Hey guys. This is the post number 11, the blog post for the week ending May 11. Today we’re going to discuss Opportunity Zone Funds. What are they? Why am I interested in them? What are the pros? What are the cons? And what’s the bottom line?
An Opportunity Zone Fund is a fund that invests in and makes substantial improvements in an at-least-somewhat-undercapitalized area called an opportunity zone. The idea here is to get money to flow to areas of the country other than Silicon Valley, Wall Street, Seattle, Boston, Washington D.C. and other flourishing coastal cities, to incentivize investors to invest in places that need the money. I’m from one of those places — shout out to exit 4B — so I can tell you that God (and Andrew Yang) knows they need it. And the incentives are these:
- if you keep your money invested in this area for at least ten years, then you will pay NO capital gains tax on your profits from the investment. (The other benefit here is what I like to call the illiquidity premium. To avoid capital gains, I can’t touch this investment for 10 years. Great. The more likely you mess with your investments, the more likely you are to fuck them up.)
- And if the money you invest is a capital gain from a prior investment, then you can defer paying that capital gain until either December 31, 2026 or until you sell the new OZ investment, whichever come first. So your money grows tax free during that time, like an IRA.
- And finally, you can not only defer, but reduce the taxes on that prior gain as well: after 5 years your taxes go down by 10%, and after 7 years, they go down by an additional 5%, which means that in total 15% of that prior gain is excluded from taxation.
Knowing the history of the idea also helps in understanding it. Basically, the idea started when Facebook billionaire with a conscience Sean Parker (otherwise known as the Lord of the Rings wedding guy — God, this is a good time to be a geek) went to Tanzania and was like, fuck, this place is super poor and needs investment but I’d never invest here because it’s too risky, And then he realized that there were place in his own country that were the same way — need the investment, too risky to invest in. (“Domestic emerging markets” to use Cory Booker’s memorable phrase.) And Parker was like, what could I do to fix that? And his answer was to get the reward to outweigh the risk.
So think about this: what if the next Facebook is located in an Opportunity Zone? Then if you invest in an OZ Fund that invests in that next Facebook, then when it blows up, your tax on your 2000x Peter Thiel-esque return will be … $0. That’s right. Tax free billions, bitches. Jeff Bezos style, but without the shady Amazon shit. Because that next Facebook should still be paying profits on its income, but you, as an early investor who had the balls/social conscience to take your talents ($) to Oakland, pay no taxes on your investment. Boom — now the potential reward is so sweet that you’re willing to take the risk and invest in American Tanzania.
In my particular case, American Tanzania appears to be the greater Phoenix metropolitan area, where my OZ fund, Virtua, has made its initial investments (although the fund plans to invest outside that area in the future). And my OZ fund is investing in real estate — hotels and apartments — not start-ups. So I’m not going to get a tax-free 2000% return. But I might, if everything goes well, get their target tax-free 14% return, and that’s not bad.
The problem here is that there aren’t that many OZ funds yet. And the ones I found that look half-way reputable, like Virtua, all invest in real estate.
That’s okay, because I’ve been looking to increase my exposure to investment real estate. And I wanted to try an OZ fund for the tax benefit. This is the best one I could find when I made the investment in January 2019. I researched it online and talked to their sales rep several times. Read a Wall Street Journal article about them. No red flags were raised. But in retrospect, I should have done better due diligence. I should have asked for the names of some existing limited partners to talk to, and then I should have called them up to see if they were happy with the investment. Also, in the course of writing this article, I found some negative stuff about them online that either wasn’t there yet, or I just didn’t find at the time, to the effect that some clients are unhappy because they have too many projects going and aren’t great at communicating with clients. That said, nothing negative has happened to me and hopefully it won’t. You’re never going to make everyone happy all the time, and hopefully the negative stuff I found is the exception, not the rule.
Anyway, I went with Virtua. But new OZ funds are coming up all the time because there are literally opportunity zones in every state. For example, another fund I seriously considered is offered by Fundrise (a crowd-funding real estate platform I’ve invested with before, but not in their OZ fund). And here is one, The Pearl Fund, that goes where the real potential is — start-ups that just happen to be located in an opportunity zone. See prior best case tax free Facebook IPO. But the minimum investment is very high — $250,000 — and who knows if they are legit? I would have to do some serious due diligence before putting that kind of money in.
So, to sum up.
- Pros: potential major tax reduction; potential diversification; lack of liquidity.
- Cons: physical area of investment may be riskier than prime real estate; not many opportunity zone funds to choose from yet, but more all the time.
- Bottom line: no risk, no reward. I invested in Virtua’s OZ fund. Too soon to know whether that was the right call. I’ll let you know in 10 years. But whether I picked the right one or not, I am confident that OZ funds are a good idea — the trick is to find the right one.