Greg Genovese: Project-Driven OZ Funds

Greg Genovese

Happy New Year! The Opportunity Zones Podcast took a short hiatus last week for Christmas, but we are back for another episode. Today, I am speaking with Greg Genovese, president of Sound West Realty Capital, a real estate development group based in the Seattle area.

Originally from the California Bay Area, Greg relocated to Bremerton, WA last year to head Sound West’s opportunity zone projects. Over his 30-year career in the real estate and securities industries, Greg has held executive management and distribution leadership roles resulting in over $4 billion in new equity investments for some of the country’s preeminent real estate securities, raising new investment equity for various REIT, private placement, 1031 TIC/DST, debt, and IPO offerings.

Click the play button below to listen as Greg and I discuss what investors should look for in any opportunity zone investment, the business case for opportunity zone investing west of Seattle, and why he thinks shovel-ready, project-driven OZ funds excel, compared to blind-pool OZ funds.

Episode Highlights

  • How Sound West Realty Group’s OZ Fund I is positioned to take advantage of growth areas to the west of Seattle.
  • The advantages of a project-driven opportunity zone fund versus a blind-pool fund, particularly in the early stages of opportunity zone investing before all of the IRS regulations are published and finalized.
  • How Sound West is able offer liquidity events for their investors at key tax incentive marks (in particular, Years 5, 7, and 10).
  • Who Sound West’s capital base is, and where they’re located.
  • The case for direct investment in real estate as a recession-resistant asset class for capital preservation.
  • The four things that investors should look for in any opportunity zone investment.
  • The positive social impact that Sound West’s fund is creating, beyond what the real estate development project itself will do for the city.
  • Sound West’s fee structure, where your investment dollars go, and how Sound West makes their money on property management, asset management, carried interest, and the disposition fee based on the sale price of the property at exit.
  • Future OZ fund plans for Sound West Realty Capital.

Featured on This Episode

Industry Spotlight: Sound West Realty Capital

Sound West Realty Capital

Bremerton, Washington-based Sound West Realty Capital is the real estate securities division of Sound West Group — the largest real estate developer in Kitsap County, Washington. Their office is located in downtown Bremerton’s opportunity zone, and first offering — Sound West OZ Fund I — is due to be released in early 2019.

Learn More About Sound West Realty Capital

About the Opportunity Zones Podcast

Hosted by OpportunityDb.com founder Jimmy Atkinson, the Opportunity Zones Podcast features guest interviews from fund managers, advisors, policymakers, tax professionals, and other foremost experts in opportunity zones.

Show Transcript

Jimmy: Welcome to the “Opportunity Zones Podcast.” I’m your host, Jimmy Atkinson. And joining me today on the show is President of Sound West Realty Capital, Greg Genovese. Greg, welcome, and thank you for coming on the show.

Greg: Thank you, Jimmy. Appreciate you having me on the show today.

Jimmy: Absolutely. So Sound West Realty Capital is a division of Sound West Group, a full service real estate company based in the greater Seattle area. Greg, did I get that right and can you tell me a little more about Sound West? Where are you guys at exactly and who’s on the team?

Greg: Yes. Sound West Realty Capital is an affiliate company of the largest developer in Kitsap County, which is part of the, just outside of Seattle in the greater Seattle area on the Peninsula. The company’s name is Sound West Group. And we launched officially as a real estate securities company in June.

And it all started actually with what’s called an SER report, a study evaluation and recommendation report that I was hired to do as a consultant for the Sound West Group into opportunity zones and possible opportunities on investing. This was actually back in March of 2018. And with, over that three-month period, it came to light through our research and going back and forth to Washington, D.C. and meeting with members of Congress and Senate and other members of committees and incentive groups for opportunity zones, that opportunity zones funds would in fact make a good investment vehicle for not only high net worth investors, but through the wealth advisory capital markets.

So the short answer, Jimmy, is that in June of 2018, we developed Sound West Realty Capital. I’m the president and partner and principal with the other members of the development group at Sound West Group, which is also property and asset management company as well. So it’s a full service real estate company and now we have the real estate securities division as well.

And our first offering, we’re calling it Sound West OZ funds, or Sound West OZ Fund I, is due to be released probably in the next couple of weeks and available for investment at the start of 2019.

