Anyone have experience or strong opinions about investing in an Opportunity Zone Fund?
An outside manager I have through my Schwab accounts has suggested this as a vehicle for me. I have never heard of this before he mentioned this.

I am 55
Home paid off.
$200K in a 529 plan, one child in high school.
One investment property with a monthly renter, not interested in dabbling more into rentals. 10-year mortgage on that property, rent pays my mortgage and condo association fees and repairs but not taxes.
About $1.7 million in qualified IRA, 401K accounts.
A little over $2 million in heavily stock-weighted funds, spread between Schwab and Vanguard.
Ownership in an entity that I will need to sell upon retirement (no immediate plans), currently valued at $600 K.


Edit: just got off the phone with the outside investment manager. Gist is, as I understand it:
Created by the 2017 Tax Cuts and Jobs act, designed to spur economic development in distressed communities
Take capital gains from this year and invest into the fund.
Gains are not recognized until December 31,2026.
Capital gains from the fund are reduced by 10% for all funds put in after 2019
If funds are held at least 10 years, the investor's liquidation of the investment in the fund does not result in any federal income taxes
2% fees
The particular Opportunity Zone Fund he is interested in proposing to me is located in San Jose, CA

Thanks in advance

First off, congrats on your accomplishments. Seems you've invested well over your career and put money away in all the right places. With your house paid off, you could live comfortably on way less than what your investments will throw off each year.
Secondly, before getting into opportunity zone's I think the bigger question is, what is your appetite/reasoning for investing in something like this? You could just keep plowing all of your money into the same avenues you have been, reaping those same rewards. It seems you want something that has a different risk profile than the stock market, which usually means real estate, but you don't want to deal with renters anymore.

It seems you're backing yourself into a PE real estate vehicle to take advantage of tax gains first, business opportunities second. Shooting from the hip, do you know enough about the management team, San Jose, and how people succeed in opportunity zones to pick a winner? Are you okay with not? Whats the standard ROIs and length of holding?

That 2% fee looks pretty steep to me for managing a fund, but I don't know if they're pulling in 20%. 10 years seems long as well, especially attaching yourself to california's real estate market.

As a side note, what area of San Jose is so dilapidated that it needs an EOZ?

You raise some excellent questions.

A few specifics:

• Asset management fees of 2% is pretty typical for PE, so that shouldn't raise eyebrows in and of itself.
• If you hold in the OZ for 7+ years, you defer capital gains taxes on your original purchase, and you also get to reduce the capital gain by 15%.
• If you hold in the OZ for 10+ years, you do not pay ANY capital gains taxes on the increased value of the real estate. Ie, Invest $10M, borrow $10M for a total project cost of $20M. Sell in 10 years for $60M. Gain = $40M. Taxes on $40M gain = $0

My firm has 1 OZ fund and will likely open a few more if we win a few RFPs. The main investors have typically been folks that have seen significant appreciation on their stocks and are rolling the proceeds to our fund avoid the capital gains taxes.

Sincere thanks to both of you. I will try to go through my thoughts and what I know so far. I will also state that I have reached out to my CPA (who likes the tax aspects but isn't familiar with the investment vehicle), and my Schwab manager (who is out of town and will get back to me).

As far as my objectives, I am NOT a FIRE type. I want to keep working as long as I am good at what I do, who knows when that might be. I also want to leave something to my son when I exit stage left.

As far as appetite for risk, my outside manager (who was referred to me by my Schwab manager) has no idea as to my entire portfolio. I have $800,000 in an IRA with him, and $1.1 million in a taxable account with him. The only thing he knows of my goals are that I jokingly asked him how long it would take me to get to $7 million with him and he said less time if you keep putting money into the funds. He looked at my unrealized capital gains YTD in the taxable account and states I have about $170K. If I were to do the investment he would recommend $100K going towards this.

I know nothing of the management team. He is recommending the Urban Catalyst Opportunity Fund.
Urban Catalyst team

Their investments are in San Jose. By name, they are:
Fountain Alley Bldg
The Mark at SJSU
The Iron at Civic Center
The Keystone, Madera, and Delmas Senior Living Center, all at Google Village
Paseo Office Bldg, San Jose

IRR is currently stated at 15.9%, per the outside investor who is pitching this to me.

When I asked about how realistic that IRR was, the outside advisor responded:

Real estate development is in a different category than the typical cash flow based real estate investment. It is riskier and also demands a higher expected return. Even if you apply a handicap on the expected return, you're still likely to realize a nice tax equivalent results. Also, the location of this fund is in the direct growth path of Silicon Valley and has much more growth potential than the typical Opportunity Zone.

