CAIA Seattle Webinar - Is Opportunity Zone Fund Investing Still Compelling?

Hosted by CAIA Seattle, the team from Griffin Capital joins us to discuss “Is Opportunity Zone Fund Investing Still Compelling”.

Subchapter Z of the tax code, possibly the most compelling tax legislation in decades, coupled with a growing sea of unrealized capital gains and the potential for higher future capital gains tax rates, offers investors a significant opportunity from a planning perspective. As Opportunity Fund investors seek to analyze the benefits of these strategies both from a tax planning and investment perspective, the team from Griffin Capital joins us to discuss what has changed for investors seeking to place capital in these strategies in 2022, relative to prior years, and whether the investment opportunity is still compelling irrespective of tax benefits.

“Whenever we get back to in-person meetings, we’d love to invite new people into our region that regardless of whether you’re in a hedge fund, whether you’re in real estate, we cover a little bit of everything in alternative investments as you’ll see in this conversation here.”

— Chris Carsley

Watch the discussion

Transcript

Hello and thank you for joining us for CAIA Seattle's webinar on opportunity zone fund investing. This event is being recorded and will be distributed to registrants following the webinar. We encourage audience participation. So please use the Q and A or chat features to ask questions to our speakers. Here to open our event is the CAIA Seattle chapter head, Chris Carsley.

Chris: Everyone. Hey, thanks for joining us this evening to talk about what is definitely a timely subject. So, I'm looking forward to getting the updates for people who are not familiar with what the CAIA is or CAIA is some people call it, it's a nonprofit organization with over 30 global chapters and literally tens of thousands of specialists in alternative performing research and providing a network for people who want to come in and educate themselves and be part of that network in alternative investments. So, if you want further information about that, you can reach out directly to, chapters@caia.org, or if you know someone within a chapter within your geography, please, reach out directly to that chapter head or board.

And we are more than willing to talk to people. We love new members. I know here in Seattle and the Pacific Northwest; the meetings are free. Whenever we get back to in-person meetings, we'd love to invite new people into our region that regardless of whether you're in a hedge fund, whether you're in real estate, we cover a little bit of everything in alternative investments as you'll see in this conversation here. So, with that please reach out if you're looking to do due diligence, as everyone's starting to look at alternatives, I hope everyone's not too hurt in their portfolio from our January performance in the stock market.

But with that, I'm gonna hand it off to Nick Rosenthal from Griffin and he will do some introductions and then guide us through our presentation today.

Nick: Great. Thanks, Chris. I want to take a moment and express my gratitude to you and the folks at the CAIA Seattle chapter for sponsoring this event.

I know it takes a lot of work to put a forum like this together, and any time we have an opportunity to provide some education around opportunities on fund investing, certainly something that we find worthwhile as Chris said, my name is Nick Rosenthal. I'm the managing director of advisors’ solutions here at Griffin Capital Company.

I'm joined by Kevin Shields. Kevin is the founder, chairman, and CEO of the firm, as well as by Eric Kaplan. Eric runs Griffin capital companies’ private equity division. And that is the division here at Griffin under which our opportunity fund investing platform sits. So today what we'd like to do is really provide some education around what's going on in the opportunity zone fund space really changes from 2022 versus 2021 as investors looking to allocate to the space as well as really address questions around the investment merits surrounding the underlying investments. Obviously, it's our fundamental belief that tax benefits are transformative, but in the absence of good underlying attractive tax benefits, won't make a bad investment a good one. So, it really first starts and ends with the investment. And then the tax planning characteristics that opportunities on fund legislation allow for creates some really unique and interesting planning strategies as well as helps to augment the after-tax investment returns.

But it really should be about what does the underlying investment look like? So we'll talk about that entry point as well. Before we get started I just want to provide a little bit of an overview of Griffin Capital Company. We were founded in 1995 by K. Since that time we've owned, managed, sponsored, or co-sponsored approximately $21 billion in investment offerings.

Our senior management team has on average 25 years of experience across the platform. So certainly cycled tested. We have been involved really in a myriad of investment strategies and structures all really surrounding the real estate investment space. Our 40 act interval fund business, which is a combination of both grilled preceding credit is being sold to Apollo.

In a transaction that was announced in December, our public read tragedies, which were publicly registered on trade and reads are now all internally managed by the various and sundry management teams. So our focus at the firm today is really our direct real estate platform which is predominantly focused right now on multifamily development. And that is both in a non-taxable format, which is the opportunity zone fund platform and more of a build stabilize, sell strategy merchant build investment development strategy also focused on multi-family. Since the inception of the firm, we've completed over 650 real estate transactions total and $25 billion in transaction volume.

But what I will tell you, it really sets us apart is our alignment of interests with our investors. We are investors first and foremost and that shows up in our co-investment across our platform. Griffin Capital, along with executives and employees have invested in excess of $300 million of cash.

Into our offerings. And that's really how we became interested in the opportunity zone fund space. So as we were looking at the draft legislation in 2017, that ended up in the tax cuts and jobs act at the end of 2017 we were really taken by the unique tax benefit characteristics that we saw we didn't feel comfortable building strategy around that until 2019 as the treasury came out with clarifying rigs.

But we have been very active investors in the space and observers in the space since 2017, really formulating our first fund in 2019. Since that time we've raised two funds all focused on ground-up multifamily development, those offerings are closed. We are building $2.2 billion in total project costs 21 multi-family communities total in 7,300 units in 20 distinct qualified opportunities on census tracks.

So we have been very active as investors in this space and our strategy has been exclusive. On multifamily. We launched our fund three really in November, started taking in the capital in the middle of December, and we raised approximately $70 million in investor capital over the last seven weeks and opportunities on fund three, which is our current strategy.

All of that capital at Griffin comes through financial intermediaries. We did not take direct investors. So we work with the family office, multi-family office, registered investment advisors, wirehouses, and broker-dealers. And those are the relationships that we support at the firm and their clients are our investors.

As we begin to start this conversation, I want to bring in Kevin, as I mentioned, the founder and CEO of the firm and I'd like Kevin to spend a little bit of time level setting on the investing and opportunity. In which subchapter Z was created from which governs opportunities in front of the best.

And just to give everybody an idea of what they associated tax benefits are for opportunities on front investors. So I'll kick it over to you, Kevin, and let you share a little bit about the tax benefits.