Jimmy: Very good. So Sound West Realty Capital spun off in June of 2018, which is relatively recently, but I know that Sound West has a lot of experience in your locality in particular. How long has Sound West been at this? How much experience do you guys have? How far does the company go back and how much real estate investing have you done over the years?

Greg: So it hasn’t been a long time as far as the Realty Capital Group. Like I said, we, it really got started in March with the report; it launched in June. But the group itself has actually been in existence, of the development company and the asset management company, property management, etc., has been in existence since 2010, and within a very short amount of time became the preeminent developer in Kitsap County in Peninsula here just outside of Seattle.

The company has, as far as full cycle and full investment programs, of just over $300 million and that’s, if you counted property by property, it’s about 151 properties, but that’s inclusive of some single family housing deals that the company has built. But if you took it project by project, it’s about 25 separate projects in the greater Seattle area and they’re happy to report or we’re happy to report average annualized returns to our investors have been well over the 12% market in many cases into the 20% mark. And we’re currently asset managing on current investments of anywhere around 200 to 250 million with another 250 million of projects that are shovel ready and we’re ready to start digging, you know, the moment we get the thumbs up from design and review and the council’s and get the permits.

Jimmy: Very good. So you guys obviously have a lot of experience in that area then. I know you have a lot of roots in that area. For listeners who aren’t familiar with the greater Seattle area, can you paint a picture of exactly where Kitsap County is and Kitsap Peninsula is in relation to Seattle?

Greg: Yeah, absolutely. And thanks for bringing that to light. I’m actually from the San Francisco Bay Area, and, you know, Kitsap County and Bremerton is outside of Seattle. But I know just, you know, being somebody from the San Francisco area, when you’re talking about somewhere else, it’s just hard to picture it.

But for your listeners that, you know, I’m sure almost everybody listening in knows where Seattle is. And if you look at Seattle, and the reason I brought up San Francisco is there some strong analogies and similarities between San Francisco and Seattle in the sense that Seattle and San Francisco are very crowded. Home prices are increasing dramatically, wages are increasing. It’s high tech area. A lot of large fortune 500 companies are in both places. In Seattle in particular, you have Expedia and Travelocity and Amazon and Boeing and the US Navy actually has their largest naval base here in Seattle. And what’s happened, just like you’ll see across the country, is that the Seattle area, like San Francisco, like Austin, Texas, a lot of these other areas around the country, they are finding themselves somewhat locked in with areas to grow.

And so if you were to take Seattle and look at it from the, you know, moving north, there’s really nowhere to go yet, you know, pricing and values continue to go up. And if you look south towards Tacoma, it’s also a tough area to go to as far as growth for Seattle, and you really can’t go east. But west of Seattle is the Puget Sound. And just across the Puget Sound, which used to be about an hour ferry ride, which is now a 28 to 30-minute ferry ride, is Seattle, or the, sorry, the Peninsula. And the Peninsula is made up of a number of cities that are growing dramatically, like Kingston, Bainbridge Island, Silver Dale, Bremerton, Port Orchard, just to name a few. And these are all areas that are now beginning to absorb the massive amount of growth that is happening in the Seattle area.

So Bremerton, where Sound West Group is located and where Sound West Realty Capital is headquartered and where I’ve just moved to, is one of the fastest growing cities in the State of Washington. In fact, if you look at Seattle, in and of itself, it’s growing right now at about 19% per annum and is actually the fastest growing city in the country the past decade, actually, overtook Austin. And because of that growth, and now the demand for housing has started to tentacle itself out and move itself to the suburbs, but the only real suburbs to go to is now that, like I’ve mentioned before, the 28-minute ferry ride over to areas like Bremerton. And that’s actually, Bremerton is where our first opportunity zone program will be located.

Jimmy: Very good. So I spent some time over the summer, actually in Bainbridge Island. Beautiful location out there in that area of the country. I absolutely love it. Let’s dive in a little bit and talk about your opportunity zone fund a little bit more. First of all, how much are you looking to raise for your opportunity zone fund, and who is your capital base?

Greg: One thing I’ll preface before I get into the numbers is, you know, you had asked, you know, about the fund itself. And we’re in the camp really when the opportunity zone initiative was put on the books at the end of 2017, but really started to hit the radar screen in early 2018 in so far as investment groups, institutional investors, real estate development companies looking at these, at the initiative for possible funds, we decided very early on to be project-driven or project-specific about each one of our funds because we felt that it really comported best with the rules and regs as they were stated by the Treasury Department at that time, and have only been validated by the proposed regs that then came out later in October.