We get a lot of questions about the timing with respect to COVID. The truth is you had to assume there would be a recession somewhere in the next 10 years and the best time to have it is during the construction phase. Major players like CBRE and Boston Properties have slowed down (or frozen) projects and that should lower overall input costs like labor and materials.



I appreciate the answers.

I am in a situation not dissimilar to yours, and there is a lot to like on the surface for this investment. I'd certainly entertain throwing $100k of otherwise capital-gains-taxed money at it, that I wouldn't need for 10 years. I would have numerous questions, and some concerns, and will share a few ideas with you as food for thought.

1) Expected Returns - - First and foremost - I would look at this like any other investment. Pure tax arbitrage is not a good enough reason for me to invest, as we know taxation policy changes over time (and certainly will over the ten-year time horizon). I would primarily evaluate it on a basic cash return on capital equation. Real estate people get wrapped up in describing returns in couched terms intended to promote what they're trying to sell. While there's a place for IRR, Cap Rate, and other discounted cash flow methods, a pure cash-on-cash return is still pretty important to evaluate if the opportunity makes economic sense.

2) The market - like another poster, my first inclination was to doubt there was any San Jose property that qualified for this, but it appears downtown is a relatively needy area? I've been there, and it doesn't seem too down and out to me, which is good.

3) The projects - - I have major concerns about two of their asset sub-classes - - class A office space is in trouble everywhere due to COVID, and Silicon Valley companies are among the most likely to promote extended work-from-home options, thus reducing demand for this type of space. The other one is the SJSU campus housing, for similar reasons. I don't think student housing is where I'd want to place too many bets right about now. The others don't bother me as much (although the jury is still kinda out on senior housing's future), and on the whole, the risk profile might still be acceptable.

4) California - - I have many friends and relatives in the state, and it's a mixed bag with regard to real estate overall. The main plus is that property taxes are reasonable, at least compared to Texas. The main negatives relate to a fluid development policy, which ebbs and flows at the whims of elected officials, not to mention public sentiment. That's why it's important to have well-schooled feet on the ground. This is where a bit of due diligence on their management team would be important - do they have what it takes to win in that environment?

Six months ago, I would have been much more favorable toward this idea - now, I'd be careful, but would also inspect something more close to home. I have found that east Austin, for example, has several of these zones, including all around the future site of Tesla's new gigafactory. I have no recommendations on investments there, but it might be worth having a comparison point before you take the plunge.

Good luck, and keep us updated on your progress, if you don't mind.

Those are all great points, especially #3.

The father of a good friend of mine from high school and A&M was a CPA and investment manager. He had only one client - obviously a very wealthy man - and he managed all of his investments and did quite well. He told me one thing, and only one thing, about investing: "Put a plaque behind your desk that says, "I never made an investment because of tax implications". There are worse things in life than having to pay taxes because you made money." Perhaps he was right.

I will posit these questions to my internal and external advisors.

The outside investment firm is based on the left coast, so that advisor might be able to answer some of the questions about the firm's track record in this arena.

Lastly, unfortunately, this wouldn't be the stupidest thing I've ever done with $100,000.

Not to deviate too much from a really great thread, you mentioned your aren't a FIRE type, but I think its worth recognizing that you have already achieved the financial independence part of FIRE. Which is honestly the best part of it, retire early is a whole different ball of wax. Most people who have the FI part down are at the point in their careers that they enjoy what they do and the routine-RE isn't on the map.

I would seriously consider picking your head up, looking around, and taking inventory of what you want the rest of your life to look like. If your balance sheet looked like 7 million vs 5 million-what would you change about your life? What about 15 million vs 5 million? There's nothing wrong with keeping plowing away, but I think you've got an opportunity here that most people don't realize until its passed.

Most FI people I know who keep working do so for the enjoyment, routine, and financial peace of mind for when they spend money on big ticket items. Its easier to drop that bonus into a new boat compared to taking the top off of an investment portfolio.

Back to EOZs.

16% seems screaming for a long term hold program. I'd think an honest underwrite should look closer to 11%. Land selling brokers are smart and price their land to the highest and best use - and red lined underwriting. Also keep in mind these guys are managing money with something like a 5 pref. I don't know what the waterfall looks like in this program, but they're probably making a few hundred bps spread by the time it gets to you - and you get to pay 2% in obvious expenses. I've heard of some of these funds needing a 20 to advertise a 14 to investors. Applying that here suggests a 20+ to the investment which is WILD for an OZ deal (read skeptical).

Then back to fundamentals: understanding the demand for new supply in these markets is super important; if COVID fall out prompts a sublease glut, few folks will be interested in 2x rent in spec office.