Kevin: Thank you. All right. Great, Nick, thank you for that introduction and I echo your sentiments.

It's a pleasure to take part in the Chi event. And when we started before we went online here, Chris had indicated that he gets calls from people asking whether or not the qualified opportunity zone opportunities still exist. And we're here it's to certainly reinforce the fact that They still exist and there are still phenomenal opportunities associated with us development opportunities and multi-family.

As Nikki indicated, the investing and opportunity act was a small bill that got subsumed in the tax cut and jobs act. In December of 2017, we started taking a pretty close look at this legislation really early in the first quarter of 2018, to try and figure out what strategy we wanted to bring to market.

And with whom we wanted to partner from a joint venture development perspective. And we have a kind of assembled a kind of a who's who of national multi-family developers is our strategic partners, but as we sit here today and to answer the question about whether or not it's still viable to invest in a qualified opportunity zone fund ultimately to the extent that you invest in the fund today you realize the capital gains event invest in the fund today.

You don't pay your capital gains tax until your first tax is installment in January 2027. So the actual capital gains tax defer through the end of 2026, which is a nice benefit too. It's a nice benefit to have that present value effect of the deferral, but really the economic driver behind the legislation and the significant proponent of the tax benefits associated therewith is to the extent you stay invested in a qualified opportunity zone fund for a period of 10 years or more, then you will receive at the end of that 10 year period, a hundred percent fair market value basis.

Step up in whatever the fund invest in or in our case develops a hundred percent fair market value basis step up. So that means that when you sell one or more of the assets in the fund, or they sell the entirety of the fund in one fell swoop, any capital gain that was realized it's associated with that development activity, and the growth of those assets is returned to the investor tax-free and that's a pretty phenomenal benefited at the end of the day. And that's the benefit that continues to exist. Even today. So here's really more of a graphical depiction of that timeline. So the qualify, the investor investing in opportunity act was really intended to stimulate and motivate.

Americans, who've got embedded capital gains on their balance sheet to liquidate those capital gains generate a capital gain event and redeploy those capital gains into qualified opportunity zones. And there are 67, some hot zones targeted that were addressed and identified in the middle of 2018.

And to be a qualified opportunity zone, you really have to manifest one or two characteristics. You have to have a poverty rate of greater than 20% or prevailing median family income, add or less, 80% of the metropolitan median family income. So it's really intended to redirect capital gains into communities that need the development activity or need the investment activity.

So you sell whatever asset and it could be any capital gain unlike a 10 31 exchange, which is all targeted specifically to real estate. It could be any capital gain. It can be long-term capital gain. It can be short-term capital gain. It could come from the sale of an operating business. It could come from the sale of collectibles of stamp collection of coin collection.

It could be a low basis, highly appreciated stock. Anything that triggers a capital gain is eligible to be invested in the qualified opportunity zone fund and the real tax benefits attach themselves to the capital gain. So once you exercise a transaction or consummated transaction and generate a capital gain, you've got 180 days in which to redeploy those capital gains into a qualified opportunity zone fund and get the tax benefits associated therewith, so 180 days to invest in the fund.

Again, you don't have to pay the capital gains tax on a realized capital gain until 2027. So you get to furrow through the end of 2026, and then you stay invested for the 10 year period. You get a hundred percent fair market value basis. Step up a couple of nuances to that rules. Pretty straightforward.

If you're selling a little basis, highly appreciated stock the day in which you transact on that stock sale, it starts that 180 day period clicking. If you, however, we're an investor in a passenger vehicle, a partnership, if you were on a limited partner in a partnership or a member of a limited liability company, any paths or vehicle, if the paths through the vehicle itself, the partnership and the LLC. sells an asset triggers a capital gain and distributes those gains as a taxpayer, you have a couple of different, you have three different options with which to commence this, the tolling of the 180 day period. You can either pick the data which the passenger vehicle actually sold the asset much if you had sold stock individually, that the day they sold the asset gave rise to the capital gain.

You got 180 days, but you got a little bit more flexibility. You could also pick the last day of the past through vehicles a taxable year, which generally tends to be the end of a calendar year. So 1231. So that would push your capital gains investment period out through close to the end of June.

Or you also have the choice to pick the date of the pastor's vehicle’s tax return without extensions, which is generally March 15th for a passenger vehicle. So if you pick the latter date, you really have until September 11th, 2022 to redeploy those capital gains. So for us as an advisor, One of the things that you want to be contemplative and consultive of with respect to your clients, are there still opportunities to engage in creative tax planning for gains that were realized and passed through a pass-through vehicle in 2021?

So again capital gain was recognized by a passive vehicle that ultimately was distributed to those investors. At any point in 2021, theoretically could be redeployed into a qualified opportunity zone fund all the way through, up to and including September 11th, 2022. So still opportunities to engage in tax planning for realized gains realized in 2021.

So one of the things that this site tries to articulate is really what are the benefits on a side-by-side basis of investing in an asset that isn't boring. It's not fun versus virtually the exact same asset across the street in a non-qualified opportunities zone. So the basic assumption in here is you invest a million dollars.

You've lost a billion dollars. The investment generates a 9% cumulative internal rate of return over a 10 year period. What does that look like on an apples-to-apples basis? So if you just looked at the bottom right-hand corner net of tax, you're going to generate $1,685,000 worth of net after-tax proceeds, inclusive of your initial investment game by investing in an asset that is not located in a qualified opportunity zone.

Conversely, the right part of this chart is what the return characteristics look like. If the asset is in a qualified opportunity zone seam economic characteristics assume a 20%, a capital gains tax rate, the 3.8% ACA, and we just picked a middle of the roads conforming state that has a 5% State income tax. And in this instance, the qualified opportunity zone fund investment throws up just shy of 2.1 million in net after-tax proceeds. So an additional 393, $394,000 of additional proceeds for having invested. In an asset in a qualified opportunity zone fund in a qualified opportunity zone versus one that is not.

So with a 23% lift in that after-tax proceeds, I appreciate the comment that Nick made and I'm going to reiterate it. And it's something that we return to thematically time and time again, which is the, as you can see from this chart, the tax benefits are significant on a relative basis, but the tax benefits themselves do not make a poor deal, a good deal.

