’ve ever watched Fresh Prince of Bel-Air, Will and Carlton, they live down in the pool house. That’s an accessory dwelling unit. If you watch “Happy Days,” the Fonz, where he lived, above the garage, that was an accessory dwelling unit. Now, the regulations and laws in California and other areas of the country have opened up to such a point where value-add in the development space, through the use of accessory dwelling units on single-family residential properties, is creating a large market for what we’re looking to do. And we’ve already had some success with that process already. So we’re excited to create a qualified opportunity zone fund to incorporate that model into what we’re already doing.

Jimmy: That’s great. Yeah. So, essentially, it’s oftentimes a guest house, or a pool house, or a carriage house, or maybe an extra apartment that’s built up above the garage, just anything like that. So we’ll refer to all that generally as “ADU” throughout the course of today’s episode. So, you touched upon this in your last answer, but the bigger macro picture, Adam, is that there’s a housing shortage in this country. And we’ve covered that topic on several previous episodes of The Opportunity Zones Podcast, and particular areas of the country have bigger housing needs than others. And California is certainly no exception to that fact, especially lower-income housing, affordable housing, workforce housing. And oftentimes the solution is we just need higher-density housing in a lot of these locations. I think ADUs help provide that. Can you add some additional color there, though, Adam? How else can ADUs help to address that issue?

Adam: Sure, Jim. I mean, you hit it right on the spot in terms of the housing needs and the crisis that the whole country is going through. And I think accessory dwelling units just provides another option, another tool for addressing that situation, addressing that problem. You know, in terms of what we’re doing in San Diego and what the laws allow, you know, like you mentioned, there’s the ability to convert garage space, and even, if you have a piece of property that has a larger lot, and there’s space on that property to build out, you can build in accessory dwelling units. And it does just provide another option for people who want to, you know, help build in those new living spaces, those new areas, for all sorts of people who are needing it. You mentioned affordable workforce housing. We’ll talk a little bit more about that. But yes, I mean, it’s just another tool, an option. I think it’s a great way to add in value for people looking to help address that issue.

Jimmy: And has there been a push by certain communities around the country, and maybe you can speak specifically about San Diego, because I know that’s where you are now, and that’s where your fund has some focus in? In terms of changing the local regulations and zoning laws to allow for this, what exactly is unfolding in that regard?

Adam: Since the start of 2020, you know, we’ve had laws across the state that have opened up the ADU development space. And San Diego has been at the forefront, I would say, in terms of creating laws that allow for ADU development in areas that have the highest density issues, and have the highest need for affordable housing and affordable rents. And they even allow for some of the regulations to not only serve as a tool to create rentable ADUs, but also ADUs that can be, you know, sold and resold to the community, depending on the involvement of nonprofit organizations. So, you know, I think with the creation and enactment of SB8, 9, and 10, and for those who don’t know, that’s state bill, Senate Bills 8, 9, and 10, in the state of California, those are even more expansive regulations, that allow for the development of single-family housing, and provide for more avenues to bring in units and bring in solutions for this growing problem.

Jimmy: Good. And I’ll be sure to link to those Senate bills, California Senate bills 8, 9, and 10 in the show notes, for today’s episode. And as always, you can find those show notes at opportunitydb.com/podcast. What does it typically do to the value of the property? Let’s say the case of a single-family home, there’s a little bit of room on the property to develop an ADU, maybe a guest house or a pool house, you know, what have you, to increase the density, and maybe add another bedroom and bathroom to the property in an ADU. How does that affect the value of the property, typically?

Adam: You know, it’s just a common answer from an attorney. It all depends. It comes down to redeveloping something in your backyard, where you’re building ground-up, then you’re gonna add in the most value compared to maybe an area in your house that could be walled off and turned into its own separate space, which is called a junior ADU in a lot of areas in San Diego, junior accessory dwelling unit, or if you’re converting a garage, and doing the garage conversion. But just to give you a small example, we have a project right now that is in the first phase of two phases of accessory dwelling unit value-add. And the first phase was taking the existing home, a two-bed, one-bath property, with an attached garage, rehabbing the home, and then extending the garage out slightly to create its own ADU in that garage, converting the garage into a two-bed one-bath accessory dwelling unit. The original purchase price for that home was about $385,000. We’ve had appraised value for just the duplex, or I should say, the ADU conversion, at about $775,000 closer to $800,000 just for the rehab and the conversion there. So, you know, there is a pretty significant increase in value, especially if you’re doing it in a way that’s, you know, rehabbing existing structures, or adding in new value and new square footage to the property.

Jimmy: Right. Yeah, that’s pretty substantial return on investment, then. Pretty substantial value increase. In some ways, I would imagine you could pretty quickly add on some sort of ADU to the home, and then just flip it and get out within a year or two if you needed to. But I would imagine, turning our attention now to your opportunity zone fund, that you wanna have a longer holding period within your ADU OZ fund. But correct me if I’m wrong, and also tell me a little bit more about your fund. What’s your investment thesis exactly, and what are you doing within your fund?

Adam: Right. I appreciate that. And I think the idea of taking that strategy of finding properties that have that value-add potential, we are looking, like I said, the first phase of these projects is taking the existing structures, within the fund, of rehabbing those structures, getting those to a livable, rentable status. But then from there, a lot of our projects that we target are able for an additional significant value-add on their open backyard space. And taking that same example, I mentioned the home with originally a two-bed one-bath with a garage, now through the first phase, the home is now a three-bed, two-bath, with the two-bed one-bath accessory dwelling unit. In the backyard space, the second phase is to add in eight additional one-bed, one-bath units, that would allow for us to go from having one unit originally now to having 10 units. And then, from there, you know, holding that property, cash flowing through the rental income, for the eventual sale exit, after the 10-year hold is established, to get the step up in tax basis. So we’re using that as a way to, again, bring in, you know, the accessory dwelling units, but do it in a way that provides value for our investors and then the community as well. Because these properties are going to incorporate parking, incorporate outdoor community spaces, and things like that. So it’s adding units in a way that doesn’t add in unnecessary congestion.

