Frank Ferrara, Senior Client Service Manager in North America, explains why impact investors are interested in Qualified Opportunity Funds and why full automation is needed to optimally administer such funds.

What has the attention of real estate investors these days? OZones and QOFs. These may sound like names of comic book action characters – and for all intents and purposes, OZones and QOFs offer some unique, if not heroic feats in the world of private equity and real estate investing.

I had the good fortune recently to attend a real estate development conference where much of the discussion surrounded Qualified Opportunity Funds – “QOFs,” an investment opportunity born out of Qualified Opportunity Zones – “OZones.”   OZones were introduced in 2017 under tax reform legislation[1] and offer a tax benefit designed to encourage investment and development in low-income communities in New York City and other parts of the US.  Beyond just an investment opportunity, key leaders in private equity and real estate industry weighing in on the topic agree that the symbiotic relationship of the OZones and -QOFs are likely to attract those seeking to make an important impact in meeting environmental, social and governance (ESG) factors. In this case, the social impact is specifically in lower-income communities.

Why the interest?

Looking purely at the expanse of opportunities in the OZones, the numbers speak as to why investors are taking notice. Some 8,700 census tracks were identified, approximately 78% of which are urban and rural areas and 22% in more rural spots.  Some of the major markets  identified include New York State, New Jersey, Jersey City Connecticut, Los Angeles, San Francisco, Dallas, Chicago, Boston, Miami, Washington DC, Seattle, Nashville, Atlanta, Oakland, San Diego and San Jose[2].

Coupling the sheer footprint opportunity of the OZone program with the investor appetite for QOFs, we can expect to see quite a mark in the key areas of:

  1. Social development: QOFs will meet the growing investor trend to invest in funds with sustainable practises or with an impact to meet ESG factors. Particularly in New York City, the OZone program dovetails nicely with the city administration’s vision for affordable housing, providing more options for New Yorkers to afford accommodation within their budget. According to the New York City Housing Development Corporation, more than 30% of residents spend more than 50% of their income on rent. Shortage of accommodation pushes prices up and shortages of affordable accommodation in New York reflect a larger trend. Nationwide, no citizen earning minimum wage can afford to rent a two-bedroom apartment[3].
  2. Real estate: QOFs will likely be a great source of funding for developments in New York City as well as throughout the country. Indicators suggest cautious optimism for total 2018, following a more subdued 2017. Sellers will see a bump in property value, developers will be dusting off plans, and construction firms will be ready hard-hats in hand.
  3. Tax: According to the Internal Revenue Service[4] the program allows the investor – individuals, family offices and corporations – to defer capital gains by reinvesting gains into a QOF and to potentially exclude future gains on investments within the zone. There are three significant potential tax benefits which can be realized over the course of a QOF investment period:
    • Temporary deferral of capital gain by investing in the QFund until the earlier of the disposal of the investment or December 31, 2026. Note the timing. In effect, this means investments must be made by December 31, 2019 in order to maximize potential tax benefits.
    • A step-up in basis of the gain invested. 10% of the capital gain may be excluded permanently if the investment is held for 5 years. An incremental 5% (for a total of 15%) may be excluded if held for 7 years.
    • The entire gain from the sale of the QFund investment may be permanently excluded if the investment is held for at least 10 years. This exclusion of taxable income applies only to the gains generated by the QFund.
  4. Private Equity and Real Estate funds: From Maitland’s point of view, the most significant benefit from the OZones program will be the boost to the private equity and real estate (PERE) funds industry. This is partly due to the flexibility of the source funds – taxpaying investors that trigger certain types of gains from a taxable sale or exchange of any kind of property (e.g. stocks, real estate, art etc.) with an unrelated person before 2027 may use those proceeds to invest in a QOF within 180 days of the sale or exchange. With the maximum benefit derived if investments are made by 31 December, 2019, expect pressure on fund managers to set up QOFs swiftly. We are likely to see a flurry of activity in the coming 12 to 15 months.

Fund Administration Solutions: Faster and Efficient

Managers will furthermore have their work cut out for them as QOFs are not set up as the traditional PERE funds. The inherent challenge is 1) ensuring a fast-to-market set up since there is an obviously limited supply of real estate that falls into this grouping and 2) the extra time and effort that will need to go into where and how assets are allocated.  Moreover, if managers are still relying on in-house, manual systems to manage capital calls, distribution and all four stages of waterfall payment, they are going to battle. Hence, to meet the demands of QOFs administration requires full automation.

Administration of QOFs is not complicated but it does require heavy lifting, the kind that can be easily harnessed with an integrated platform of advanced analytics with powerful investor reporting tools to ensure timeliness and accuracy. Moreover, with the steps required of set-up from inception of the fund through to liquidation, having a well-versed team by the manager’s side ensures that funds are up and running – quickly and appropriately.

In fact, having served as the outsourced fund administrator for a leading New York-based real estate development and private equity firm with a mission to acquire and preserve affordable housing throughout the US, Maitland can attest to the time sensitivity to make investments by the deadline. First-time fund managers looking to make their start as a QOF should consider working with an administrator to alleviate the back-office burden and therefore remain focused on their core goal: maximizing performance as well as delivering on environmental, social and governance investment.

[1] https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions

[2] KPMG “Opportunity Zones – Unlock New Opportunities” – November 2018

[3] KPMG “Building Optimism – the Current State of Real Estate Development in New York City” – September 2018, p5

[4] For more information, please refer to:

  • The IRS “Opportunity Zone Resources”: click here
  • “Opportunity Zones Frequently Asked Questions”: click here
  • Proposed regulation providing guidance under new section 1400Z-2 of the Internal Revenue Code: click here

Frank Ferrara

Senior Client Service Manager
Tel: +1 646 664 4288
Back to Intouch

Maitland is licensed as required for the services it offers. For further information on the licence permissions applicable to your jurisdiction please visit our website at maitlandgroup.com. The content and opinions herein are for information purposes only. They are not intended to constitute legal, financial or other professional advice, and should not be relied upon as such or treated as a substitute for specific advice relevant to particular circumstances. Neither Maitland as a group nor any of its member firms or affiliated entities accepts any responsibility for any errors, omissions or misleading statements in this publication, or for any loss which might arise from reliance on the material. No mention of any organisation, company or individual, whether on these pages or not, shall imply any approval or warranty as to the standing and capability of any such organisations, companies or individuals on the part of Maitland. Before making any decision or taking any action that may affect your finances or your business, you should consult a qualified professional adviser. Please note that, whilst all reasonable care has been taken to ensure the correctness of this publication, the information may not be applicable for all jurisdictions. Read our Data Protection Policies.

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