They do make a good deal and exceptional deal given the additional two hundred and sixty-two hundred seventy basis points of internal rate of return that the QFC investment is going to drive over that 10 year period. But fundamentally it all begins and ends with your analysis of the sponsor and their investment thesis, the asset class, in which they intend to invest how they're going to deliver that asset.

How did they mitigate risk? Because a lot of this is really geared towards development or substantial renovation. And the real estate side, there's a whole nother world of investing qualified opportunity zones, the businesses that are located in qualified opportunity zones, which is going to separate from the world in which we populate, which is the real estate world.

But again, I'm going to continue to emphasize it begins and ends with the real estate assets. So you've got to have a very acute focus from an underwriting perspective on the sponsor, their thesis, the asset class, and ultimately the asset in which they intend to invest.

Nick: Kevin, you mentioned real estate.

One of the things that might be helpful is to talk about how real estate income is treated from a tax perspective in this structure. And then I want to ask you a question about this slide that just came through.

Kevin: Yeah, so the short answer is it's a development transaction. So in our case, with respect to the funds, our first fund, we raised 460 million to develop nine communities.

In the second fund, we raised 585 million of equity to develop 12 communities totaling 21 and 2.2 0.2, 2.3 billion of development in the Ford pipeline. And ultimately you can anticipate as we do on a performance basis when you're going to start to make cashflow distributions, and I'm going to return to our ability to create liquidity during the life of the fund, toward the end of the presentation.

But ultimately as we build an asset and deliver the essence stabilized. Recapitalize the asset with permanent debt start to make tax-free distributions. When you're making a debt finance distribution. If you recapitalize a real estate asset and pass it through to limited partners or members of an LLC distribution in order than Q O Z environment and the subchapters, the environment, generally the distribution is tax-deferred.

So you don't pay any tax on the distribution from debt, finance, proceeds upfront. However, it does reduce your basis in your partnership interest. So your membership interest in the LLC, which catches up to you with the back end when you sell the asset because you're being, you're paying capital gains tax on the difference between the net sales price and your adjusted basis, but here by virtue of the step-up in basis, accorded us by subject.

You see the code that the interim distributions that you're making from the definition. Transactions really tax rate. And then on a cash flow perspective, as we deliver those assets, stabilize them, which means we're leasing them up to high eighties, low nineties occupancy. The point in which we would recapitalize the asset with permanent debt and retire, the construction loan will start to push through to the fund investors of which we are one we've invested capital in each of our three funds.

We'll be searching for cash flow distributions on a monthly or quarterly basis. And so if you'll look at the portfolio, you start with zero current cash flow, you're getting some tax benefits in the interim passive loss pass-throughs cause you're depreciating. And then you'll start to ramp up your cash flow, your ramp up the recapitalization distributions, but the cash flow distributions themselves are highly tax advantage as well because Europe you're in a passenger vehicle and we're generating depreciation deductions, which is sheltering the current cash flow distributions.

And again, because there is no concept of recapture in QSE world it all is returned to you effectively on a T largely a tax-free basis.

Nick: Thanks, Kevin. So these become very tax-efficient income vehicles down the road. After the assets are stable.

Kevin: Correct.

Nick: So one of the questions that came through was for individual gains when you're looking at your 180 days that 180 days has the ability to span calendar years.

Correct. So if I harvested gains in October of November of 2021, I'm doing tax planning here in January or February, those gains are still eligible for opportunities, open investment, as long as I make that investment within 180 days.

Correct?

Kevin: That's correct.

Nick: Okay. Thank you. So a lot has been made as we saw flows into opportunities on funds accelerated at the end of 2021, about a specific benefit sunsetting for opportunities on funds investors.

And the question that a lot of fund investors have for 2022 is did I miss. So I think it would be helpful if you could articulate the difference in entry point for a 2022 investor relative to a 2021 investor, relative to that tax benefit, and what it might mean.

Kevin: Yeah. As I said earlier the substantial component of tax benefits associated with subchapters, the, of the code and making an investment into a qualified opportunity zone fund, is that a hundred percent fair market value basis.

Step up that you get at the end of the ten-year period, the deferral is a nice benefit. If you go back in time to the point, which this legislation was first adopted, the way it was drafted is to the extent that you had an investment in. For a period of seven years or more you would have received a 15% basis step-up in your zero basis capital gain.

So generally speaking, your capital gains have zero bases. If you invested a million dollars at the end of 2019, you're really only paying in capital gains tax on 850,000, you get a 15% basis step-up. If you had held your investment in a fund for five years or longer, you'd get a 10% basis step-up five years longer prior to the end of 2027.

So that trigger point was really 1231. 21. So if you would invest it in a qualified opportunity zone fund prior to December 31st, 2021, you would have still benefited from a 10% basis step-up in your zero basis capital gains. So again, if you invest in a million dollars, you're only paying the capital gains tax on 900,000, you're getting that 10% basis step-up.

It's almost comical to me, how much that drives people's decisions to try and get in before the end of these sunset periods. We raised a tremendous amount of our equity in the first fund. In December of 2019, we raised a significant amount of equity in both the closeout of our fund two and the launch of our fund three in December of 2021, because the investors were trying to capture that last 10% basis step-up.

And the reason I find that comical is people got really panicky about making sure that they get in before 1231. And our mantra really has always been. Don't rush into an investment decision for the sake of garnering that additional 10%. Take a step back, take a deep breath, recognizing the fact that 10% basis step-up is not really going to significantly tilt the windmill.

You want to make sure that you're making the right investment first. Returning to that theme that it's about real estate first and foremost, and the tax benefits are secondary. And by the way, if we just went through a very simple analysis to quantify over a 10 year period, what that 10% basis step-up means in terms of internal rate of return, you can see right here in the middle of this bar of this chart, that the after-tax internal rate of return for an investment made in 2021 would drive about a 7.3% internal rate of return, as opposed to a seven 11 or a 7.1, 1% return to the extent the investment was made in January.

So it's really only 19 basis points in total return. And if you're talking about an underwritten, a total internal rate of return pre you know, before the tax benefits of, call it between eight and 10%, and then you add the 225 basis points on top of that. Which is the tax benefits. You can see the 19 basis points are really not material.

So it's funny. It gets back to the question that was Chris was asking just before we got our mind here, which is there still qualified opportunities on fund investments available as it is still a product it's very much still a product that can generate significant tax benefits as a result of that 10 year holding period.