Jimmy: Oh, okay. That’s pretty substantial then. You’re essentially taking a single-family home with a large backyard and you’re converting it into a multifamily property, in some sense, if I understood you correctly.

Adam: No, that’s correct.

Jimmy: Okay. Good. Tell us a little bit more about your fund. How much are you raising? What areas are you focused on, and what types of property types and rates are you targeting?

Adam: In terms of property types, again, we’re looking at the residential mixed-use space. And then, from there, we are looking for investors who have at a minimum of $50,000. But our raise, initial round, would be $25 million, with a max raise of $250 million. So, within that time span, we’re looking to acquire properties that fit that model in terms of the value-add space, not only in San Diego. We have other markets that we’re targeting. I’m originally from the Ann Arbor, Michigan area, Detroit area, so, you know, there are opportunity zones in those areas that are very attractive. My partner, Matt Williams III, he has a development background in the Atlanta and Dallas area. So, you know, we’re targeting those areas as well, and have some projects that are already in mind for potential expansion.

So, I think the whole idea for our fund is to add dwelling units, not only through accessory dwelling units, but the housing options that fit that market. So, you know, I think we will see accessory dwelling units continue to expand in their regulations across the country. But, you know, until they catch up in other areas, I think there are definitely options that still fit what our fund’s mission is, and adding in those units in a way that provides not only more housing for rentals but, again, more housing for new homeowners, homeowners that wouldn’t have had an opportunity to be homeowners unless there were funds like this and developments like this.

Jimmy: As you mentioned four different markets, San Diego, obviously, and then you also mentioned Ann Arbor, Dallas, Atlanta, what do you like about those particular markets?

Adam: They all share some of the same characteristics in terms of different demographics and sizes, but they’re all areas that are highly sought after. They’re seeing growth and, you know, continued growth in a way that is driving prices up to heights, you know, there’s just new for those areas. So we’re seeing those… You know, Dallas, in particular, they’re starting to incorporate more ADU laws into their own regulation. So, again, that provides even more value for potential developments, you know, things that could have been subdivision build-outs in the past, that might now turn into subdivisions with accessory dwelling units incorporated into it. Again, more value added to the property, more housing added, you know, immediately, to provide for the community’s needs. So, yeah, I think those four areas all serve as areas of high need, just based on their growth, and places that we’re comfortable with and have seen the growth over a span of 10, 20 years, sometimes.

Jimmy: The congressional intent of the opportunity zone legislation in the first place was really to help spur economic activity, and social impact, really, in a lot of economically downtrodden areas throughout the country. How is your fund and the projects that you’re developing helping to deliver on that promise of creating social impact?

Adam: You know, we’re looking at it for three areas, not only just adding in the housing, but also through the job creation that comes into play from the construction, and the ancillary businesses that are going to be necessary to support more of the community. We have our own ideas in terms of what some of those businesses would be, to help serve the community and also fill needs that are already there. But at the same time, I think, in the end, if you’re adding the housing, bringing in the job creation, both through the construction and the ancillary businesses, and then, on the other end, one area that we’re looking to build more support for, and hopefully, these are some changes that we see with the opportunities zone tax laws down the line is just the ability to incorporate more community involvement at the investor level. And I think that’s something that’s important to us too, because we definitely want involvement at all levels, and want people to share in the growth that should happen, and using the fund.

Jimmy: Did you say that was a law that you’d like to incorporate some of that additional community involvement?

Adam: I think in, just in terms of some of the possible changes and ways to expand and open things up. I know that in some states, I believe Ohio is one state that has allowed at a state level to give at least some benefit to the opportunity zone investment for people who aren’t using capital gains. So I think that’d be an area that if possible we could, let’s say, incorporate in California, or find some way to get, help build in involvement from the community as a whole.

Jimmy: Yeah, I think there’s a lot still left to be written in the story of opportunity zones. I do think some additional changes to the law, and changes to some of the regulations could help open it up a lot more. So yeah, that’s an interesting idea, I think, there, Adam. Well, what can you tell us a little bit more about the team at ADU OZ fund? You mentioned your partner, Matt Williams, briefly, a few moments ago. Give us a little bit more background on him, and on yourself as well, and the experience that you two have.

Adam: Okay, yeah. Matt is, he’s a retired military veteran. He, since serving in Afghanistan and being active, he has been in the development space. And like I mentioned, he has familiarity and success in multiple different markets. I mentioned Dallas and Atlanta, but also areas in Pennsylvania, obviously, in San Diego, other parts of California. So, he’s definitely the construction development manager in terms of knowing how to execute these projects and put them together. On my side, I have a background as a real estate and business attorney. I’m also licensed as a real estate broker. So, you know, I really focus on knowing how to navigate the laws, and combine the different areas of local, state, and federal law, to try to synthesize a formula that fits our model, and that’s compliant with what’s out there, but also allowing us to take advantage of the laws and codes that are designed to spur on this type of development. So, you know, I think we create a great team. Outside of that, you know, we do have, we keep a very experienced staff of experts and consultants at the ready, and they’re on our chain, just in terms of helping us navigate the opportunity zone tax laws, and just design and build out our projects in general.

Jimmy: Good. Turning back to your fund for a moment now. You just launched it, just within the last few days, end of 2021, or maybe beginning of 2022 here. You’re raising $25 million. What types of properties have you already identified? What does your pipeline look like exactly?