So our first fund is actually a project in and of itself. So I wanna make sure your audience and you understand where our modus operandi, our focus, our investment strategy will be towards projects not necessarily open-ended or what we call blind pool funds. I’m not against them, we’re not against them. We just feel that in the early stages, especially of opportunity zone investing, that being project specific really makes the most sense. Our first offering is actually titled Sound West OZ Fund I. And we, by the way, we decided to call these OZ funds for a couple of reasons, and it started to catch on nationally.

One is for the simple fact that, you know, stands for opportunity zone, but two, because we’re basically a Seattle company and, you know, everybody looks at it as the Emerald City. So we thought it would be a nice play, and it worked really well on that title. So it’s Sound West OZ Fund I. It’s a $50 million Reg D private placement available to accredited investors. Our primary market for raising the funds will be basically in two areas. One will be through direct investing through the high net worth investor arena where they can come directly to us.

And then two, will be through the wealth planning or wealth advisory community. And when I say that just, you know, for those in the audience that may not know, that would be through your financial planner or through your wealth advisor. So we anticipate having selling agreements with a number of the national regional independent selling groups or financial planning firms where the accredited investor can actually go to their financial planner and our programs, you know, starting with OZ Fund I, would be available to their investor for direct investment. In so far as what the deal is or what the project is, it’s actually titled Marina Square Project.

And I think probably at the end of this conversation, you’ll, I would assume you’ll give our web address so people can actually go to the website if they’d like to take a look at it. But it’s going to be a three-asset class project. It’s right here on the ocean, right next to the ferry terminal in Bremerton, Washington. And it’s the only oceanfront or waterfront property left in the city. Sits directly in the opportunity zone. It’ll be three asset classes.

One will be a Cambria Hotel, so it’ll be a hospitality deal. And for those that don’t know, Cambria Hotel is the luxury hotel adjunct to the Choice Hotel Company. So if you’ve heard of Choice Hotels, they’re, they own Quality Suites and hotels like that. This is their upper luxury, kind of like a W. Hotel. So Cambria hotel will have part of the property or half of the property. It’ll be managed by Columbia Hospitality, who is the number one hospitality manager in State of Washington, mainly in Seattle.

And then it’ll also be 122-unit, multifamily class A apartment building and then paid parking as well. So it will be all three of those asset classes. We actually expect to pitch our first shovel full of dirt in March. And we expect by 30 months later for the development to be complete, hotel occupied, and have a stabilized asset.

So we’ll hit the ground in in early 2019. And the way we’ve put our opportunity zone program together is that we’ve actually planned for, Jimmy, in our pro forma, that we would have liquidity events for our investors. You know, again, there’s no guarantees on this, but we have a pro forma’ed and we’re making sure that we put the deal together so that we do have liquidity events for our investors at the key tax incentive marks for opportunity zone investing.

And what I mean by that is in year three, let’s say, we expect to refinance the hotel and the rest of the property. And therefore, we have a capital event for our investors when it’s stabilized. In year five, when the first tax incentive kicks in for opportunity zones, we will have a liquidity event at that time as well available for liquidity for our investors, and then also a year 7, and then also at year 10. So I could probably keep going on but I don’t know if you wanted to put another question in there.

Jimmy: No, that’s fine, yeah.

Greg: I hope that was helpful to you.

Jimmy: That was helpful. That’s a lot to unpack. That was a big answer there. So you spoke a little bit at the beginning of a project-driven fund versus a blind-pool fund. I think that’s really unique about your fund. You know, you are asking your investors to invest based on the project itself and the actual fundamentals of the project as opposed to just your name or a very broad investment strategy. So I find that interesting. I think that’s, that should be very valuable to your investors. So you gave a little bit of information about who your capital base is, mostly private wealth management, some high net worth individuals. Where are your investors located or where are you anticipating they’ll be located? Do you expect that they will be regionally clustered in the Pacific Northwest? Or will it really be a national capital base?

Greg: Yeah, you know, that’s a that’s a good question and there’s no real clear answer. I can tell you, you know, being in the real estate securities industry for 30-plus years now, so I really, you know, been here from the start, you know, way back in the late ’80s, all the way till now. I can just tell you, you know, one, it is a national program. It will have a national base for investors. You know, we’re getting calls daily from all over the country. And, frankly, it’s pretty well spread out. Jimmy. It’s, you know, all the way from, you know, Maine to California, down to Texas, you know, all the way up to here in Seattle. So as far as national interest, it’s definitely there.