And the fact that you've missed out, quote-unquote, missed out on that five or 10% basis step-up really. It's not material in the grand scheme of things from an overall return perspective.

Thanks, Kevin. So assuming that 20 basis points or 19 basis points, doesn't. It doesn't shy you away from space.

I guess the question becomes is the entry point attractive from an investment perspective. And so I want to bring in Eric Kaplan, who I mentioned is the president of Griffin capital private equity, who runs our opportunities on some business and overseas. Now over $2.2 billion of multi-family developments in this space to give us a sense of how the market is shifting.

Obviously, we saw record real estate transaction volume last year, over $600 billion of real estate transacted in the US yields have been low institutional investors have been increasing their allocations to real assets. Eric, from your perspective, we have focused at Griffin on multifamily.

What is your perspective of why that continues to make?

You'd have to be un-muted Eric, to get your perspective. Liz could unmute you. That would be great.

There go in the upper right-hand box of your picture here.

Eric: No problem. Yeah. Thanks, Nick. As you alluded to, why did we choose multifamily? And as a firm, we've invested in multiple property types and really have expertise across the full spectrum and at a macro level, when you're thinking about a long-duration capital investment like a QO is the investment.

You want return characteristics that are stable and predictable. And as you can see from the slide when you compare the performance over one to 10 year rolling holding periods for multifamily versus industrial regions, Office and hospitality on a risk-adjusted basis, which is the commonly used the sharp ratio, which is commonly used.

You can see them multifamily has continually outperformed those other asset classes, so great historical performance. But then when you want to look forward, there are a number of long-term secular trends that are providing tailwinds to the multifamily space. Number one is there's a well-documented housing shortage.

The government's just not doing enough to provide housing. In addition, as you can see from this slide, home prices are increasing more rapidly than income-making homes, buying out of reach for a number of folks which allows landlords. To raise the rent. So for example, home prices were up 16% in 2021 nationwide, and rent growth on the apartment side was about 13%.

So this increase in home prices is a great boom to landlords'’ abilities to raise the rent. And then if you look, Nick, if you'll go to, there you go. If you look at this slide, there's good demand coming from both ends of the age spectrum. On the gen Z and millennials side, folks are tending to get married later.

They're delaying their household formation. Again, homes are not affordable for them. They've got student debt. So poems are just out of reach to many of them. So they're continuing to rent longer on the other side of the age spectrum or the baby boomers. And a lot of folks like myself, we don't need a four or five-bedroom.

So we're continuing to downsize in some of us are entering the renter market and others we'll just buy a new home. So empirically the multifamily sector is holding up really well or, over long holding periods. And then the next question is, how has COVID, changed the industry and change the strategy that we're employing.

And we really think about it in two ways, how resilient was multifamily during COVID and what changed and how do we adjust our strategy? And the reality is multifamily was incredibly resilient. In fact, as you can see from this slide, rent collections never were below 92%. We had terrific rent growth. As I mentioned earlier, rent growth.

13% last year and is expected to be above historical averages going forward. But what we did see was an accelerated movement of population to the Southeast and Southwest west markets. So you know, better weather, high quality of life, lower cost of living. So markets like Tampa, Phoenix, Nashville also saw increasing population in the pandemic, just continue to accelerate this.

And in our strategy, as Kevin mentioned, is very targeted, it's strictly ground-up multi-family development. And we only invest in markets that exhibit this long-term job in population growth where the gap between renting and owning is growing. So again, if you look at our 21 assets, Phoenix, Austin, Nashville, Denver Tampa are the key markets that we're we're invested in.

Nick: So Eric, we've seen a lot of people retire. We've seen a lot of them move into these kinds of lower costs, better live, work, play environment stage. Obviously, that's driven housing shortages and challenges with affordability, but we've also seen a tremendous amount of capital enter the multifamily space targeting core assets.

So when you are thinking about it, does it make sense to be a developer or does it make sense just to buy core assets? What is the dynamic right now, but between valuations in the core market versus the spreads that you can achieve as a developer? Yeah,

Eric: That's a great question. It can, that really goes back to the earlier question, is the entry points still compelling for, ground-up multi-family development.

And there are really three reasons that we’re very bullish. The first is supply. We spoke earlier that most of these major Southeast and Southwest markets are undersupplied. From a housing perspective, we don't expect that trend to change anytime soon it is likely to be enduring. And then secondly, on the demand side investor demand for stabilized multifamily properties continues to increase.

And that's for a number of reasons. One is just the stability of a, of cashflow from apartments, particularly when you compare it to an office building where if you lose a tenant your cash flow will be significantly diminished just by way of example. So you're seeing a lot of demand come into the multifamily space for these stabilized prices.

Mo the institutional investors have always been being investors in multi-family. The pandemic has exacerbated this. In fact, Blackstone's bought over $7 billion worth of apartments just in the past two months. So as a result of these supply and demand factors, the spread between the cost to build a, which is what we're doing by partnering up with the developers that Kevin mentioned before, and the ability to provide that product to the folks who are seeking stabilized, cashflow who want to buy an apartment building that's been constructed and well leased up.

It's allowing us as the supplier of apartments to get very attractive risk returns.

Nick: And so ultimately you're building assets into this market where evaluations are very strong. Kevin, can you talk a little bit about how within the opportunity zone fund structure that effectuates the opportunity to have some interim.

Kevin: Yeah, we are, but I want to just piggyback up some of the stuff that Eric said. That's the other thing that's important though. And one thing is there's a lot of the questions we get are, we've got three vintages of funds, right? We've got the 2019 vintage, the 20, 20 vintages in the 2021 now 2022 vintage.

And the question is, Hey, how have those opportunities changed in w was it a better opportunity in 19 and 20, as opposed to 21 and 22, 22? And to Eric's point, it's amazing to me how stable the relationship has been between exit cap rates are stabilized. Cap rates are free and clear yields and the yield to cost.

So if we're building to kind of 150 basis points to 200 basis points, spread that number really has not changed that much. Over the last few years. And as a result of the opportunity, we still find it very compelling just from a pure acid perspective. And it's really a combination of things.

So you think about inflation or you think about interest rate volatility, or ultimately increasing interest rates that drives up the cost of construction. So your, you have, the cost is going to start to get compressed, but at the same time, the capital flows have been compressing cap rates, and that relationship has remained fairly stable.