Adam: So, right now, we have a couple infill lots that we’re redeveloping. Those are already under contract, and more are working towards just the design for what the build-out would be on those. And then, I believe I mentioned earlier, in the Atlanta region, we have some connections to a subdivision that is located with an opportunity zone that is needing to be finished off, built out. And that’s another area, again, that we would look to potentially bring in the use of accessory dwelling units if it made sense. But, you know, in the San Diego space, we have multiple other projects that are in the pipeline, that fit that larger-lot, mixed-use or single-family zoning designation that is primed for value-add.

Jimmy: And, wanna speak about some of the challenges now with managing and raising money for an opportunity zone fund. It’s a heavy lift, just doing the types of development that you’re undertaking to begin with, but then you’re also layering the opportunity zone tax benefit on top of it. And you’re also dealing with a lot of local regulations and zoning laws as well, and local tax incentives and tax benefits. What have been some of your biggest challenges so far in terms of getting this fund up and running, and developing these properties and raising money?

Adam: No, that’s a great question. I think, like you said, there’s a lot of different areas and directions to go into, to really cover all of your bases in terms of building relationships, and making sure you’re covering those different levels that, the need that you want to make sure the fund moves in the right direction. I think, for us, we see it as a challenge but a opportunity to put together different collaborations that may not have always been used or utilized to put these types of projects together. For example, we are working with nonprofits and other organizations that could immediately use this housing to build support and traction for the projects, that would allow, you know, in a sense, for it to gain some more familiarity and comfort with this type of accessory dwelling unit value-add.

And, you know, I think just in general, accessory dwelling units have met some negativity from people who may not want them in their neighborhoods, but I think it’s impossible to deny the need for housing. So, you know, I think what we’re looking to put together, and how we’re looking to execute, you know, that’s why I mentioned earlier, the need for adding in parking and adding in some of those community amenities that allow us to say, hey, you know, we’re looking to address this problem. We’re looking to provide a resolution to this situation that really fit this need, but at the same time, doing it in a way that still is conducive to a quality neighborhood, and building community in a way that helps revitalize it.

Jimmy: Very good. Well, Adam, it’s been a pleasure speaking with you today and learning more about accessory dwelling units and your ADU OZ fund. Before we go, though, can you tell our listeners where they can go to learn more about you and the ADU OZ fund?

Adam: Sure. Thanks again, Jimmy, for having me on the show. For all the listeners who wanna get more information, please, you can reach out to us at info@aduozfund.com. Visit our website at www.aduozfund.com, or you can even reach out with a phone call at 619-704-2477.

Jimmy: Perfect. And for our listeners out there today, I will, as always, have show notes for today’s episode on the Opportunity Zones Database website. You can find those show notes at opportunitydb.com/podcast. And I’ll be sure to link to all of the resources, and I’ll even list that phone number as well, that Adam just gave, and all the other resources that Adam I discussed on today’s show will be linked there as well. Adam, thanks again for joining me today. Been a pleasure.

Adam: I appreciate it. And one more thing. I did wanna mention @aduozfund is our Instagram handle. Please follow us, and we’ll keep you updated on our projects and our progress for everything going on.

Jimmy: Fantastic. And we’ll link to that in the show notes as well. Thanks, Adam.

Adam: Thanks, Jimmy. Appreciate your time. Thank you.

Impact investing is an investment strategy that strives to generate social or environmental benefits in addition to financial gains. It also spans diverse range of assets, including bonds, public equity, and private equity, such as opportunity zones and New Market Tax Credits. But how does impact investing work, and how might one select a specific fund to invest in?

Reid Thomas is Chief Revenue Officer and Managing Director of JTC Americas, the North American division of JTC Group, where he is responsible for overseeing the day-to-day operations of the Specialty Financial Administration business unit.

Click the play button above to listen to our conversation with Reid.

Episode Highlights

• Information about JTC America’s survey on the impact investing elements of opportunity zones.
• Investment types that are highly specialized and with a focus social and economic good.
• How to identify investment activities that can create an impact based the social and/or environmental issues they want to address.

Featured On This Episode

• Reid Thomas on LinkedIn
• JTC Americas
• Impact Investment Survey

Industry Spotlight: JTC Americas

JTC Americas, formerly NES Financial, is the North American division of JTC Group. JTC is a publicly listed, global professional services business with deep expertise in fund, corporate and private client services.

Learn More About JTC Americas

• JTC Americas
• JTC Americas on LinkedIn

About The Opportunity Zones Podcast

Hosted by OpportunityDb.com founder Jimmy Atkinson, The Opportunity Zones Podcast features guest interviews from fund managers, advisors, policymakers, tax professionals, and other foremost experts in opportunity zones.

• Subscribe on Apple Podcasts
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Show Transcript

Jimmy: Welcome to The Opportunity Zones Podcast. I’m your host, Jimmy Atkinson. And today we’re discussing impact investing and an upcoming impact investing survey. Joining me today to discuss this is Reid Thomas, Executive Vice President of Sales and Marketing at JTC Americas. They are the organizer of the survey that we’ll be discussing today, and they’ve partnered with me and my team at OpportunityDb to bring this survey to the industry. Reid, thanks for joining us today. I believe you’re joining us from San Jose if I’m not mistaken. Is that right?

Reid: That’s right, Jimmy. And it’s always a pleasure to be here. Thanks for having me on again.

Jimmy: Yes. A pleasure to have you on the podcast. You’re one of my most prolific podcast guests. You’ve been on a few episodes with me. I’ll be sure to link to all of your prior appearances on The Opportunity Zones Podcast in the show notes for today’s episode. So let’s talk about the impact investing survey that JTC Americas is organizing. First, what is it exactly, and why are you doing it?

