The Land of OZ
By John W. Gahan III
9 min read
New Year’s Day Family Conversation: A Scenario
New Year’s Day – 2019
Gerry Golden, the venerable founder of The Golden Companies, dabbled with semi-retirement in 2018, having transitioned day-to-day operations of his affordable housing operation to his children, Gina and Greg, in 2017. The portfolio was doing well, near 100 percent occupancy, generating fees and modest cash flow for the Golden family. Life was good.
Nonetheless, when he awoke on New Year’s Day, Gerry reminded himself of his 2019 resolution: “In 2019, I want a new challenge. Retirement is just not for me. I don’t feel productive unless I am in the game…doing what I do best…finding deals.”
It was a family tradition to gather on New Year’s Day to strategize for the coming year. While watching the Rose Bowl parade at his son Greg’s house, Gerry wasted no time, pushing Greg’s and Gina’s buttons.
“What are you doing about Opportunity Zones…um…opportunities?” he asked. “Are you forming funds or getting money from someone else’s funds? Did you even know that 30 to 40 percent of existing tax credit properties are in areas now designated as Opportunity Zones; in other words, places we already do business. Frankly, it is disappointing that I haven’t heard you utter one word about OZones.”
Gina started to speak, but Gerry continued. “Don’t interrupt me – let me finish. For decades, our company has made its money on cash flow, developer and property management fees and, after we have worked our butts off for over a decade, if we are lucky, we make some at the back end. But those back-end dollars get chewed up by taxes. OZones are different. Our back-end profits can be recycled into our projects and back to our pockets, without sharing as much with Uncle Sam.”
Gina had heard enough. “Actually Dad, Greg and I are quite far along in plans for OZones. There is an OZone 20 miles from here, near the university. We signed an option to buy 12 acres of raw land and are looking to build 250 units of housing, in three projects. Mixed-use; work-force housing on one site; housing for the elderly in that old abandoned mill; and a third building for student housing.”
Greg jumped in. “It’s time we think about more than ourselves. Remember Gina’s college friend, Brenda? She made millions with technology start-ups and just gave $150 million to the university dedicated to student housing for county residents who commit to working in the community for three years after graduation, devoting one day a week to community outreach. The university is doubling down, with loan forgiveness for those who make that commitment.”
Gerry beamed with pride. “Okay, I was way off the mark. I am both surprised and excited. On the ride over here, I scheduled a meeting with our investor friends for tomorrow.”
Gina was on a roll and not ready to stop. “Dad, if we are going to meet with anyone on OZone thoughts, we need our counsel present. Remember that Boston attorney you hired a couple years ago to negotiate our Low Income Housing Tax Credit buy-outs? Jay Gee. His shop has a whole team of lawyers focusing on OZone structuring. They represent individual fund creators, syndicators and, most importantly to us, Jay has represented developers for decades. We’ve already talked to him. Maybe he can join us tomorrow.”
Shortly thereafter, Gina heard from the lawyer. “Happy New Year, Gina,” Jay said. “I do have a some thoughts about OZones for you. There is no reason, other than historical relationships, to limit yourself to one investment company as your source of funds. There are plenty of Opportunity Funds being formed. It might be in your interest to create competition for your projects and maybe partner with a different type of equity provider.
“Also, if you are combining traditional tax credit equity with OFunds equity, it all comes down to the documentation. It is all about the terms under which these new funds will invest in your deals.”
January 2, 2019 – Meeting at Investors’ Office
The next day, with Gina and Greg in tow, Gerry plunged right in. “Here’s what I know about OZones. We sell assets we were thinking of selling anyway. We don’t pay taxes on our gain for a while but instead roll that gain into new deals. When we sell the new properties for a profit, we don’t pay taxes (or maybe reduced taxes) on that gain. Have I hit the high points?”