The other thing about multifamily is very responsive. To changes in underlying inflation. As you can imagine the least life of multi-family properties is anywhere from a month to annual. So we have the ability to reset rents on a fairly frequent basis. The most responsive asset class to inflation is hospitality because they reset the rents every night.

But we've got $5.8 billion of office three on our portfolio. Those much longer duration leases are much less, are less responsive to changes in inflation. So you're in the right asset class if you anticipate increases in inflation going forward. But what this chart is intended to demonstrate is how, and I alluded to this earlier, how we drive.

Interim liquidity through the four corners of the fund because the individual investors are not required to pay the capital gains tax upon the sale of the asset to get deferral through the end of 2026. The question that we were asking ourselves structurally when we were putting the fund together is how can we create interim liquidity by the time 2027 rolls around?

So the individual investors don't have to look elsewhere in their portfolios for liquidity to pay those, what would otherwise be a Phantom income tax liability, capital gains tax liability of 2027. And this is really intended to address that. So the bar chart in the middle is our straightforward development asset, a hundred million dollar property.

So I would say on average, our assets are all-around a hundred million dollars. So as we finance that in the front end, we pick up a 60% construction loan or $60 million and invest $40 million of equity or 40% of the total capitalization to get to a hundred million dollars. Development costs to develop a 350 unit, a hundred million dollar property takes a couple of years to develop the last asset, but yet the units get released in phases.

So you've got a lease-up that's going over to on overtime, and then it'll take maybe another 18 months or so to stabilize that asset and get it to the point where it's got sufficient occupancy, which in our mind is going to low 90% occupied, where you would want to exercise yourself in terms of replacing construction debt with permanent debt.

So if you put 6 55 or 60% construction debt in place over that three and a half year construction, the stabilization period, if you're developing in this example to 150 basis points yield the cost. So if you look at the left, you'll say the yield to development across a six and 8%, that's driving a stabilize market capitalization of free and clear you the 5% that's at 150 basis points spread.

In the yields, the costs, if you factor that in over the three age stabilization period, the math just dictates that it's stabilization your a hundred million dollar properties, then going to be worth $130 million. It's just math at that point in time. Now that you've stabilized its multi-family. So we'd returned to the permanent debt market, which was largely driven by the agencies, Fannie Mae and Freddie Mac put on a conservatively leveraged 65% first mortgage loan, permanent loan pay off the $60 million construction loan.

The 65% permanent loan equates to about 84 and a half million dollars of permanent debt. Now we're left with 24 and a half million dollars of excess. Debt finance distributions. We can use it to buy our joint venture development partners out of their promoted interest, to the extent that they want to be bought out, and ultimately make distributions to the limited partners, which as I said earlier normally that would reduce your base, your base in the partnership unit.

In this case, by virtue of the fact, you've got that a hundred percent fair market value-based stuff up. We can make those definites distributions on a very tax-efficient basis, which is tax-free.

Are you muted, Nick? I can't. Yeah, my

Nick: apologies. I said that's certainly powerful because you've got that deferred gain liability. That's coming due in 2027. The opportunity, some pretty significant interim liquidity certainly helped us deal with that from my planning.

Kevin: Yeah. And I tell you, it's selfish on our part too, because we've invested 11 and a half million dollars of our own capital gains in the three funds.

So as we sit down and think about structure, it's really, how do we solve the problem for ourselves? How do we solve the problem for all of our investors? We stand shoulder to shoulder with our investors. And it's one thing that, is compelling is to invest in everything that we ultimately develop and, or sell so that we maintain a keen alignment of interests.

This is just one example of the alignment and interests that we keep with our investors. I'm going to make one other comment. About our focus on multifamily. And frankly, if it wasn't multifamily, it would probably be industrial, which has also been a very hot real estate commodity through the course of the pandemic.

Just given the Amazon effect. The problem with industrial is they're they tend to be smaller assets from a dollar size perspective. So you're trying to get a good diversified fund of a decent magnitude from an overall size perspective. The multifamily asset class is very scalable. As you can tell, we're building assets that are each about a hundred million dollars, and we're focused specifically on a single asset class.

So this relates to our fund, but also anything else that you might be looking at or analyzing. And we focus on a single asset class because of the time and experiences. That's really the only way that you can derive a portfolio premium when you're going to liquidate. So as much as we spend a lot of time in the front end and in structure and design and fund design, we spend equally as much time, if not more time, figuring out what the monetization events going to look like.

How do we drive a positive economic income outcome to our investors by investing in this particular fund, if you, if we get to the end and we've got nine or 12 assets in each of the fund one and two, and we're looking to monetize we can, we've got a couple of other arrows in our quiver by focusing on a single asset class.

We can either sell the assets one at a time and break up the portfolio, but we stand probably a much better chance of driving. A portfolio premium by selling it all in one lump sum. So if you've got a billion-dollar transaction, frankly, if Blackstone hasn't bought the rest of the world by then, we're happy to sell in the last 3 billion.

As opposed to, if you mixed your asset classes, if we had mixed multifamily with retail or industrial or hospitality, really your exit strategy is only one arrow. There's only one arrow in that quiver and that's to sell the assets individually back into the market. Cause it's very atypical that you'll find a buyer who wants to buy multiple asset classes in a single transaction.

You generally get their pricing and more aggressive pricing by people that are asset class-specific. One of our big partners in fund one is a, is Avalon bay. I want bays one of the largest publicly traded multi-family real estate investment trusts in the country, $40 billion for the assets.

They would be a nice natural candidate. To buy a portfolio of assets that are ultimately, we're going to be approximately 10 years old, by the time we're ready to unwind the online the funds. So it's an important element to think through. And as you're again, thinking through the structure, the investment thesis, it's equally as important to think through the very end of the life cycle of the fund and think about the strategies that are going to be employed to monetize those assets or monetize that fund and drive the best possible outcome for the investors of which we are one.

Nick: So when it comes to thinking through obviously the process as you put on your hat, as someone on the research side of the business, what advice would you give somebody as they're evaluating opportunities? And I'll leave that both the Kevin and D.

Kevin: Well I, yeah, I'll go ahead. And Kevin, I'll take the first stab at it from a more macro perspective.

So as you think through, from an underwriting perspective, it's not just a question of, Hey I'm going to underwrite this particular fund, or I'm going to underwrite this sponsor, or I'm going to underwrite the investment thesis. I've got to get familiarity with respect to them who the development partners are, how do they mitigate risks?