Reid: Yeah, what we’re really doing is putting together…we’re doing a survey in order to put together a market research report that really focuses on the impact investing elements of the opportunity zones. And it’ll extend beyond that but opportunity zones is obviously the homebase for this. And the reason we decided to do this is because it’s no secret that the future of the opportunity zones program depends really on the perceived success that the initiative is gonna have in terms of delivering the economic results to communities in need. I mean, Congress has been all over that. That’s the rhetoric we hear consistently. There’s quite a few versions of legislation that have been introduced to propose measurement of impact and impact reporting. All of the different industry groups and various stakeholders are behind that initiative as well. So, what we really wanted to do was use this survey to develop research to really help the industry understand what’s going on in terms of investor motivations, as well as sponsor desires.

Jimmy: And I’m curious now, who are you expecting to take the survey? Are you surveying the different product sponsors, fund managers, whatever you wanna call them, or are you surveying investors or a little bit of both? Who would you like to have take the survey?

Reid: All of the above. One of the things we’ve observed is that we’re seeing fund managers, in particular, starting to shift to promote the impact elements of their funds more aggressively. And that’s what got us started on this. That’s a trend that we’ve seen across our client base now of over 200 opportunity zone funds. And so we were curious when we saw that as to what was behind that. And so we interviewed several of our clients to put the structure of the research report together, the survey together. So, part of the questions were oriented at additional sponsors to really learn what their views are on the importance and relevance of impact, how that plays into their fund formation strategies and investor recruiting strategies. On the other hand, investors were very interested to learn what investors are looking for and how this all connects. So this is one of the real important reasons why we’ve partnered with your firm, Jimmy, because you guys do such an excellent job of communicating with the community that’s out there. By partnering with you, we can get a really good perspective, not only of what fund managers are trying to do but what investors are trying to do. And hopefully, by connecting those dots, we can help fund managers design and develop products that are better suited for investors and we can help investors find the types of investments that they’re looking for.

Jimmy: Yeah, I think in some ways, we’re trying to get to the bottom of, I don’t mean to put words in your mouth, Reid, so push back against this, if I misspeak here, but I think we’re trying to get to the bottom of, is impact investing important to the investing community? And if so, why? And so then how can investment product sponsors or fund managers better market their products to drive home that point? Is that right? Is that kind of what we’re getting after here?

Reid: Not only is that spot on, but in addition to that, we’re looking for more detail than even that. So as an example, how do investors prioritize the impact elements of their investment? What kinds of trade-offs might they be willing to make, if any, in terms of an investment yield for certain elements of impact? What kind of reporting are they looking for along the way that the sponsor could provide? Those are the kinds of things that we think will be really, really helpful. But at a high level, you’re absolutely right, that’s the goal.

Jimmy: What other types of questions are you asking on the survey?

Reid: Yeah, those are types of questions, those are good examples of questions as to what we are definitely doing. We’re also asking lots of questions for fund managers in terms of their current fund structures, the types of things that they’re investing in, how they’re measuring and tracking the impact of the investments they’re making, those types of things. So it’s really a comprehensive survey. I think, in total, it’s about 25 or 30 questions. And we’re sending it out to enough people and we’re hoping to get lots of responses so that it’ll be certainly statistically valid, and something we can slice and dice in various ways together to provide the industry with some really meaningful information.

Jimmy: Yeah, the survey is open now, and we’re helping you promote it because we’re invested in learning the answers to a lot of these questions. And we’d like to hear from as many investors and fund sponsors as we possibly can. So, if you are interested in learning more about the survey, you can head over to opportunitydb.com/survey to learn more and to participate. Reid, I wanted to ask you about JTC Americas. I know you’ve been on the podcast several times before. You and I know each other quite well. We’ve known each other for a few years but for those who may be unfamiliar with JTC Americas, can you tell us a little bit more about your firm, its history, and what you guys do exactly?

Reid: Sure. So JTC is a global company. Actually, we’re a $1.5 billion market cap company traded on the London Stock Exchange. We have offices in 23 countries around the world. About half the business is a private wealth, private client business, and the other half is administrative services, like fund administration. So JTC Americas, we’re really focused on providing fund administration services to investment types that are highly specialized and really have a focus on ultimately doing good. You know, there’s been so many financial initiatives and incentives created over the years with good intentions, but far too often they fail to ultimately achieve the goal that they’re intending to. And one of the reasons for that is because the administrative burden can just be so huge by trying to provide all the data everybody wants, trying to meet all the regulations or compliance standards. These burdens can be just too much to allow the initiative to ultimately succeed. And in some cases, when there’s not enough of that stuff, then the system or the initiative gets abused, and it fails in that way. So, our approach was to really develop our own technology, which we use to do the administrative services to both protect against abuses and fraud, protect investors, protect fund managers, and at the same time, make it easy for them to comply with all the regulations and standards that are out there, including just basic financial reporting, financial statements and the like. You mentioned, we work together a lot, really in the opportunity zone space, because that’s an area that obviously, is a financial investment vehicle that has a lot of complexities, but it’s intended to do good and we wanna help see that through.

Jimmy: Yeah, your firm was perfectly positioned to capture a lot of those funds that needed that type of professional services, that fund administration platform that you have. When we’re talking about impact investing, especially with this impact investing survey that we’ve been discussing since the top of the show, what type of impact reporting does your fund administration platform offer for private equity funds or opportunity zone funds specifically?

