Can Qualified Opportunity Funds Be Creative? Q&A with Altus Group’s Rick Kalvoda

The most recent Opportunity Zone guidance provided more clarification on the investment side, but Qualified Opportunity Funds, at this point, remain somewhat cautious. Connect Media recently turned to Altus Group’s Rick Kalvoda to shed more light on how QOFs have been, and are likely to, react to current and future guidance.

Q. Given what we know now, how creative are QOFs likely to be?
A. Most QOFs today are not getting overly creative in their investment decisions. Investors want to be sure that the risk-adjusted returns are feasible, pre-tax. And the QOFs right now are truly focusing on ground-up development in economically-distressed areas near major metropolitan markets. The second round of guidance released by the Treasury in April was overwhelmingly favorable for QOFs and their investors, affording fund management significant flexibility. But, time and time again, we hear from the QOFs that they are being careful to rely on the law rather than the guidance.

As we approach an election year, funds are cognizant of potential changes in the guidance, though the heart of the bill has support across party lines. A key piece of the bill yet to be appropriately addressed relates to reporting – what is the impact that the QOZ investment is having on the community, and how can it be quantified? With each investment, our clients are making sure that they are able to answer these questions because, at some point, QOFs will need to report this to the government. With hotel and warehouse investment, the answer is in jobs. The multifamily developments tend to include an affordable component.

Q. Can you talk a little about fund-to-fund transfers?
A. Though (Treasury) Secretary Steven Mnuchin seems to be considering the allowance of fund-to-fund transfers, under current regulations the tax benefit will not transfer with the sale of a fund interest. An investor’s basis must remain in the same fund for the full 10 years for maximum tax benefit. The fund, however, may sell OZ investments and reinvest proceeds into another OZ investment without disqualifying an investor’s tax benefit. Because of this, we expect to see more money in multi-asset funds, as opposed to single-asset OZ investments.

Meanwhile, the first-mover advantage lies with the first funds to get set-up with the wirehouses, and therefore gain access to the largest number of mid- to high-net worth investors via private wealth managers. This process has been very slow, as wirehouses tend to have a lengthy due diligence period. The result has been a slow capital raising process for many QOFs. QOFs are getting close to approval from the wirehouses, and as soon as they do, the capital flow will increase. Wirehouses have an incentive to complete these processes in the next few weeks. The 180-day window to defer 2018 capital gains taxes by placing the gains into an OZ investment expires on June 28, 2019, and their clients, the investors, do not want to miss out.

Q. The 30-month safe harbor requirement is gone, but what if additional challenges arise?
A. The new guidelines state that if a QOF is unable to place capital in an earmarked investment due to government inaction, the capital earmarked for that investment shall be exempt from the 90% (asset) test. Though many of our clients are only taking on shovel-ready deals, the extended safe harbor opens the door for investment in more complex developments as well as investments in notoriously difficult places to build such as the Bay Area.

For comments, questions or concerns, please contact Amy Sorter