It's also in the other side, which is what kind of capital do you want to invest in that fund? What kind of dialogue does the financial advisor want to have, or the rep, the registered investment advisor wants to have is, are clients in terms of counseling them. So let's assume you've gotten through the underwriting and you pick two or three fund sponsors that you feel comfortable with.

It really becomes a question of where do you want to attach those capital gains? What can? What kind of capital gains do you want to have a forward-looking conversation with your investors and get them to stimulate capital gain sets that would not otherwise have been realized? We see a lot of our investors that have sold operating businesses that tend to be fairly episodic and it's going to happen.

Yeah. It's happening around us. If you will, where people have sold the business, they sold an operating business, but they've sold it for whatever particular reason they have in mind, in terms of how and why they want to monetize the business. Now they've created a transactional event. They've created the capital gains, and now this is a discussion that the advisor is going to have with his or her client about where they could potentially deploy those gains on a tax-efficient basis.

So the business sale is a big source of investment dollars that comes into our fund, but that's reactive, right? That's a transaction starting to happen. There's also an ability to be much more proactive as a financial advisor, which is you've got visibility into your client's portfolio. You can identify where they've got highly concentrated stock positions.

You have a view as to the stock positions that have a low basis that about that highly appreciated. In fact, one of the transactions that I engage into January. Capital gains is at the behest of my children when they were, nine and 10, they encouraged me to load up on apple stock because they had this cool thing called an iPod, and that was going to transform the music business.

So I loaded up on, I literally loaded up on Apple stock and, 1998 and I was sitting at, and I never traded it. And it was sitting on these huge gains. So I was looking at our qualified opportunity zone. I'm looking at the tax benefits. I've got a lot of visibility in terms of what it is. We're trying to create who it is we're partnering with and what kind of outcome I think we can expect what a great opportunity for me to take some of that apple stock remove some of the gains from the table and reinvest those gains.

In a qualified opportunity zone fund, which happened to be around. So there's a really good opportunity as a financial advisor or a research analyst to think through portfolio dynamics and your individual client, and to figure out where you want to mind some of those capital gains specifically to invest in a vehicle like this.

And then from a real estate perspective, the odds are most real estate investors who are serial 10 31 exchange. People are really focusing on the 10 31 exchanges option, but the qualified opportunity zone fund is an equally strong option to invest capital gains that are harvested through the sale of real estate.

And they can then they can interact. In fact, we had a transaction that we closed. We sold an asset up in the bay area in San Francisco, generated a very substantial capital gain for 20 investors that were in that transaction. And we had two of those investors that took a portion of their money invested.

It, kept with the qualified intermediary and consummated, the 10 31 exchange. And they also chipped off a piece of that capital gains and invested in our qualified opportunity zone fund. So there's a lot of discussions that can be had between the advisor and their clients in terms of strategizing from a tax perspective and looking through their portfolio to figure out where there are gains that are embedded on their balance sheet, that should be freed up and redeployed into something integrated into a vehicle like this.

So that's really more of a macro discussion. I know Eric if you wanted to be a little bit more fund or property specific.

Nick: Sure.

Eric: Yeah, that'd be a little bit more granular. As both Kevin and Nick said, first and foremost, this is a real estate investment. So you want to make sure you have the right sponsor.

They have the right team to execute. They've got a track record of success. Who are you doing business with and how have they fared over the years? Obviously, that's number one. And then are they investing in the right asset class, which can withstand economic cycles? As we've told you, we're very bullish on the multifamily sector.

And then the next question is what's their strategy for controlling costs and reducing risks? Are they well capitalized is the strategy diversified. And then more, most importantly, because this is a government program, you want to make sure that your sponsors have the proper compliance and legal protocols in place.

So they don't step over the foul line and put the QR, the QOF status in jeopardy.

Kevin: I think I want to just piggyback on that last comment. I felt that amazing particularly early on. I, we, we spoke. At a number of conferences, we've been on a number of panels we're subject matter experts. I always found it a little disconcerting that there were sponsors that kind of came out of the middle of nowhere and say, boom, I'm in the qualified opportunity zone fund business, without really having a full appreciation that when you go down this road, we are wedded to these investors for the better part of it for over a decade.

So as part of the sponsor due diligence, and I appreciate the comment, Eric, you've got to be comfortable that the sponsor is going to be around for 10 years and they can continue to service those clients. And to the point that you made Eric, there's a lot of compliance protocols. That has to be wrapped around fund management and how we report.

And when we report, this is an area that's come under a fair amount of scrutiny lately, just because some of the bad actors, I would say are bad actors in this space. They know the good news. I think ultimately is that the general, the GAO, the general accountability office did a study. And I think they released that study at the end of last year.

And they were ultimately very favorably pleased with the amount of investment that was coming through the qualified opportunity zone legislation, how that investment or those investments were really targeted, to the betterment of their local communities. You think about it. Us investing $2.2 billion in 20 different qualified opportunity zone communities around the country.

The incredible positive economic impact that has on the ground, both from an employment and labor perspective, but all of the collateral and ancillary services that go along with adding another 700 residents to a specific community has got a real multiplier effect in terms of the economic benefit to those communities.

So I think that the legislation has. Largely been successful. I'm hopeful that there is a bill floating around and it won't have the strength to stand on its own, but it's a qualified opportunity zone extension act, which was HR, HR bill one last year that I'm hoping gets attached to some of the other top tax policy and legislation that's going to be passed much.

Like the investment opportunities act was not a bill that was going to get passed on its own, but it was, as I said, subsumed into the tax cut and jobs act, there's still a lot of bipartisan support on both ends of the aisle in both sides of the aisle from, with respect to this legislation, which is very positive.

I can tell you in the last administration, the last couple of administrations, we become increasingly less bipartisan. So it's nice that you've got a program, a government-sponsored program here. That's still, it garners a lot of bipartisan support.

Nick: Thanks, Kevin. No that's very helpful.

Before we get into Q and a, I just want to talk just very quickly about just the profiles we tend to see of our investors. Kevin talked about the sale of real estate. One of the things that's really powerful about the sale of real estate and thinking about it in the context of an opportunity zone fund investment versus a 10 31 investment is the opportunity to separate basis from gains.

