Qualified Opportunity Zones were created in 2017 to encourage high net worth individuals, family offices and institutions to invest in low-income areas. Investors can benefit from several tax incentives by making a commercial real estate investment in QOZs, which makes investing in a QOZ seem unique, exciting and rewarding. However, investors must not abandon their business acumen when choosing the manager to invest within a Qualified Opportunity Fund, or QOF.
Deals that make sense even without tax incentives are usually the most sustainable choice, but another deciding factor for investors should be working with trustworthy people. No matter how great a QOZ investment’s tax advantages are, any plan to transform properties in a QOZ neighborhood will need sure and dependable execution. Success is by no means assured, but private real estate investors can lay the groundwork for high performance by evaluating potential QOF real estate asset managers thoroughly before investing in a fund.
While Qualified Opportunity Zone Funds are so new that they don’t have a track record yet, their managers should—and their key performance indicators should largely be the same as that of their other private real estate funds. Investors should consider the following criteria when evaluating Qualified Opportunity Zone Fund managers:
1. Proven development experience. Previous real estate development success can be one of the best predictors of the manager’s future success with their QOF. Yet, many inexperienced managers will be making unfamiliar investments solely to capitalize on QOZ tax incentives and fees they can generate from their investors. They’ll be embarking on complex finance, construction and operational plans, and inexperience could lead to an unsuccessful QOZ investment. Investors should start by visiting the firm’s website and searching online for press releases about the manager and their previous investments. If the manager has no track record, or negative press on past deals, run.
QOF investors are banking on the fund manager’s ability to navigate underwriting and due diligence challenges on a timetable that meets federal tax incentive requirements. Experienced managers with previous real estate development success are going to be more likely to win deals and execute at a high level. Additionally, look for real estate managers that have previous development success with the same types of properties they’ll be focusing on in their QOF. There are different nuances associated with investing in, and developing, each type of property. Having experience with the nuances of that property type, and knowing how to approach those nuances, can be the difference between hitting a home run and striking out.
2. An expert team. An accomplished real estate fund manager also needs an experienced team with depth who have trained at respected, institutional-quality real estate firms. A deep bench will ensure resiliency and success over the extended 10-year QOZ Fund investment period. A QOF manager should also have an in-house legal counsel; be engaged with a top-tier law firm with extensive QOZ knowledge; or both. QOZ Funds face significant compliance issues, and failure to fulfill the letter of the law may expose investors to adverse tax implications.
Managers that rely on one or two key team members could end up in big trouble if one of them, or both, end up leaving the firm behind. This risk is mitigated by the manager having a deep bench of investment and asset management professionals who are willing and able to succeed the key team members above them, if it becomes necessary.
3. Market selection. A high-performing manager will have a clear-cut market selection plan backed by detailed criteria and proven measures of success. With more than 8,700 federal opportunity zones, managers must be able to substantiate why the area they’ve chosen for investment isn’t a dart thrown at a federal opportunity zone map. Investors should ask the QOF manager about the criteria they use when evaluating and choosing where they plan to invest.
Some examples of characteristics that the most promising markets and submarkets possess are strong population and job growth, a diverse economy, higher forecasted demand than supply for the property type, attractive cost of living rates and a business-friendly environment.
4. Transparency. Real estate fund managers should be willing to share details on their previous investments’ performance and provide prospective investors with references from their auditor, legal counsel and current investors if requested. The offering documents should also clearly delineate and explain their fees. Hesitancy or over-complexity could indicate they’re trying to hide something.
5. Alignment of interests. Does the QOF manager have skin in the game? Generally, no individual QOZ investor should be putting up more cash than the real estate fund managers themselves. If the manager’s principals are not willing to invest in their own projects, neither should anyone else. At Origin, our founding partners make material investments along-side investors in all of our funds, including $7 million in our Qualified Opportunity Zone Fund.
To establish a 10-year-plus relationship with a fund manager, investors should be comfortable with the team. The principal can’t have one foot out the door, and all acquisition, financing, legal and leasing experts need to be in place before the investment is made. The team should have significant experience, processes in place to “see around the corner,” and a plan to navigate whatever the next 10 years could bring. If it’s hard to imagine dealing with the manager’s team year after year, don’t invest. A tax incentive alone is not a reason to invest, and investors must first be comfortable with the investment strategy and managers.