Due Diligence And Qualified Opportunity Fund Managers

Due Diligence And Qualified Opportunity Fund Managers

Posted by on Jul 27, 2020


This is the first of five blogs detailing the importance of researching Quality Opportunity Fund managers, when targeting Qualified Opportunity Zones for investment.

A great deal has been written about the Qualified Opportunity Zone (QOZ) program, since it was introduced as part of the Tax Cuts and Jobs Act in 2017. The program has mostly been lauded for its community improvement potential (channeling resources toward disadvantaged, lower-income areas) and investor benefits (capital gains tax deferrals).

Even better news for investors is IRS notice 2020-39. This extends your 180-day investment deadline from July 15, 2020 to December 31, 2020. What this means is, if your original investment deadline was set to expire between April 15, 2020 and July 15, 2020, you now have until the end of the year to target a Qualified Opportunity Fund (QOF) in which to invest your capital gains, so you can defer taxes on those gains.

The issue here, however, is that not much attention has really been paid to QOFs, which are the vehicles used to invest in Qualified Opportunity Zones. Due diligence on the funds and their managers is just as important as, if not more so, than research on the QOZ projects, themselves. If the QOF isn’t in compliance with directives set out by the Internal Revenue Service or U.S. Department of the Treasury, you could lose the tax-deferral benefits. In that case, any deadline will be meaningless.

Anyone Can Launch A QOF . . .

It’s pretty easy to set up a Qualified Opportunity Fund. Legally established partnerships and LLCs can do so by:

  • Filing IRS form 8996 with their federal tax returns, and
  • Ensuring at least 90% of their assets targeted for improvement are in designated QOZs.

So, let’s say that your uncle owns a couple of retail properties in a federally designated Opportunity Zone. Let’s also say that he runs a couple of business operations in those properties, which are set up under an LLC. Technically, your uncle could file that form 8996, call his entity a Qualified Opportunity Fund, and then ask you to park any profits realized from the sale of your stamp collection into his “fund,” so he can improve the real estate. He could also try to woo you over by telling you about the sweet tax benefits you’ll receive if you invest in his fund.

While the above is a somewhat simplistic example, it demonstrates what you, as a potential QOZ investor, might face when trying to find a bonafide QOF in which to invest. Take a moment to google the term “qualified opportunity fund.” The 170 million results will include sponsored ads, promoting all kinds of funds, promising all kinds of high returns.

The issue with your fictitious uncle -- and the googled QOFs -- is lack of experienced management. In 2019, research company Preqin indicated that a little more than 70% of QOFs are being run by “emerging managers,” in other words, managers with little or no experience. The main reason for the inexperience? The program is still very new. As of this writing, there are few, if any, metrics pointing to QOZ successes or high rates of return. Because the program is only two years old, most QOZ projects are still under construction; the timeline from ground-breaking to completion and lease-up is typically several years.

But Not Everyone Can Run One Successfully.

Without those previous performance metrics, how are you supposed to know if a QOF manager is one with which you want to park your capital gains on a long-term basis? There is good news here. Just because your targeted QOF might not have a track record, the fund’s manager might, thanks to past projects.

As such, your thorough research process should determine if a fund’s manager has experience, or staff with experience, in the following areas:

Development and/or asset management. It should go without saying that a QOF manager should be well-versed in the development and/or management of the fund’s properties. Such managers are transparent about previous experience with operation plans, scheduling, working with contractors, and so on. If that transparency is lacking, then move on.

Administration and paperwork. Rules, regulations, and requirements are part and parcel of any real estate project. QOZ projects require even more bureaucracy, at both the federal and state levels. Be sure your targeted QOF manager has the know-how, or the expert staff, to navigate complex compliance waters. One wrong step or oversight could see you paying more tax than you counted on.

Involvement and alignment. If the QOF manager you are investigating doesn’t have any monetary resources in the project, quit your research. A trustworthy fund manager with skin in the game has added incentive to make sure a project succeeds. That manager should put at least as much as, or more, money into the QOZ project as do you and your fellow investors.

Property types. The manager with whom you choose to partner long-term must have a deep-level understanding of the property type that the fund is managing or developing. If your manager has a multifamily development background, but the fund is financing an industrial development, you can do one of two things. First, make sure that manager has industrial experts on the team. Or second, walk away.

Local markets. Your QOF manager must have in-depth experience of the area in which the QOZ project is being built and managed; a fund with boots on the ground is an absolute requirement. The fund’s manager should know about current and forecasted regional factors, including competition, demographics, and business trends.

Backtracking For Future Assurance

The IRS and U.S. Treasury issued their final round of QOZ program guidance in late 2019. In the wake of that issuance, Qualified Opportunity Funds are quickly springing up. Information about the fund’s manager will help determine whether a QOF represents a good investment for you. Realized Holdings will provide a more in-depth look at QOF manager requirements in future blogs.

The important aspect is that the QOZ program is still in its infancy, and fund managers with program-specific know-how simply don’t exist. However, examining QOF managers’ previous experience in similar situations can determine the viability of your targeted QOZ project.

To learn more about investing your capital gains from the sale of your real estate or other assets into Qualified Opportunity Funds, contact Realized Holdings by logging on to Realized Holdings (realized1031.com) or calling 877-797-1031.

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.


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