Reid: It’s interesting because when we were building our product, we looked for solutions that we could implement that aligned with sort of the types of work that we would have to do anyway to provide the financial accounting, financial reporting services. So what we developed, we developed on our own. We also partnered with Howard W. Buffett, who’s famously the grandson of Warren Buffett, who has developed a way to report financial impact called Impact Rate of Return, that we could create an algorithm to work with. And so, by doing the fund accounting that we’re doing anyway, we can provide sort of standard information, like, what is the Impact Rate of Return, sort of to Howard’s formula, ut we also can calculate jobs created, labor income generated, taxable revenue generated for the community. We can track those kinds of things as just standard practice. In addition, we created the ability to have it be customizable because everybody has their own sort of passion for something, right? So, if the investment strategy is really oriented at improving education, there’s a way we can configure the solution to report on various education-related metrics. So we’ve been involved with a number of very, very interesting projects with all kinds of interesting goals, and we’re excited about using that system to help them achieve it. And then the reporting is something that’s online, available in real-time that the funds can use and to help them market their successes. Investors can track progress and something that’s available to all of our clients today.

Jimmy: No, that’s great. It’s great work that you do. And I know you represent a lot of qualified opportunity funds that are open and receiving capital and closed funds as well. You represent a lot of the industry is what I’m trying to say. I wanna get back to the survey for a moment. Actually, let’s zoom out and take a look at impact investing as a whole before we do that. And maybe I’m about to ask you a question that you’ll say, “Well, I don’t know. I gotta wait until the survey results come in,” but I’m curious if you do have any idea. I guess a two-part question for you, Reid. One, do you feel that there has been a trend toward impact investing from investors over the last several years or over the last generation or so? And two, why do you think that is if that is the case?

Reid: Certainly the data supports that that’s a trend. Impact investing is, I suppose, one class of the broader ESG investing definition. ESG, as a category, has exploded in the last years, it is extremely high profile, and the data would suggest that ESG funds actually perform…funds with an ESG focus or investments in firms with an ESG focus have a more positive…ultimately a more positive return. And so the market has been growing like crazy. This is particularly true, we find internationally, the European markets are further ahead, I would say than the U.S. is, in terms of its investing emphasis in this area and in terms of the reporting requirements. There’s much more governance and compliance sort of reporting standards in Europe. But the U.S. isn’t that far behind. And I think part of it is driven by just the shift in our demographic. It seems that this is…climate change, as an example, social impact, helping other communities, these are the things that have come to bear, I think, both from a generational perspective, as younger people mature, this has been something that’s front of mind for them. And now that they’re of age in many cases where they can make investments, they wanna help. Also, the pandemic that we’ve gone through for the last couple of years has certainly heightened awareness of folks who are challenged in some of these communities and could really use some help. So it’s becoming a big deal. It’s continuing to gain momentum. And I don’t think there’s gonna be any slowing it down. And in fact, I think just like we’re talking about in OZs about having some level of reporting related to the impact benefits of the investments, I think we’re also gonna see even at an SEC level, more diligence and more focus on making sure that ESG metrics and ESG reporting actually stand up to what they’re saying.

Jimmy: Yeah, particularly, if that was the intent of Congress when passing some of these laws that created some of these tax-advantaged investment vehicles, opportunity zones, being the elephant in the room here, of course, that we’re discussing right now, I think it’s important that at some point, we as an industry are able to prove that, hey, yeah, this is actually creating some impact. And in some of these places, it is doing the work that Congress intended to do. Absolutely, Reid, I couldn’t agree more.

Reid: Yeah, I think in terms of, you know, why this is happening, that’s one of the…bringing it back to the survey, going that next level down to try to look at the specific motivations of investors and what determines which impact investments they might pull the trigger on versus others is really where we’re trying to go with this survey, ultimately, right, to get it to a much granular level to help fund managers actually decide how to implement and structure funds in a way that can be most successful for everybody.

Jimmy: Right on. And the survey is open right now and it’s gonna close fairly soon, I believe. But once all the numbers are crunched and you’re able to put together a report, is that report going to be made public to anybody who wants to get access to it?

Reid: Yeah, that’s our plan. Definitely, those that respond to the survey, of course, all the responses will be anonymous and private, but on an aggregate, we’ll make the data available to those that participate. And we’ll also, through your help on your website and other marketing events, let folks know how to get that information.

Jimmy: Very good. Reid, well, like I said, the survey is open right now. And we are working with JTC Americas to help promote it and drive some response to it. So if you are an opportunity zone fund sponsor, or issuer, or if you’re an impact investor, or OZ investor, however you identify yourself, we would love it if you could help us out and take the survey. You can learn more by heading to opportunitydb.com/survey and there you can learn all about how to take the survey and how long it will be open for. And actually, if you’re listening to this podcast, maybe a few weeks after it’s aired, the survey may already be closed, but then you can opt in there to learn more about how to access the conclusions from the survey. So, either way, head to opportunitydb.com/survey to learn more. Reid, it’s been a pleasure speaking with you today. Appreciate your time.

Reid: Always a pleasure, Jimmy. Thanks so much for having me on. And thank you to your listeners for listening.

What happens to opportunity zone capital if the qualified opportunity zones fund sells? And how does reinvestment of those proceeds from that sale occur before the end of a 10-year holding period? These questions and more present unique opportunities for alternative investment options with significant tax benefits.

Jeff Feinstein is a Managing Partner at Pinnacle Partners, a joint venture equity real estate investment firm investing in opportunity zones.

Click the play button above to listen to our conversation with Jeff.

Episode Highlights

• Who is eligible to benefit from the OZ tax incentives.
• What gains are eligible for deferral, when investments in Qualified Opportunity Funds (QOF) must be made.
• How to transact a sale and recycle the original gain within an OZ investment in order to maintain qualified opportunity zone investment status.
• How qualified opportunity funds can remain an option for deferral of capital gains within noted time frames.
• Timeline of the tax benefits, operational requirements of the fund, and exit strategies.
• Multifamily as the largest asset class within the opportunity zone wrapper.
• How to achieve the full tax benefits in the 10-year hold period.