Historically, when you’re raising money ain Reg D, or, you know, private placements, the investment float just sort of tends to be somewhat regional. And so, you know, if we had a property in Dallas, Texas, you’ll find that, you know, the majority of the investment actually comes from that area. Especially on project-specific deals, people tend to want to invest in areas that they either know well or believe that they know well. But, you know, you don’t see people making too far of an outreach generally. But as far as where we can invest or where investors can come from, it’ll be on a national scale.

Jimmy: Gotcha. Yes. The opportunity zone incentive, it does provide quite a unique opportunity and it doesn’t surprise me, you’ve gotten a lot of lot of calls. You’re getting calls every day. That’s great. Who are you hearing from, primarily? Are these just individual investors or is it family offices or institutional? Or is it a mix?

Greg: Yeah. Well, until you said institutional, the answer was just a blanket, yes. I would say, you know, we’re hearing from institutions, endowment programs, and a lot of it has to do with the fact of, you know, the members of Sound West Realty Capital, a lot of our members here have, you know, roots in the capital markets. And so you bring your expertise and contacts with you. And a lot of us, including myself, have some pretty deep roots on the institutional side and the endowment side and the pension side. So we’re hearing from them, definitely.

But I really believe, you know, until we have…this, like I said, this is a $50 million offering. If we ever grow to the point, I think, where, you know, the offering sizes can be a little bit higher and we know that we’re hitting it right down the middle of the fairway as far as the rules and regulations are concerned with the Treasury Department, the majority of the investing is really gonna be done by the wealth advisory family office community, and through high net worth investors directly. I spoke and attended…I won’t give you the name of the company, but a very large family office, probably the largest family office event in the country in Dallas in October.

And it was at the Four Seasons in October and it was specifically for real estate investments. And the amount of attention that we received, and I’m not saying this necessarily because we are who we are, but because of the topic of opportunity zone investing, and the fact that this is really…you know, other than a 1031 exchange in real estate, this is really the only avenue and tool that’s available to the investing public to be able to capture their capital gains, reinvest it in some other asset class and protect those capital gains.

And so the idea of opportunity zone investing has just, you know, gone off the hook. But I think, and I just wanted, if I could step on my soapbox for a moment here, I think sometimes that we’re seeing a lot of exuberant, you know, and a lot of enthusiasm for the fact that opportunity zone investing will give you these huge tax incentives, tax mitigation and then complete deferral at some point for your opportunity zone investment that sometimes it’s overlooked at what you’re investing in.

And I think there’s probably billions and billions of dollars of potential capital gains that wants to go into opportunity zone investing. However, I have to, you know, admonish and say but be very careful because although you’ll be in a deal, you don’t want to invest in a deal specifically because of the opportunity zone tax incentives, you want to invest in a deal because the deal makes sense, and it’s a good investment and you believe you’ll make a good return. The fact that you’ll have tax mitigation and have ultimately tax deferral on a part of that investment at some point should be, in our opinion, a secondary goal. Although it’s the it’s the main reason for people wanting to do it, but I don’t think you evaluate it based on the tax incentives. And I hope I said that properly for you.

Jimmy: Oh, absolutely. And, you know, this actually comes up on almost every single episode of the “Opportunity Zones Podcast, ” the point that the tax incentive is great, but you can’t let the tail wag the dog here. You need to make sure that the underlying investment makes sense. So what would you say to someone who asks, “Beyond the tax incentive, what is the business case? Why should I invest in real estate in opportunity zones?”

Greg: Well, let’s take it from step one, you know, why real estate? You know, forget opportunity zones for a moment. But, you know, what a lot of us in the, you know, the securities industry, you know, have been basically, you know, looking at in plain sight has been, you know, a 10-year run or almost a 10-year run in the stock market, and investors quite frankly, and this isn’t their fault, I haven’t met an institutional investor or a wealth advisor or anybody in, your portfolio manager or anybody that has been in the industry for a long time that hasn’t seen the last four years, even in the last three or four years, that the stock market is in, you know, either bubble territory or, you know, somewhat inflated.