Thanks again for all of the replies. It really helps to discern how to approach the investment as well as how to ask my advisors further questions. In response to a question about the points raised by I bleed maroon, the outside advisor (whose firm is local to these projects) responded:

"I completely understand why in the short-term there would be concerns about the COVID impact on CRE. However, I do not believe that it will persist especially once there is a viable vaccine. The office space and student housing projects are both needed in an expensive market (CA) where there is a bedding shortage for students and the need for affordable offices in area that is going to be home to the Google Transit Village. I believe that there is a lot of potential opportunity in this specific fund. Remember this project is not designed to build shopping malls in terrible locations. There are multiple benefits (defer taxes, 10% reduction in taxes paid and tax free growth) as an investor in addition to the added diversification from the real estate.

The management team at Urban Catalyst has done over $6B in acquisitions and $5B in development. Our firm ran due diligence on the fund and the team to make sure that we were comfortable investing our clients money with this firm.

Please let me know or Evan know if you have any additional questions."

And, just now from Evan:

"Hi Guys,

A couple notes.

Our base case is that COVID will not be a relevant problem in 10 years. If it is, then we should all get prepared for a rough 10 years! The work from home rhetoric is mostly that. The big names are still moving forward with their decentralized HQ strategies. Facebook just leased 750k sq ft in New York, and I know that Twitter has shown interest in one of the buildings Urban Catalyst is working on. As for student housing, there is a serious shortage 30 years in the making. Prior to COVID San Jose State has had parking lots sectioned off to allow student to sleep in their cars. To Marks point, you probably don't want to invest in most Opportunity Zones, because they are frankly bad areas with low upside potential. One of the reasons we like Urban Catalysts story is that it started out as a standard real estate development syndication and, due to local politics, just happened to be designated as an Op Zone.

We're always happy to get on the phone to go over more detail.

Thanks,

Evan XXXX"



In response to the investment in general, my Schwab advisor said, cc'ing the outside firm:

"I am not qualified to give you advice on this particular opportunity zone investment. I understand that XXXXX had done their due diligence and acting as a fiduciary for you. If they are recommending this then they are doing this in your best interest.

The one think I will chime in on is making sure you understand the positives and negatives about investing in these products, but I am sure the Aaron or Evan has covered this with you. Guys correct me if I misstate something.

The clear benefit is reduction of current capital gains in return for you making a long term investment into the opportunity zone investment. You need to weigh the reduction in capital gains against the time that you need to commit to the opportunity zone investment.

Your question on performance of the opportunity zone is important also. All of these were created just to take advantage of the new rules to qualify to reduce capital gains you have taken someplace else. There is not a track record on opportunity zones but like Aaron stated the firm they are working with has a long history of doing this.

At the end of the day I want to make sure you know what benefit you are getting for committing your funds to the time that is required to qualify for the tax break, along with any projections from the opportunity zone investment. This is the conversation I would have with Aaron and Evan to see how this fits into your overall portfolio with them. Schwab does not offer this product directly so I can only discuss the basics of these investments and Aaron and Evan can be more specific on how this will impact you."


My Schwab advisor's response does bring up the whole FIRE issue. As I said before, I have no intentions to retire any time soon, and although that is a long horizon $100,000 not easily accessible from my portfolio will not keep me awake at night. I have disability insurance should something untoward happen to me. Otherwise, my retirement plans aren't weighing on me too much at this point. I have a narrow skills base, so there isn't really all that much that I can do "productively" if and when I retire. Hope that makes sense.

Again, I really do appreciate all of the help.

I see a lot of points selling the future upside, but they're kind of hand waving the future of CRE. I know its just an elevator pitch, but I don't see anyone addressing the current predicaments that led to the EOZ in the first place. If there is such a future in that area of San Jose, why is there not a huge amount of money already flowing into it? The market overall is pretty smart with their investments. Especially around taking college kids money for apartment real estate. There is something structurally deficient about that investment area-what is it? Distance from HQs? A sewage treatment facility? Nimbys? Homeless Camps?

The second set of question I have are: Does anyone who invests your money have a stake in the success of that property also? How are the PE guys having skin in the game? I know you're not asking to be an angel investor, but these firms are basically going to take your money and then shoo you away from continued due diligence.

My personal take is these guys funds are the equivalent of merchants selling shovels and Levi's during the California gold rush. I would be very careful.

Thanks for the response. I can find out what skin the firm has in the game. I would not be adding additional funds to open this up. The outside advisor is recommending I take some of the $1.1 million I have with them in my taxable account and shift it into this (based on what will get me the capital gains I am trying to avoid having to pay). I put money into that account from time to time anyway. I always ask my Schwab advisor to look at my portfolio and see where he thinks I should put my next deposit.

Extremely informative thread. Was not familiar with OZ's.