Stretch, a lanky Texan, spoke first, barely able to contain his glee. “Bingo! You nailed it! I know the legislation and guidance inside and out, having read all the comments the lawyers and accountants sent to Treasury. The program is designed to be for investments made after January 1, 2018, but I have some ideas how to use OZone dollars in deals bought a year or two ago. I love it when Congress goes live with a great idea without thinking through the details.”
Victor didn’t even wait for his colleague Stretch to pause. “Stretch, why do you always go where no rational soul would go? Why do anything that might focus Treasury’s attention on us?”
“Geez Louise!” Stretch said. “Stop being such a downer!
The law is the law. I’m not doing anything illegal. This comment period has been a gold mine of ideas we can use to our advantage. Treasury asked for comments and all the lawyers and accountants couldn’t help themselves, inundating Treasury with what they say is missing, asking for more guidance and more rules. For them, everything must be spelled out, like an Ina Garten recipe. Not me – I do deals in the areas of uncertainty before the IRS tightens the law.”
Heidi, another colleague, fidgeted with nervousness before she spoke. “Wait, wait, wait, you are going too fast. The rules aren’t even written yet. Let’s both wait until everything is spelled out?
There are a ton of questions and only a half ton of answers. We don’t even know what reporting will be required. Is it really worth it to rush in?”
Gerry had heard enough. “We are getting nowhere fast. Let me ask, have any of you actually closed an OZone investment yet?” The silence was deafening.
Gerry erupted. “You haven’t formed a fund, let alone closed a deal and you don’t even have a working partnership document. We are further along than you are. We’ll meet with our counsel and send you our ‘must have’ terms. If you can accommodate us, great, but, if not, we’ll take our thoughts elsewhere.”
At a coffee shop outside the investor’s offices, Gerry was frustrated. “No one in that room was ready to do anything. Heidi is too paralyzed to act, Victor wants to play ‘follow the leader’ instead of being the leader and Stretch has never seen an out-of-bounds stake he doesn’t want to move.
“We have other, better potential partners,” Gina said. “They are community development oriented, they have syndicated tax credits and they are tight with the university. They might be a good fit.”
“One housing project is fine for us and our residents but it doesn’t move the needle for the community,” her brother said. “If we work in tandem with other projects, we multiply the community impact while doing what we are good at.
Gina then suggested, ”We need a session with Jay and his team.”
January 3, 2019 – Conference call with Gerry, Greg, Gina and Jay, their lawyer.
“First, you need to figure out your end,” Jay said. “There’s a lot of structuring to map out…twinning OFunds with LIHTC or historic credits or both…maybe different investors… different holding periods, different exit strategies.
“There are two places to get OFund money: someone else’s fund or forming a fund yourself. Remember the issues I identified in your tax credit partnership documents?
Provisions, like ‘exit’ rights, forced sales, assignments, back-end splits and consent rights. OZone investment documents will give rise to the same issues. When you accept someone else’s money into your deal, the money dictates the terms of the partnership agreement negotiations. It will start with their form documents.
“But, right now, there are no industry standard forms. We can negotiate everything, with particular attention to what happens when you want to sell the property. And, you know from experience, the time to be thinking about exits is on the way into a deal, not when you are trying to get out.
“You can dodge a lot of those issues and have more control if you create your own fund. If it is your money, it is your rules. The current regulations are encouraging. Allocating different values to land and buildings makes it easier to satisfy the ‘substantial improvement test.’ Self-certifying makes initial compliance simple and the timelines work. Having a safe harbor on working capital makes sense when other people’s funds invest in our deals, but if we create our own qualified OFunds, we don’t need that. I see little risk in creating funds in the first quarter of 2019 while we wait to see how the regulations shake out.
“Most of all, I like Gina’s idea of teaming up with others who are social impact investors or others with properties in the local OZone.”
“I like it,” Gerry said. “OZones are just the new challenge I need. I will even co-invest with my own money. If our investor friends’ company gets its act together, they get first shot at being involved. But we’ll also see what others can offer. We’ve got a great idea, a dedicated law firm to guide us in structuring and it’s only January 3rd. What a start! We are going to be fine in 2019!”