So in an opportunity zone fund investment, you're investing again or part thereof. You get to take your basis back. So for investors that don't have an extraordinarily low basis, this is a compelling way to deal with some of that. Implications of selling that real estate asset. And it is also a way for you to take back the basics and build a diversified portfolio with that.

The other thing that becomes interesting in that structure is when the real estate is owned by several partners and those partners don't necessarily want their kids to have to be in business together, down the road. So w we tend to see as opposed to the 10 31 transactions in that. And investment into an opportunity zone fund where the partnership or LLC that owned the real estate realizes the gain distributes the proceeds to the individuals.

And then the individuals invest in the opportunities on the fund. We see a fair amount of folks that are harvesting gains from growth portfolios, which is obviously part of the security sale component, but also the retirement planning can component it obviously for retirement planning. You've got a lot of investors that you work with like that is four or five, six years away from retirement.

So this is a way of getting both growth and income and four to five years down the road generating that income in a very tax-efficient way. And then on the business planning business sales side, obviously that investor has again, has to deal with that gain. This is a way of getting additional diversification with real estate exposure into that portfolio.

But also for tax planning purposes spreading out when they take those gains liabilities over. So I want to jump to Q and a quickly. We have a question that came in. It says, given the favorable tax treatment of opportunities on investments, what is the driver behind institutional investments and opportunity zones?

When many of them have favorable tax status. And I think that's a, just a misunderstanding what we were articulating is that opera, the ability for institutions to acquire multifamily and their desire to acquire more multifamily is part of what makes pricing so favorable in that market.

And obviously as an opportunity zone fund investor, and more importantly, as a multifamily developer, we're really focused on what that value is four to five years out. When we go up to recapitalize that asset and distribute money back as well as what the value of the portfolio looks like after 10 years When we go to liquidate that portfolio.

So to the extent that there is strong institutional interest in the asset class, that's very constructive to valuations. And so we want to be investing into a market where other people want to own those assets because that is going to be good for values when we refinance the assets. And then ultimately when we sell the assets, we don't see taxpayer bubble investors, making investments in opportunity zones, because to the extent that you don't have a capital gain, you don't get the benefit of the tax.

Chris. Did you see any other questions come in or,

Chris: I had one comment and then a question it's great to hear that you feel the legislation has been successful. I'll tell you this, there's been a few articles out there, a few that were floating around amongst our board here, that it wasn't performing what the intention was.

So you guys can collect your data of how you're having a positive impact and get that into the right hands. There could be a further paper of this program that has been successful and I may even be the catalyst that creates that extension that I think all of us would like to be able to see so that's my comment.

One of the questions is let's take a step back to exit You're looking at any time you get something, that's where there's a, there's an end date to an event that's occurring. You can actually have an occurrence where you might have a lot of people trying to exit all at the same time. And there's been, it's been pretty prolific where there's not just you guys, but a number of different people creating funds for this exact purpose.

What are your thoughts or your beliefs well, okay? We get 10 years out and how many people are going to be looking to sell how much money is going to be coming out of this. And people are going to be rebalancing per se. You might have some people that naturally, Hey, I'm in a great real estate investment.

Why would I want to sell? But there could be the other side as well to where you're seeing may be exited this as a strong word, when we get to that, into that ten-year period, what, how are you guys thinking about that now? Or is it not a

Kevin: concern to you? That's a great question, Chris.

And I'll tell ya, because having thought through this, there's a couple of responses. One of the more interesting ones is once the designation was made in June of 2018, one of the questions comes back to this, Hey, what happens with the 20 20 cents to send them, am I now going to lose the status of a qualified opportunity zone?

And the answer to that is no that's indelibly marked. So once those 8 6700 designations are remade, there's no change. Not only there's no change as a result of what happens from the 2020 census, but it's designated as a qualified opportunity zone all the way through. 2047. So theoretically you could hold these assets through the end of 2047 and realize all of that appreciation.

Tax-free in 2047. Now that's not the way we underwrite it. So we underwrite it as a, basically, a 10-year old, so that we're ready to exit and in a pull the push the exit button, as soon as that ten-year period is up, but we've got latitude and flexibility. If we need to extend it for another year or two, to make sure we're hitting the right window, I will tell you two responses.

One is I'm not really worried about a flood of properties coming onto the market in 2032 or 2033 because as much as you've heard a lot about the size of the qualified opportunity zone fund market and the amount of development activities that are going on, that's undergoing that could potentially exit in 10 years.

It's still a very small percentage of the overall real estate capital markets. So it's not, I don't really believe it's going to move the needle appreciable. I worry more about what the environment is going to look like in 2032, the overall global real estate market than I do, whether or not there's going to be a supply glut.

And that's why you want to build in a little flexibility to the end game. And when you actually have to monetize and give yourself some latitude and flexibility to push it out a year or two, if we, if in 2032, we're experiencing what we experienced during the great financial crisis, that is not a good time to be transacting.

You're going to want to sit on that portfolio. Particularly if you've got a performing portfolio, that's throwing off a nice tax, efficient yield, that's much more of a concern than to meet in the supply glide. And you build in that flexibility so that you can be sure you exited the appropriate time relative to what's going on in the overall market.

And again, we're driven first as an investor and second as a sponsor. So we're patient, and we can exercise that discipline and patience to make sure that we're exiting at the right time.

Nick: That makes sense.

Kevin: Eric

Nick: We have a question that came in just as a function of, our thoughts on interest rates, obviously, likely in a rising rate environment who knows, but like in a rising rate environment, how much of a rise in rates is baked into the sort of the way you model con capital costs when you recapitalize the asset?

No,

Eric: That's a good question. We build in a spread and just to give you an example of that that spreads typically 150 to 200 basis points over there, interest rates at the time. So for example, our construction loans are live or based loans, ly bores in the, 10, 12 basis point range.

And our spread with our lenders is called in the 250 basis point range. So the rate maybe 262.6% at the time. And our underwriting, we're typically in the four and a half to five and a half percent range on our underwriting. In fact, we're seeing some great savings on our interest costs in both funds one and two, because we have built-in those spreads.

And then we do the same thing on the permanent debt side as well.

Nick: So I think that was really the question is, obviously you have your cost of capital with your construction financing. What do you underwrite in terms of your perm debt? Yeah, we're we're

Eric: again in the five to five and a half percent range.