The problem is you’re stuck between a rock and a hard place. If you get out now, then maybe you’re gonna lose two years of 30% returns, you know. So even though you understand there’s a lot of risk, it’s really hard to pull the trigger and move your money away from that market.

Jimmy: Timing the market is always a dangerous game to play.

Greg: Exactly. So it’s, they’re not doing anything wrong by saying in the market, but they have to understand that the risk, you know, continues to go up. And we’re now starting to see the wheels kind of getting shaky in the stock market. So the play for real estate, and I’m talking about more recession-resilient or recession-resistant asset classes, where you may not be looking for the biggest returns in the world, but you’re looking for the safest, you know, asset class to make sure the capital protection is there before you’re looking at your return on your money.

I think, historically, real estate has always been that asset class. And I think the general demand that you’re seeing in real estate is coming from that perspective. That said, real estate has also had a huge run up in values as well. So you have the two major markets in our country, which are real estate and the stock market, both having big, big runs. So where you invest and what you’re investing in is tantamount to your success. Now, and the reason real estate sort of wins out every time when it comes to capital preservation is the simple fact that…and I’m not talking about traded rates here, Jimmy, I’m talking about direct investment in real estate.

If you go to a strong demographic that continues to grow, even during times when, let’s say, the stock market starts to pull back and you have a good capital preservation model built into the real estate, like which we could talk about Bremerton a little bit more if you want, but analogous to the deal that we’ve put together where you have hospitality and a growing area, you’ve got multifamily in an area with huge amount of demand and you’ve got paid parking and retail, and a small amount of retail in an area that continues to grow, those are good places. And I don’t want to use the word park your money, but those are good places to move your higher risk liquid assets out of the stock market and into.

So real estate has always been that good play. With regard to it being in an opportunity zone, two things were happening. One is, the opportunity zone initiative was put into place specifically to bolster the three major components to grow an area. And that is, the investments themselves should be put into place to help increase jobs, increase wages, and increase values of homes and homes and land. And if you go into a deal that you feel that you can check those boxes, in my opinion, whether it’s our deal or the Acme’s company’s deal or the X, Y, Z company, it doesn’t make difference, I think those are the deals that the investor really should be looking at, especially over the next few years.

We’re looking at a 10-year time horizon, but I think over the next three to five years because we have inflated stock market and quite frankly an inflated general real estate market, I think the investor needs to look at it from a project specific standpoint, look at it from a risk mitigation standpoint as far as how safe is my capital in the deal. Third is, will the deal make me a return or make a return for me that is appropriate for what you’re looking for? And then four, will these tax benefits actually help me versus paying those capital gains taxes if I were to sell out of my spot? So I think that’s why real estate in an opportunity zone, and I got through the long way. but I think I think it added a lot more context and color for your audience on, you know, again, making the point that you don’t want to just invest in any run of the mill opportunity zone program for the tax benefits. I think there are three or four steps in front of that before you get there.

Jimmy: Absolutely. That’s a fantastic answer there. Thank you for that, Greg. So let’s talk about your project and the opportunity zone that you’re in. Your office is actually located within the opportunity zone that you’re investing in the Bremerton community. By the way, for our listeners out there, if you wanna head over to the Opportunity Database website, I’ll have a map of this area specifically on the show notes page at opportunitydb.com/podcast. But, Greg, back to you. Your office is located in this opportunity zone so you’re actually there. Can you paint me a picture of downtown Bremerton for me and our listeners? What does it look like now? And what is happening there? And how do you expect it to transform over the next decade or so?

Greg: Let me start with this, just talking a little bit about the demographics and the demand. Like I’d mentioned before, you know, the cities that are…you know, the fastest growing cities and the more, as far as optics are concerned, the larger cities in the Peninsula, which is where the demand is really coming from the Seattle area, you had mentioned, you had spent some time in Bainbridge Island. The only wild card in there, or outlier really would be Bainbridge Island. Bainbridge Island, again, you know, this is west of Seattle, about a 30-minute ferry ride away from Seattle, really is an upper middle income to upper income area. And so the values and the pricing and it’s…and I’m not sure, you know the Bay Area pretty well. We talked about it earlier on a call that it’s analogous to a, you know, a small hamlet, upper scale, you know, area. That would be an outlier.