Featured On This Episode

• Jeff Feinstein on LinkedIn
• Pinnacle Partners
• Novogradic
• Schedule K1

Industry Spotlight: Pinnacle Partners

Since the inception of the Opportunity Zone legislation, Pinnacle Partners has been actively identifying and participating in qualifying real estate projects in attractive urban designated Opportunity Zones. Pinnacle is a source of strategic relationships for JV Partnerships with actionable opportunities in targeted Opportunity Zone markets.

Learn More About Pinnacle Partners

• Pinnacle Partners
• Pinnacle Partners on LinkedIn

About The Opportunity Zones Podcast

Hosted by OpportunityDb.com founder Jimmy Atkinson, The Opportunity Zones Podcast features guest interviews from fund managers, advisors, policymakers, tax professionals, and other foremost experts in opportunity zones.

• Subscribe on Apple Podcasts
• Subscribe on Spotify
• Subscribe on Google Podcasts

Show Transcript

Jimmy: Welcome to The Opportunity Zones Podcast, I’m your host, Jimmy Atkinson. Today we’re gonna be talking about recycling OZ capital, what that means and how reinvestment of proceeds from an OZ investment can still keep its status as a QOF investment not lose any of the associated tax benefits. Joining me today to discuss this topic and more is Jeff Feinstein. Jeff is managing partner at Pinnacle Partners, and he joins me today from Seattle. Jeff, welcome to the show.

Jeff: Hello, Jimmy. I’m very pleased to be with you.

Jimmy: Fantastic. Pleased to have you here with us. Jeff, we just did a webinar just a few days ago and that went quite well, I think, and we’ll touch base on that a little bit later in the show today and discuss your new opportunity zone fund. But first, I wanted to talk about the concept of recycling opportunity zone capital. If a deal inside of the qualified opportunity fund ends up getting sold, what does that mean? How does reinvestment of those proceeds from that sale…and in this case, we’re contemplating a sale before the end of a 10-year holding period. What happens next so that those proceeds don’t lose the status as a Qualified Opportunity Zone investment for your LPs?

Jeff: Yes, so maybe some context and background. Pinnacle Partners has been an early mover in the execution of the OZ legislation. We seized upon this in ’17, as it was being legislated with support from tax and legal advisors, and OZ compliance experts, we were able to execute as early as 2018. It was 2019 when the regs were finalized, but all ambiguity was removed. But again, we took a little bit of risk but I think it was a calculated risk to get involved and execute early. And so indeed, we are a JV equity investment firm dedicated to OZ investing. We seek the highest quality projects in those zones, working with best-in-class developers. So we become the LP equity, the qualified equity to capitalize an OZ the project.

Having said that, because we represent our investors and we’re, you know, stewards of their capital, we’re desirous of, one, delivering the highest rate of return, two, ensuring that all investors enjoy the associated tax benefits granted by the OZ legislation. And we think, and I think you agree, these are the largest tax benefits to investors that the U.S. government has ever provided. So, the most significant of those benefits include tax elimination, which is accomplished after a 10-year holding period. There are many other compliance requirements that, of course, you’re well aware of that include substantial improvement. But suffice it to say the tax elimination, or qualifying for tax exemption after the 10-year hold, is extraordinarily compelling.

So, with that as background, and again, acting as a steward for our investors, we provide the optionality to exit early from an OZ if our investors provide supermajority consent, and of course, you might imagine this has to be, frankly, a compelling and substantial return opportunity for all of our investors. So, the first project that we partnered and capitalized was a workforce housing project in the Seattle Historic District. It was positioned to be supporting, we call it kind of 60% to 75% area medium-income renters who wanted to live near work and have a multitude of transit options. And we were providing housing in this particular sub-market that’s otherwise sparse. So, the investment thesis had an impact orientation and solid returns for sure. So, we were delivering workforce housing to this important sub-market.

We had permits, we broke ground, we went vertical on the site, and we were nearly completed when we received an unsolicited offer from our county jurisdiction, that is King County, who in an effort to support those that can’t obtain housing so readily if not homeless, they have been acquiring assets to provide transitional housing. And that has included extended stay hotels, other pre-existing apartment buildings. And in our case, a new construction opportunity well located near a variety of services that could also be supporting this community. So, this unsolicited offer was reviewed and evaluated and we presented to our investor base, and again, unanimously approved the sale to the county, and that has since closed.

So, we got to work fast to determine what we could do to recycle the original capital gain, and protect the OZ benefits that our investors fully expected and had begun to enjoy. So, again, with great support from our tax advisors, and OZ experts, we learned the following, that within an OZ investment, you can transact a sale and recycle the original gain. So, the original investment can be to use a kind of another real estate term rolled over and into another opportunity zone investment. And in doing so, you get to retain…in this case, it was a 15% step-up, you get to retain the 10-year clock that had already begun on the investment. And you can still pursue tax exemption or tax elimination after the 10-year holding period.

So, that’s exactly what we did. Pinnacle Partners has been able to source and present to our investor base, on an ongoing basis, a number of very attractive opportunity zone projects. So, we had another project available for consideration. And again, we provided each and every investor the opportunity to do one of two things, they could either roll over the original investment, protect those tax benefits and enjoy participation in another very attractive OZ project, or two, they can cash out. And in doing so they’d be responsible for paying the associated taxes on that investment. That’s called an inclusion event. So, we presented those options to our investors and I would tell you, I think it was 96% decided to roll over into another project and preserve those tax benefits.

