Qualified Opportunity Zone Funds must hold at least 90% of assets located in opportunity zones or stock/interest in Qualified Opportunity Zone Businesses (QOZB). QOZBs are trades or businesses in which all of the tangible property owned or leased are located in QOZs. A QOZB must earn at least 50 percent of its gross income from business activities within a qualified opportunity zone for each tax year. Current identified investment types in opportunity zones are multifamily and commercial real estate developments or renovations, new businesses, expansion of businesses into OZs, or expansions of businesses already located in OZs.

There is also a requirement to substantially improve the QOZ property. A subsequent Revenue Ruling by the IRS defined the term substantially improved to mean that taxpayers must double their adjusted basis in the property after purchase and during any 30-month period that they hold their QOZ property. Accordingly, most QOZ investment offerings are large institutional development projects with equity raises of between $50 million to $250 million. The stated minimum investment amount for most QOF offerings is $100,000 but may be reduced upon request.


Professional Real Estate Investment Management

Opportunity Zone Funds allow investors to enjoy the benefits of passive real estate investment without the hassles of direct management, maintenance, and the oversight required with active real estate ownership. The developers and contractors include many well know firms such as Cantor Fitzgerald, Silverstein (developer of the Freedom Tower in NYC), Griffin Capital, Capital Square, and Inland Capital to name just a few. At the time of writing, many of the sponsors are on their 5th to 8th QOZ offering with the earlier QOZ projects materially completed.


Where are Opportunity Zone Locations?

There are over 8,700 qualified opportunity zones throughout the United States, Puerto Rico, and the Virgin Islands. The current QOZ legislation provides that the opportunity zones are designated by the governors of each state in accordance with demographic information based on the 2010 census. Recent QOZ projects have been located in areas such as Silicon Valley in California, the Las Vegas Strip in Nevada, and various downtown areas in Seattle (WA), Richmond (VA), and Los Angeles (CA). The distressed communities within these areas are well on their way to urban renewal.


QOZ Fund Offerings

A qualified opportunity zone fund (QOZF) is an investment vehicle organized as either a partnership or corporation that holds at least 90 percent of its assets in QOZ property (the “90 percent Asset Test”). Qualified opportunity funds can invest in a wide variety of real estate or new or existing businesses including commercial real estate, housing, infrastructure, and start-up businesses. QOZ offerings include the development of institutional quality properties including but not limited to luxury apartment communities, mixed use properties (with restaurant, retail, and residential units), class A office buildings, medical office buildings, bio-life office buildings, student housing communities, self-storage facilities, industrial warehouses, and hotels.

QOZFs can hold a single asset or multiple assets. A QOZ property includes interests held by the qualified opportunity fund in a qualified opportunity zone business (“QOZB”). These investments are offered under Regulation D of the 1933 Securities Act and include QOZ funds (limited partnerships) and QOZ Real Estate Investment Trusts (REITs). These QOZ investment offerings are issued by various sponsors. The offerings include investments diversified over multiple designated opportunity zones as well as offerings that invest in a single opportunity zone asset. Investors have multiple and diverse QOZ investments to choose from and, if so desired, can build a diversified personal portfolio of multiple QOZF investments.


QOZs vs. other alternative real estate investments

QOZs may provide higher projected returns than DSTs, due to the nature of their structure and the upside potential of the developing real estate. Accordingly, most QOZs may be considered as a growth-oriented investment opportunity. In addition, OZ funds also provide a preferred return to investors. A preferred return means that investors will be the first to receive returns up to a pre-determined level. Upon reaching this level of return, the remaining profits are split according to the negotiated rate. The preferred return is also premised upon the full return of the original principal investment to the investor.

In most cases the QOZ is a development project and will not be able to distribute cash flow from rents until the property is constructed and stabilized (substantially leased up). However, the preferred return will begin to accrue from day one of the investment at the stated preferred rate. Most QOZ development projects will finish construction within 2 or 3 years during which time the sponsor will begin to pre-lease the properties. Cash flow should begin and continue to escalate higher and higher within 2 or 3 years of the initial investment and may exceed the preferred return at some point during the 10-year hold period. In any event, the sponsor must pay the investor the accrued annual preferred return and a return of capital before the sponsor may begin to participate in the returns from the property.

If the investment is made near the end of the equity raise or well after the QOZ was originally offered, the development projects may have begun and may be substantially complete. In these cases, cash flows could begin sooner rather than later. From time-to-time, QOZ offerings take possession of a property just before the certificate of occupancy is awarded and begin cash flowing from day one. It should also be noted that it is also possible for such investments to incur a loss of principal, or a total loss of principal. Likewise, cash flow over the hold is not guaranteed.


Who is Eligible?

Eligible investors in QOZs include any taxpayer that has capital gains from stocks, bonds, real estate, selling a business, etc. Investors must invest their capital gains in a QOZ within 180 days of a realized capital gain event. If the investment is made through an investment fund or a private REIT, the investor must meet the net worth or income requirements for an accredited investor per the 1933 Securities Act. The Security and Exchange Commission defines an accredited investor as an individual with either $1 million in net worth (excluding the equity in one’s principal residence due to the Dodd-Frank Act) or net income for the last two years of $200,000 or greater ($300,000 if accreditation is for a married couple) with a reasonable expectation of such earnings in the current year.


QOZ Investment Process

As stated above, QOZ investments are offered under Regulation D of the 1933 Securities Act. Accordingly, prospective accredited investors must receive and review a private placement memorandum (PPM) for the investment. The PPM is a full-disclosure document that presents all material facts and possible risks about the investment. The Act also requires the issuer (sponsor), its counsel, and the distributing securities broker-dealer to perform significant due diligence. Investments may be closed within a few days of completing prerequisite subscription documents (i.e., brokerage forms, purchase questionnaire, and purchase agreement). Accordingly, investors may easily satisfy the requirement to invest in the OZ within 180 days of the liquidation of their down leg relinquished capital asset.


The QOZ and Reallocation Strategy

In conclusion, the QOZ is an integral part of the reallocation strategy from a traditional stock and bond portfolio into alternative real estate investments. The strategic benefit of the QOZ is that is allows for full tax deferral of capital gains from the sale of stocks and bonds and provides for a 100 percent reallocation of sale proceeds into institutional real estate. This ability to defer capital gains was unavailable before 2018 and only recently made portfolio reallocation a viable investment strategy for the private investor.
In addition to the initial tax deferral, there are the added tax benefits of bonus depreciation with the sheltered cash flow without recapture and the 100 percent tax exclusion by virtue of a stepped-up basis on the sales price at the end of a 10-year hold. The low minimum investments in QOZ’s, allow the investor to diversify the deferred gain over multiple offerings and achieve outstanding diversification opportunities into non-correlated real estate assets.

With the capital gain portion of the sale proceeds invested into multiple QOZ offerings, the bulk of the stock and bond sale proceeds can be reinvested into direct alternative real estate investments with higher yields such as DSTs, private REITs, and real estate funds. Most of these real estate offerings produce cash flow from day one of the investment and many offerings include multiple investment grade properties of various asset classes. Therefore, QOZ investments may be considered a gateway into a vastly diversified portfolio that may include equities, bonds, and real estate.