The simplest solutions are often the most effective in today’s complex environment. Qualified Opportunity Zones are not about simplicity, but many investors are racing to join. QOZ investments are restricted to QOZ Funds and are subject to additional requirements for investors and fund managers. QOZ Funds are more difficult to manage than conventional real estate funds due to the numerous regulatory and timing difficulties.
However, it would be unwise to write off one of the best investing possibilities of our time just because of its apparent complexity. One major problem, though, is the growing number of sponsors that aren’t legitimate businesses. Capital is flooding into QOZs, and people and businesses are establishing many new funds with no prior experience in the real estate industry. A wide variety of people, from regular folks to A-list actors in Hollywood, NFL athletes, and social activists, have been involved in this industry.
The combination of inexperience and complexity rarely ends well. And so, it is not inconceivable to track down the optimal investment vehicle. It comes down to doing your research like you would for any other private investment. Three key considerations for assessing QOZ Investment Funds are outlined below.
- Select Seasoned Sponsors
To reap the rewards of a QOZ, you must be careful while selecting a sponsor. Even if you’re a model investor, if you make a mistake here, the deduction might as well become a tax increase.
Timing is crucial in many areas of investing, including QOF investments. The investor must reinvest capital gains into the fund before the 180-day deadline. And it is the manager’s responsibility to ensure that all transactions are legal and high-quality. Even if the investor follows all the rules, it could nullify their tax benefits if the manager disobeys the law. Are they able to invest your money right now, or are they just taking it hoping to find a bargain later?
However, most sponsors do not have the kind of real estate experience consistent with a QOZ approach. The requirements mandate extensive renovations. Therefore, new construction is the norm for most projects. That’s why it’s important to look into the manager’s experience with new construction projects. Inquire whether they have built any properties in areas currently changing. Check out their standing in the industry. Find out if they contribute much to the fund from their resources.
Keep an eye out for investors who change their perspective on deals due to the tax incentives. The capital raised through QOZs cannot be used to bolster the capital structure as other tax incentives can. There must be sufficient income for the agreement to proceed. For the most part, a developer cannot invest $50 million in an economically poor area and then offer 50 percent below market rents. A successful transaction is required to qualify for tax benefits, and QOZ transactions should not be treated differently.
Many qualified sponsors exist who are ideal for QOZ investment and can provide the complete spectrum of tax advantages. However, under pressure from time, we sometimes have to make snap judgments. When considering a time frame of 10 years, as is required by QOZ-investing, good enough is not acceptable.
Get it correctly first because you’re investing long-term in the manager’s abilities.
- Determine the Effectiveness of the Plan
Most of the 8764 eligible opportunity zones won’t receive any funding. Every deal needs to turn a profit, and in most areas, rents aren’t high enough to warrant building anything new. Consequently, it is now somewhat more challenging to locate competitive prices. However, cities are dynamic places, and some QOZ regions are changing and suitable for future construction.
Furthermore, the QOZ definition relies on census data from 2010, and many cities have developed significantly since then. While some areas are true “economically distressed,” others are thriving. The risk of investing in the periphery is higher, but the biggest investment opportunities arise in areas changing.
Prices will rise due to more competition, yet many opportunities exist. Hire management with a track record of making smart investments in promising new areas. The hallmarks of a successful real estate investment plan are the ability to recognize communities in transition and act quickly to capitalize on opportunities there. Unknowingly, many people have put their money into “economically distressed” locations.
Remember to think about cash flow. Approximately when does the management plan to disperse funds? Remember that you’ll have to start paying the deferred taxes in 2026. From whom will all of that money be sourced? Most fund managers count on being able to refinance their holdings and return capital to shareholders, but they always have a contingency plan in place.
- Verify that the Sponsor Is on Top of Compliance
The manager must ensure that the fund continues to meet regulatory requirements. However, there are numerous opportunities for the management to make a mistake resulting in a taxable event, nullifying the tax advantages to the investor. When a manager solicits funds from investors without securing a transaction, that money must be invested within six months (or 31 months with a plan) to keep the QOZ designation.
The manager is responsible for ensuring that any enhancements made to the property adhere to any applicable QOZ regulations. It’s possible that investing in the renovation of an apartment building won’t be enough to meet the QOZ criteria of making “substantial improvements.” Spending less than expected can easily disqualify a deal from the program, and those investment funds will receive no reward. Investors can be hit with a tax bill they hadn’t bargained. In addition, investors must have access to sufficient liquidity from the manager. Knowing the law and having access to competent legal representation is crucial.
QOZs provide advantages beyond conventional real estate investments for individuals who are prepared to invest time and research. Remember that institutional real estate has never had a ten-year loss, even if you think we’re at the cycle’s peak. Property purchased in 2007 during the height of the recession is often worth much more today. Make sure you’re investing in high-quality transactions, using the right amount of leverage, and working with a trustworthy sponsor who fits these requirements. These factors will all increase your chances of long-term success in the real estate market.
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Come join us! Email me at mark@dolphinpi.us to find out more about our next real estate investment.