Opportunity zones offer family offices access to impact, tax breaks

McNally Capital, a family office, began identifying ways to take advantage of a new federal tax rule meant to encourage investment in underserved communities by tracking Amazon’s search for its headquarters.

The rule, included in the Tax Cuts and Job Acts in December 2017, allows private investors to roll their capital gains into a Qualified Opportunity Fund, which must invest at least 90 percent of its assets in Qualified Opportunity Zones to defer the tax.

Further, capital gains tax gets eliminated if the QOF investment is held for 10 years. In addition, investors may also receive tax benefits on additional gains earned from the QOF.

Some family offices have been tepidly exploring these opportunities.

“It was obvious to us that Amazon would set up offices in opportunity zones to drive revenues and impact,” said Frank McGrew, managing partner at McNally Capital, who is spearheading his company’s efforts around opportunity zones.

Amazon selected Long Island City in the Queens borough of New York, parts of which are classified as opportunity zones, and Crystal City, Virginia.

Thus, McNally focused on 25 metro areas that had opportunity zones and spent the past few months building its pipeline of some 40 high quality-assets and operating managers in “shovel-ready projects”, he said.

Over 8,500 opportunity zones, defined as economically distressed communities, are spread across urban (38 percent), suburban (22 percent) and rural (40 percent) U.S. areas.

Napster Founder Sean Parker and his think tank, Economic Innovation Group, were the primary architects behind opportunity zones.

While there are still ambiguities around some provisions, it is clear that investment in QOFs will help family offices and high-net-worth individuals save on capital gains incurred on sales of stocks and collectibles, Jeffrey Bowden, tax principal at Anchin, Block & Anchin Accountants and Advisors said.

“We are bombarded daily by lawyers, accountants, investment companies with projects in qualified opportunity zones, but we haven’t bitten yet,” said a family-office chief investment officer.

Indeed, the constant chatter has cheapened the quality opportunities, said Ross Walker, co-founder and managing partner, Hawkins Way Capital, a Los Angeles-based real estate company.

“When you are pitched an opportunity zone deal that leads with the opportunity zone benefit, it sort of raises a red flag at first in my opinion,” he said.

“The focus should always be on the deal first, opportunity zone as gravy,” Walker said.

Different approaches

Not all 8,500 opportunity zones are created equal.

This is because while Congress set a national baseline for eligibility based on income and poverty rates, it allowed state governors to delineate such zones in their respective states, Nick Parrish, managing director at Cresset Capital, said.

In determining the zones, some governors targeted the most economically distressed areas in their states. These areas will take generations and substantial capital investment to improve, Parrish said.

Other governors took a different approach, looking for areas that didn’t require such extensive improvement, he said. These are the opportunities Cresset is exploring, Parrish said.

Downtown Houston in Texas, Oakland in California, Portland in Oregon, Charlotte in North Carolina and Brooklyn, New York, are some cities with opportunity zones, Parrish said.

Opportunity fund structures

Anyone including a family office can establish a QOF so long as they follow the guidelines set by the statute and Treasury, Bowden said.

But “opportunity zone mechanics can be challenging for family offices,” McGrew said. Several fund structures could emerge from this opportunity, he said.

Special-purpose vehicles specific to a property or single project with flexible timing and local developer expertise will be one such QOF structure, McGrew said.

SPVs could also be raised for single or multiple zones that would collaborate with real estate operators familiar with processes in those communities.

A third QOF structure would be blind pools with discretion to invest in any project or opportunity zone, McGrew said.

However, the blind-pool structure with its timing rigidity may not work for opportunity zones, he said.

Based on current regulations, family offices want to know the specific properties and locations they are investing in rather than a blind-pool commitment, Walker said.

“Additionally, this is most likely a minimum 10-year-plus partnership, so there may be added apprehension about who will be in control or around that far out making key decisions,” Walker said.

Some investment firms are already raising money for their qualified opportunity funds.

For instance, Cresset Capital launched its $500 million Cresset-Diversified QOZ Fund in October in partnership with LCM Opportunity. LCM is led by Larry Levy, a well-known Chicago-based real estate investor.

Cresset signed its first letter of intent of $200 million with an $88 million equity slug for a 46-story apartment building, Buyouts reported.

The Arlington, Virginia, alternative-asset firm EFJ Capital is also raising money for its $500 million fund.

On the other hand, McNally Capital invested in building out a team to assist its 800+ family-office network with QOZ investments.

“We are really a third party that ensures compliance and increases the aperture for investments,” McGrew said.

McNally’s focus is on the right team, capital structure, strategy and impact and is curating special purpose vehicles to match investor requirements and project duration, he said.

The lure of impact

The impact investing that opportunity zones offer appeals to many family offices looking to contribute to communities in a meaningful way, Parrish said.

“We used the metrics of social impact like education, health and wellness, job creation and upward mobility for local communities to create our OZ pipeline,” McGrew said.

Investments in warehouses, distribution centers and data and call centers would utilize raw tracts of land and employ workers, creating social impact, he said.

“We expect to see increased investments in seed and startups in OZs that will offer tax benefits,” Bowden said.

Additionally, many college towns that are part of OZs could benefit from investments, he said.

For instance, a biomed company could set up/move its business to a college town and benefit from the pool of highly educated college students and professors and create a “base of knowledge,” Bowden said.

Action Item: Read more on Opportunity Zones here: https://bit.ly/2JtrAAU