There’s two other things that came with the…you can imagine the return, we generated a return from the sale. A portion of that was considered a capital gain. That happened to be a 2021 capital gain. And so that gain is treated like any other capital gain, it now has 180 days to seek an OZ investment or you could obviously pay the tax on that. So again, our investors had the opportunity and the discretion to reinvest that ’21 gain if they choose. Again, that’s a portion of the return that they enjoyed. There was a small percentage of the total proceeds that were characterized as ordinary income, and that is just taxed at ordinary rates.

So anyway, I think we might be one of the few to go round trip on an OZ investment that is capitalize, construct, and then sell based on, you know, good, compelling economics and return characteristics and yet also protect those OZ benefits by reinvesting the original gain into a new, attractive opportunity. I think this is particularly attractive in the early phases of OZ. As the program continues, I think in later instances, if you were to make a sale, say you’re eight years into your investment, that may or may not be as attractive. But we felt, all things considered, this was an extremely extraordinary return for our investors, we were doing good for the community, at the same time realizing the impact we originally had intended, and we could protect the OZ tax benefits.

Jimmy: That’s tremendous, Jeff, a lot to unpack there. First of all, you did say that this is an incredible tax benefit and you’re absolutely right. I do frequently refer to the opportunity zone incentive as the greatest tax incentive ever created. I wanna pick your brain a little bit more on that round-trip concept. I think you’re right, by the way, we were one of the first, if not the first, who has actually done what I’ve heard hypothetically talked about a lot, which is hey, what if an OZ fund sells one of the assets within the fund, what happens next? You’ve actually done it, you’ve actually helped to protect your investors’ tax status with the gain that was originally deferred, and then invested into your opportunity zone project that you then later sold. Does the 10-year clock continue to tick or does it get reset for your LPs? How does that work exactly?

Jeff: Certainly. The 10-year clock continues to tick.

Jimmy: So, if you’re already a year or 2 in, you don’t reset back to 10, you’re already down to 8 or 9 years.

Jeff: That’s correct. And then as I may have mentioned, in ’18, as you recall, the original step-up was 15%. Today, it’s 10%. Those investors in ’18 enjoyed the 15% of step-up, they retain that as well.

Jimmy: That’s important. That’s really important. You talked a little bit earlier, Jeff, about your early mover advantage, how you guys were doing opportunity zone fundraising, and some deals in 2018, even before the regs were finalized. How important was that for your firm? And what have you learned along the way because of that early mover advantage?

Jeff: Well, we got very, very clear guidance on OZ compliance, you know, substantial improvement tests, other safe harbor tests. And it was incumbent upon us to ensure we had leading expertise on the subject matter to not only guide us through the structuring of our offering, which is important but on an ongoing basis to assist us in the evaluation and in ongoing compliance of the project. So, the decision to retain OZ tax advisory support, not only at the fund formation but an ongoing evaluation of the project. So, each quarter, we are looking at evaluating OZ compliance to ensure that we are fully compliant each step of the way. So, I think that was something we decided upon early and I’m glad that we did. And then, of course, during COVID, in the enactment of the Cares Act, there were a lot of extensions and provisions. And having that counsel retained and ready allowed us to interpret those accommodations so that we could optimize, again, compliance but also, you know, serve as I said, before, kind of stewards of our investors’ investment.

Jimmy: Terrific. And clearly, you, Jeff, and your organization, Pinnacle Partners are very experienced and experts in opportunity zones at this point, in the life of the opportunity zone incentive. Let’s spend some time talking about what you have done in the past and the experience you have and how you were able to successfully accomplish this round trip OZ investment, so to speak, or recycling OZ capital. I wanted to shift gears now and look to the future with you and the new fund that you are launching, or I think you’ve just launched actually, we did a webinar on it just the other day. This is Pinnacle Partners OZ Fund VIII, it’s your first multi-asset fund, your first several funds that you had previously issued were single-asset deals. This is now a multi-asset fund. It’s a curated portfolio of multifamily opportunity zone assets. What can you tell our listeners about that particular fund and why you decided to shift from single-asset to multi-asset?

Jeff: Yeah, a very good question. So, again, our experience is an early mover, we began in ’18 with the one project we just discussed. We continued to source and ultimately capitalize seven additional projects. We’ve been very focused on supporting multifamily housing. We’ve done…in the category of multifamily, we’ve sought and partnered to deliver senior housing, workforce housing, truly affordable solutions, and what we call market rate. Within the portfolio, we even supported the first mass timber development, affordable housing development in Seattle. And, by the way, these projects are generally in the Western states. And so, we felt, number one, that multifamily was the optimum product type to pursue for OZ investing.

Second, opportunistically we were seeking any additional tax credits and programs that we could leverage in addition to OZ. And we got very fortunate with a particular partner of ours that has had two projects with historic buildings that we’re pursuing adaptive reuse. That generated historic tax credits, HTC, which can be offsetting to passiving for certain investors. So, in one case with a partner, we took an existing historic office building and we are now converting it to multifamily in an up-and-coming market in Tacoma, Washington. And then a second project is a mid-rise office building that was in need of modernization. And again, in an OZ, we can capitalize that, get the OZ benefit plus historic tax credits.

With all that said, you know, we’ve got a lot of experience to optimize the tax shield. We’ve been particularly focused on multifamily. And our investors most recently have been providing very, very significant feedback that they have appreciated our deal-by-deal approach, the institutional quality underwriting we pursue for each and every deal. And we provide all that diligence for the benefit of the investor. They wanted to retain that approach to underwriting and, in addition, obtain diversification. So they asked for a fund format, they also requested exposure into some emerging markets that have been benefiting from population migration, strong economic growth. These are cities such as Denver, Nashville to name two.