If you were going to get a Fannie or Freddie loan today, that would be in the low threes. So again, about a 200 to 250 basis point spread over today's rate.

Kevin: Yeah. And the other thing is that it's dynamic, right? These are dynamic issues. So what I mean by that is if we are an important period of time, we're going to see some protracted interest rate increases.

That's generally occasioned by a strong underlying economy, right? To the extent that you've got a strong underlying economy, you've got inflation baked in an economy that increases your construction costs increase in construction costs, drive real rental rate growth. So you may have, you may see increasing interest rates, but you're also should be met at the other end with some real-time real increases in rental income too.

So that's going to add more value to the capital asset and allow you to affect the kind of refinancing you need to affect so that you get passed through Tiffany's distributions to the investors at the appropriate period.

Eric: And given we're in such a low-interest-rate environment it's just prudent to build in those kinds of Springs.

Nick: And Kevin, we had an interesting question that came in really pertains to how we think about when we exit, if we have some investors that want to stay some that want to go is there an opportunity to recapitalize out those investors that want to leave and allow a mechanism for those investors who want.

Kevin: Yeah. So that gets back to the amount of time and effort. We think about what that exit is going to look like. So one of the things that we would certainly entertain is we could convert once the portfolio is stabilized, we can convert the limited partnership into a real estate investment trust. And then the individual investors could decide, as assuming, assuming that there's liquidity associated with the real estate investment trust vehicle, then the individual investors could decide for themselves when they wanted to sell their stock or their operating partnership unit in the real estate investment trust.

I, I made the reference earlier to Avalon bay as being one of the largest multifamily real estate investment trusts in the country. What are the options that we could pursue? And one of the reasons why you have an extra error when you're a quiver, focusing on a single asset class is certainly one of the discussions we'd want to have.

And let's say we didn't convert to a rate. Let's say we stayed as an operating agency limited partnership. We could do that. What's called a tax-deferred 7 21 exchange swap our limited partnership units for operating partnership units and the umbrella rate and the rate, and then distribute those operating apprenticeship units to the investors and let them decide when they wanted to realize that liquidity events themselves and put it entirely in their hands.

We think through those machinations is it's more complicated and there's more optionality than just getting 10 years out and saying, okay, let's sell the portfolio. Let's sell a series of individual assets.

Nick: Kevin, in that structure, the taxable event to the investor would occur when they sell their operating partnership units there.

Correct. So they continue to grow tax. That's cool.

Kevin: Yeah. I mean that that's incredibly powerful. That would be my, it'd be my desire. Not just for all the investors, but for us to, as an entity that's invested in the fund itself. And I go 10 years down the road. I, 10 years from today.

I'm already like gray and white. I can't imagine what I'm going to look like in 10 more years. And I'm not going to want to have my kids having to make decisions as it relates to whether or not they should be selling individual assets, but from an estate planning perspective, from a tax planning perspective, the ability to distribute limited partnership units or operating partnership units in a $40 billion publicly traded multifamily rate is just much more elegant from a really, from an estate planning perspective.

Nick: Chris, anything else we should have?

Chris: I don't see any other questions come around and I always like to have for the people who are listening to a little bit of a tool to walk away from, it's not if it's possible, and seeing as you guys are definitely experts in the space a lot about your fund, but you probably know a lot about, everyone else who's participating in a broader base for investors, which they come in, lots of flavors and sizes.

They may not be able to be the person where, oh, my RIA doesn't have the ability to do alternatives or something of that nature. I don't have the ability to get access to your fund. What are some of the other resources or things that you could suggest to someone to do further education, further due diligence to maybe find an opportunity and investment opportunity in this space?

The, that matches maybe their size or their particular needs, if your fund doesn't maybe they're smaller, maybe they're, accredited, but they can't write the certain ticket sizes. Any thoughts or, ways for people to get access and start their process of educating themselves and finding others.

Viable funds if your funds are not a particular fit. A lot of times there are information sources. I will say that one of the things there's lots of various researches research materials, through CAIA, but they don't really have a program of who else is out there?

It's not something that CAIA does, but I didn't know if you knew of anything that existed for people. Yeah.

Kevin: I would say that we have some really good educational materials on our website that you can, access directly by going to www.griffincapital.com and pull down some of that material.

There's a lot of material I, as you can appreciate it on the internet and. I thought we covered this before we started this call. Really? We're the only fund out there, but in all seriousness, our funds generally have a $150,000 minimum investment. We are a registered investment advisor.

The individual esters have to be accredited and qualified clients, which is the $2.3 million person. But I would say our fun auditor is a firm called nomadic and company, and they're headquartered in San Francisco and just curiously Michael Novogratz, who started that firm in 1986 was a business school.

At Berkeley with that kind of day. And he has really built an incredible franchise from an accounting perspective because their focus and niche really is on tax-driven legislation and how it impacts real estate. And that's the focus of their practice. They have a regular qualified opportunity zone, fund events there.

They just got a notice about whether or not we wanted to sponsor one of their spring events. So there's a couple of those. There's a couple of those firms and no regretted company tracks, I think 900 or a thousand of these funds. And a lot of them are smaller. Ours is, we are probably the number, I don't know, two or three.

Capital raiser in the space, just given the size of our funds. There was a lot of fund sponsor out there that are doing this, one-off transactions, smaller deals, more local and no regret a and company. It's a good source of information. It's VO, G R a DAC Novo Radek and company.

Nick: Nice. There you go.

Everybody. They have a great website. They have a great website full of information. So to the extent that ours doesn't provide you what you're looking for, I would visit Nova Braddock's website as well.

Kevin: Yeah, I think it's a, I'm pretty sure it's www.novoandovo.com.

Chris: Perfect. There you go. You can go to Griffin's site pulled out a bunch of stuff.

I know this AI has some things and now you have a third resource. So for those people who were on this call or watch it later that has some good places to get started. Gentlemen, I don't see any other questions coming through. And if you don't have any other statements, I really appreciate the time.

This is like I said, it's super timely. I do get a lot of questions on these things, so I know I've actually already guided a few people your way for information. Thank you again.

Kevin: Oh, listen. We really appreciate the opportunity and we're big supporters of your organization. So thank you very much.

Thank you.

Chris: And thank you everybody for joining us.

This concludes our webcast. Thank you all for joining us and we hope you'll connect with us again at our next event. Thanks, everyone.