The other cities working North down to South would be Kingston, and then, of course, I mentioned Bainbridge Island, Silverdale, Bremerton and let’s say Port Orchard all the way down the line, are somewhat similar in the sense that these are middle class, some have their upper income areas, but these are middle class areas to…Bremerton I would categorize as low middle class to middle class. However, it’s right on Puget Sound. It’s right next door to the Puget Sound Naval Yard where they do most of the work for the Pacific Fleet on aircraft carriers and submarines, and right down the street from Bangor Naval Base which is the largest submarine base in the country.

And the U.S. Navy has committed to put in billions of dollars, up to $2 billion to $3 billion dollars in the next two to three years into revitalizing and putting in new infrastructure into the naval base. So Bremerton really is not only a standalone port town, but really a Navy town. It’s right next door to the naval base, as I said. And so what you’re finding are a lot of startup companies from Seattle. Some of the tech companies are now coming to Bremerton. It’s your, you know, First and Main type of town. You know, cute streets with your coffee shops and, you know, it’s sort of what you’d see in the movies, you know, Anywhere USA sort of town. And, you know, like I said, it’s a revitalizing area.

It’s an area that actually I’m not sure if many of your listeners know this, but the famous music producer, Quincy Jones, grew up in Bremerton. In fact, one of our flagship developments is actually called Quincy Square named after him. So there’s a lot of history in Bremerton. It’s a historic town and the base is really made up of tech. There are some development companies. A lot of mom and pop shops, a lot of restaurants, and you also have a lot of infrastructure from large retail outfits that continue to move into the area.

So from a business standpoint, the jobs have been increasing at double digit figures the last couple of years. And what’s interesting, I think, to your listeners would be that the tax incentives, Jimmy, have actually begun to be pulled away from Bremerton which, you know, signals the fact that it’s actually growing on its own steam without a lot of help. However, it’s in an opportunity, was designated as one of the opportunity zones, which brings me back to what I always tell people, not every opportunity zone is the same.

There’s over 8,700 that you know, I’m sure you know. And I would say maybe, you know, 5% or 10% of that…nobody knows exactly what the number is, but that’s probably a pretty good accurate estimate, would make for investment quality property for a capital market structure like we’ve talked about. All of those areas need investment. I’m not saying that they’re all don’t. But as far as the avenue that we’re going down and the lane that we’re going to stay in is for the high net worth investor and for the financial planning community. And really in areas like Bremerton and those sorts of demographics are really the types of areas around the country that we’re going to be looking at for our programs.

Jimmy: Very good. Yeah, you’re absolutely right. No two opportunity zones are like, and a lot of the opportunity zones are very economically blighted areas, but there are a lot that are on the economic upswing. It sounds like Bremerton kind of fits into that latter category there. The opportunity zone program was intended to lift some distressed communities out of blight and to offer higher paying wages and more jobs for the community. But at the same time, there’s actually no community benefit requirement or at least at this point in time, that’s kind of subject to IRS regulations possibly changing in the next few months here. There’s no community benefit requirement. Are you guys doing anything to ensure that you’re creating a positive social impact in your community? And if so, what does it look like?

Greg: Yeah. Actually, I’m so glad you asked that question. To be perfectly frank, you know, that’s always sort of right at the top of our list, yet during this conversation, it’s, fell off my radar a little bit so I’m actually glad you asked it and put it back on my radar. You know, one of the reasons, and we talked about it on an earlier call that, you know, I’m from San Francisco and I’ve been in the real estate securities industry a long time, but I’ve actually moved to Bremerton to head up this company. And I’m actually in an office standing here talking you’re right now, that’s in an opportunity zone. And I would not have done that had it not been for the fact that we’re really going to be focused on what I’ve called, you know, positive social impact.

I don’t wanna go so far as to say socially responsible because with that, or ESG as you know, because there’s actually rules and regulations that pertain to programs or projects that you’re going to claim social responsible investing. But, and as you as you say right now, there is no requirement. However, it would probably meet the criteria because there is a positive social impact in just about any opportunity zone program, whether it’s in the most blighted area in the country, or the one that’s on the periphery, which would be, let’s say, an area that is next to, you know, a middle income track that is butted up against a low income track, which there’s a lot of those in the State of Washington where we are.

And I think they were smart. I think the Treasury Department was smart to keep it out, not because the fact that it wouldn’t have a good, strong positive social impact, but the investments themselves and revitalizing the areas really needs to be looked at as a positive social impact. But that’s really at the top of our list. It’s in our mission statement. It’s on our website. It’s in every interview that we do and every published report on Sound West Group, is that everything that we do is, we are always putting something into the deals to give back to the community.

