OZ WIZARD UPDATE
RATIONAL INVESTORS DRIVING MARKET
As we enter month 15 of the “Qualified Opportunity Zone Funds (“QOZF”) End of the Real
Estate Investing World as We Know It” season, a not so surprising things is happening. Mainly,
not much.
IT IS THE DEVELOPMENT STUPID
The investors for QOZF will come primarily from those individuals selling stock or businesses.
They will want to know what they are buying (similar to 1031 DST investors). A major sponsor
of a QOZF has improved their offering, now specifying the apartment developments they have
under contract to develop (smart move Kevin). I do not believe pure blind pool QOZF will get
traction in 2019, as there are easier to understand (and better?) alternatives now available to
investors.
WHY LIMITED INVESTING TO DATE?
REGULATIONS. The second round (of three) sets of regulations from Treasury are due this
month. With a third round expected late Summer / early Fall, the full slate of regulations will
not be final before year end.
Most Due Diligence Officers (as we heard at ADISA in San Antonio and at IPA in Dallas) and
many Registered Investment Advisors (as experienced by Vanessa in Portland) will be slow to
stick their neck out to approve QOZF offerings when they are not yet certain of the rules.
I suggest they are looking through the wrong end of the microscope. The law, and the first (of
anticipated three) sets of regulations, are in stone. Little of substance remains unknown and
offerings can be amended to address new regulations as they become final. Does anyone really
believe that in election year 2020 the Treasury Department will do anything negative on a well-
intended and reasonably structured QOZF?
REAL ISSUES
1. the quality of the development (e.g. will it succeed, when, and at what return on risk),
2. the depth of developer experience (in asset and location and size and scope),
3. the “staying power” financially of the sponsor (can they attract a JV partner if the
offering is not successful), and
4. the fairness of the offering (e.g. undisclosed massive markup on the subject property).
TIME.
Investors have not flocked to the handful of QOZF which are actually available for investment
(versus the 300+ announced). Unlike with a 1031 transaction, where the investor has to select
the potential destination of their funds within 45 days of sale, the QOZF investor has 180
days…and they get to touch their net proceeds of a sale (where the 1031 investor must NEVER
touch the proceeds, utilizing non-affiliated qualified intermediary to process funds into
investments).
EQUITY.
Investors for QOZF distributed by broker dealers, in my humble opinion, are likely NOT to be
coming out of the sale of real estate. Why? The 1031 DST market has shown that most of these
investors want stable cash flow around 5% /year (On this we agree Louis…and thanks for lunch).
Development deals generally do not cash flow for the initial 2 – 5 years.
ALTERNATIVES TO PACKAGED QOZF.
If a real estate investor, with significant capital gains, is not ready for retirement returns (see
DST 1031 above), they can take advantage of QOZF opportunities in their backyard (kudos to
Molly, Deb and Alan). There are 8700 census tracts which qualify for QOZF investments (about
12% of all census tracts in the USA). With over 1,000,000 parcels to consider, the opportunities
are nearly endless.
BOTTOM LINE. QOZF are a powerful tool to attract capital gains proceeds to fund SOME of the
equity requirements for rational development proposals focused on attractive already
gentrified neighborhoods. Will some equity find its way to urban and rural poor areas? Maybe,
but so far, that is not where sponsors are locating their proposed transactions.