CRE Thought Leadership

Opportunity Zone investor incentives can sound compelling.  Where else can an investor receive increased returns (by paying little or no federal capital gain taxes) and at the same time help revitalize a local community?

Although Opportunity Zones provide substantial tax breaks for investors, they can be risky endeavors for bridge lenders and sponsors alike.  In this article, we will explain what Opportunity Zones are, why they were created, and how bridge lenders may approach their underwriting of projects within these zones.

What are Opportunity Zones?

Opportunity Zones (OZs) are designated areas throughout the United States that have been selected by state and federal agencies for economic revitalization.  In order to invest in OZs and receive federal tax breaks, investors must invest in a Qualified Opportunity Fund (“QOF”).  According to the legislation, a QOF is “any investment vehicle which is organized as a corporation or a partnership for the purpose of investing in qualified Opportunity Zone property…that holds at least 90 percent of its assets in qualified opportunity zone property.”  The legislation imposes a “substantial improvement” requirement on the QOF.  In order for an existing building to be designated as a qualified OZ project, the QOF is required to make improvements to the building in an amount equal to or in excess of the purchase cost of the building (less the land value).  Additionally, these improvements must be substantially completed within 30 months of the QOF’s purchase of the building.  As an example:

A Qualified Opportunity Fund buys a property for $1 million.  The land is worth $250,000 and the building is worth $750,000.

In this example, an additional $750,000 must be invested into the building within 30 months of the purchase date.

In the last two articles in this series, we discussed two key differentiators in real estate crowdfunding: differentiation of platforms and differentiation of offerings. 

• Differentiators in offering refer to the regulatory offering types (accredited vs non-accredited investor offerings), which are of the utmost importance to real estate sponsors thinking about raising capital online. 
• Differentiators in platform refer to both the purpose (marketplace vs captive) and the incentives behind the platform, which is a critical investment due diligence item for anyone intending to invest through crowdfunding.

To date, the most successful real estate crowdfunding websites tend to be crowdfunding marketplaces focused on accredited investor offerings.  These include CrowdStreet.com, RealCrowd.com, and EquityMultiple.com.  Because these sites attract multiple sponsors (a marketplace) and can bring more money to real estate transactions (no fundraising cap), they garner the highest quality deals and attract the greatest quality and quantity of investors.  In addition, they protect their brand by vetting the deals and sponsors before permitting them to market their offerings on their platform. 

There has been a glut of crowdfunding platforms erected with the hopes of emerging as the real estate crowdfunding market leader.  However, this glut has outpaced user-adoption.  As a result, numerous crowdfunding companies have closed down or consolidated as they have struggled to generate the fee income required to outpace their large overhead. 

In the previous post on real estate crowdfunding, we covered the regulatory structures of crowdfunding offerings and the impact that those offerings have on sponsors.  In this post, we’ll look at two distinctly different types of crowdfunding platforms that every investor should be aware of and how each affects the investor’s ability to find great deals.  The differentiators discussed below expose the business strategies, and more importantly the incentives, behind crowdfunding platforms that impact the investor.

There are two major types of crowdfunding platforms: crowdfunding marketplaces and captive crowdfunding sites. 

• Crowdfunding marketplaces are websites built to be a truly independent and free marketplace for investors and sponsors.  The crowdfunding marketplaces are created to provide the investor community with deals from numerous sponsors, most often pre-approved for quality control. 
• Captive crowdfunding sites are sites created by a real estate sponsor to satisfy a specific business need.  They do not necessarily find the investor the absolute best deal in the available market.

Back when we were young, fresh-faced students coming out of school and entering the real world we likely had a basic understanding of investing that was limited to publicly traded stocks.  Then, as we matured, we all came to realize that investing in publicly traded stocks was only one of the many ways that we could invest our money in the hopes it would grow.  Such options are now more diverse and more available than ever and are no longer the exclusive domain of large investors and financial institutions. 

One such investment is commercial real estate.  This investment class typically takes significant amounts of capital and historically has been a relatively illiquid investment.  Over the years, however, those features have significantly changed, and now there are more ways to invest in commercial real estate than ever before. 

But before we discuss the ways you can invest in commercial real estate, it must be emphasized that all investments in commercial real estate are not equal.  It stands, as with all efficient markets, the greater the risk, the greater the reward (or loss).  Commercial real estate is no different.  And those risk profiles have designations that are common among most investment classes: debt and equity.

The Rise of a New Asset Class

Since the Great Financial Crisis, the low yield environment, as well as certain regulatory changes, have given rise to a previously lesser-known alternative asset class known as “private credit”.  Private credit funds target ownership in debt and debt-like instruments across various segments (corporate, consumer, real estate, litigation, life settlements, royalties, etc.) with the goal of generating high yields, mostly in the form of ordinary income, for their investors. 

Catching the Service Provider World Off Guard

As this asset class rose to popularity rather quickly, it seems to have caught the outside service provider world largely unprepared, having a lack of experience on how to manage, account, and administer this new asset class.  As a result, most service providers advising private credit managers defaulted to their knowledge of private equity fund formation and administration, resulting in many of these funds being structured like traditional private equity funds.