And so, what we decided to do is deliver on that request. We’ve got this highly curated portfolio of four projects, each multifamily ground up, we partnered with a leader in both OZ compliance and extensive development capability in Jill Holman and Javelin 19 Real Estate. So, together, we are sourcing the highest quality projects in those targeted cities working with blue-chip developers, and presenting that as this curated portfolio for our investors to participate in. So, we think it’s the right type of fund at the right time. It’s not a billion-dollar fund, it’s not a dozen properties, it’s very focused, not to overuse the term, highly curated, and we think it’s got the most competitive return objectives in the OZ marketplace.

Jimmy: I think it’s a compelling offer, multifamily being by far the largest asset class within the opportunity zone wrapper and probably the asset class. That’s most in-demand among investors. You mentioned Jill Holman a moment ago, I know she’s helping you with deal-sourcing and underwriting. Can you go into a little bit more detail on how she’s underwriting a lot of your deals and which target markets she likes?

Jeff: Yes, so she, you know, routine speaker at OZ conferences, quite expert on the execution of legislation. She’s been a sponsor of half a billion of projects, development projects, and some notable OZ projects. She has a great team of analysts that help with the underwriting. And so we have joined forces, that’s clear. And we are focused in Denver, Nashville, Salt Lake, Scottsdale. And we’re seeing a lot of deals and, I think you would agree, we’ve heard others applying the same that the tax benefits are compelling, you, though require a high-quality real estate project underlying any investment decision, and finding high-quality projects has been sparse, it’s challenging, and yet we’re able to derive, we think, that the best projects in those submarkets. So, great collaboration, and already we’ve got line of sight on what we call a half-look two of the four projects. And we’re really excited to be launching and have launched and now taking subscriptions before you’re in for those that seek the 10% step-up, which, you know, is expiring at year-end.

Jimmy: Right, right. I mentioned a few minutes ago through the webinar we did, Jill Holman participated on that webinar with us as well as John Shreddy at Novogradic. It was a webinar on multifamily opportunity zones strategies and essentially characterizing the strategies that your fund is deploying, Jeff. So I just wanted to let our listeners know that we are going to link to that webinar in the show notes for today’s episode, and you can find the show notes at opportunitydb.com/podcast. So, you did just mention that 10% basis step-up that benefit is expiring at year-end, and we’re very close to your end by the time this episode airs. Is the program still compelling after that benefit expires? Is it still worthwhile for investors to deploy their gains into OZs? Are they missing out on something huge if they let the end of year tick by without making their investment? What are your thoughts there?

Jeff: Well, there are three tax benefits associated with OZ investing. To use your term, you know, are they missing out on something huge? The most significant, compelling, wealth-building benefit is tax elimination. And that is obtained after the 10-year holding period, which is in full force. That, to me, is why you do an OZ deal. Now, you get a couple of other benefits that come with that. The first is deferral. So you transact, harvest a gain of some kind, short or long. A lot of people forget that you can also qualify for short-term gains, and you then qualify for deferral, and therefore you do not pay the associated capital gains tax on that gain until April 15th of 2027. So, we look at that as like an interest-free loan from the IRS to use those funds to invest in an OZ project and get, you know, a return on that investment.

The third benefit is the one that you identified here as expiring and that provides a 10% step-up. What that means, in other words, is at the time when the deferred tax is due in April 15th of ’27, you would then pay 90% of the tax, so you get a 10% step-up or 10% discount. That, to me, is nice. It’s de minimis in comparison to the other two benefits. So, you know, the program continues to be quite active attracting more and more capital to the program, for now, deferral and, most importantly, tax exemption. So, I think the program is still very, very attractive for all investors.

Jimmy: I agree. And my listeners will have to forgive me that was a bit of a softball question for you. So, I agree that the main benefit of the program is primarily that 10-year exclusion and certainly the deferral period. Although it becomes less valuable with each passing day, it’s still very valuable. I mean, at this point in time, you’re still getting essentially a five-year interest-free loan from Uncle Sam, which is nothing to sneeze at. And there is a possibility of the program potentially getting extended at some point, which may reopen up that 10% basis step-up window again, a matter of speculation at this point in time whether it gets extended or another that window reopens. For now, we can assume that it’s going to close on December 31, 2021.

But just to be very clear, because I do get these questions a lot, gains that are eligible for deferral into opportunity zone investments carry out all the way through the end of 2026. So you can have a gain as late as the end of the year 2026 and that gain would still be eligible for that final benefit, that 10-year benefit, as long as you get it invested within 180 days of that event. So about the middle of 2027 is really kind of your last chance to invest in opportunity zones and an asterisk there actually, if you realize the gain through a partnership, Schedule K1, you actually have a little bit more time even, I think it’s close to mid-September 2027 is the real drop-dead date. All that is to say, without getting too technical, is that there are still many, many years remaining on this great tax incentive program, despite the fact that one of the benefits is expiring at the end of this year. Jeff, anything else to add there, or did I cover all right for you?

Jeff: You covered it completely. Thank you.

Jimmy: Excellent. Jeff, it’s been a pleasure catching up with you again today and to speak with you. Before you go, where can our listeners go to learn more about you and Pinnacle Partners?

Jeff: Yes, well, come to our website, www.pinnacleoz.com. And you can see details on the OZ fund. It is available for subscription before year-end and continuing through 2022, likely closing the second quarter of ’22.

Jimmy: Terrific. That’s pinnacleoz.com. And for our listeners out there, as always, and as I just mentioned a minute ago, I will have show notes for today’s episode on the Opportunity Zones Database website, you can find those show notes at opportunitydb.com/podcast. And there you’ll find links to all of the resources that Jeff and I discussed on today’s show. I’ll be sure to link to pinnacleoz.com as well as the webinar about the new fund launch of Pinnacle Partners OZ Fund VIII that I discussed a few moments ago. Jeff, a pleasure as always. Thanks for joining me today.

Jeff: Well, thank you, Jimmy, always enjoy speaking with you.