So over and above the program and the project itself and what it’s going to do for the city, we actually are in the process now of working with local government, with the mayor of Bremerton and a couple of the Congress people, U.S. Congress people here, in developing a program with not only OZ I, but our next couple of projects, OZ II, III, and IV, that part of our returns, part of our cash flow, we don’t have a completely locked down at this point, but it will be a direct monetary investment into the community, whether it’d be through, to homeless centers or to education at a local junior college.

You happen to be asking the question at a point where I just had a meeting this morning with our CEO on this exact topic, to develop as part of our pro forma a cash flow in a monetary benefit that will go directly to needs in that particular area where the project is.

Jimmy: Very good, very good. Glad to hear that you guys are creating that positive social impact that the program was intended for in the first place. I wanna dive into the nitty-gritty here for a couple minutes. If I’m an investor coming to you, you probably had some interest from people who may not be as familiar with real estate investing. How is your fund structured? And what type of annual fees am I paying?

Greg: Okay, a good question. So if I were to break down the investment for your audience, as I said earlier, it’s a $50 million investment. Of that $50 million, we’re going to need about $124 million to build the project. So the way it breaks down right now is we’d be raising $50 million… These are all approximates, Jimmy.

Jimmy: Sure, yeah.

Greg: But we’d raise $50 million, then you have another $70 million in loans for the 3 different asset classes, for parking, for multifamily, and for hospitality, and then we build that out from March, and then over the next 30 months to completion. And if an investor were to buy it as a full security, and when I say a full security, I mean, this is one that sold through the investment financial planning community, how much is taken out of their investment and actually goes into the ground at the low end, which is still a good amount of money, at the low end, it would be about almost 88 and a half cents of their dollar would be making it into the ground. If you add the leverage on that or the loans, it’s over 94 or 95 cents of their dollar actually makes it into the investment.

So it’s a very low, we call it, in our industry we call it a low load, meaning there’s not a lot of commissions and fees that are taken out of it at the beginning of the investment. We call that the offering stage. So the maximum amount of your dollar is actually making it into the investment. Then during the operating phase, when it’s up and running, where we would make our money would be through property management, which is something you would pay, you know, anybody anyways for an investment. And that could be anywhere from, you know, to a 2.5%, let’s say, on the low end up to, let’s say, 3.5% or 4%. We’re gonna probably come in somewhere around 3% to 3.5% of the gross income, which is, that would be paid to our property management group, and then ancillary fees for asset management on the deal itself throughout the life of the program.

So those fees all totaled up are able to extract, based on our current pro forma about a 5% to 6% cash flow to our investors throughout the life of the program. And if you’re in our, what we call our A share, we have a preferred return in that share for 12%. And then if you’re a B share investor, and that would be an investor who does not want the cash flow, that would be a 16% preferred return. So kind of looping back to where we make money, we make a little bit of money, when the investor invests in the deal. As I said, they’d have about 94 or 95 cents that would actually make it into the ground based on the loans. We would take property and asset management fees during the operation of the program.

And then, frankly, where we would make our biggest chunk of money is at the end of the program, let’s say, in the 10th year, when we dispose of the properties. We would get a 3% disposition fee when we sell the property and that would be based against the sales price of the property to whoever we sell to, a large REIT or whoever. And the returns to the investors. This I think your investors will really like, Jimmy. We actually take nothing at all. A 100% of the returns will go to the investor until the investors have made 100% of all their capital back. That’s 100% of their entire investment, not the, you know, 90 cents or 94 cents I was talking about earlier. That’s their entire dollar back.

At that point, we’ll split returns with the investors, 90% to the investors, 10% to Sound West Realty Capital until we hit the pref marks that I mentioned earlier, the 12% and the 16%. If we hit the preferred returns, the splits will then be 70% to the investor, 30% to us. If we do 125% better than that, meaning that the B investors will now get 20% annualized returns, the split is then 50/50 after that. So I think an investor would be hard pressed to find a better, what we call in our industry, a waterfall for carried interest, then we’ve put into this program.

Jimmy: Yeah, Greg, thank you for sharing all that level of detail with us. That’s great, the level of transparency you’re able to offer to me and my listeners there. I really appreciate that. I know that a lot of my listeners are interested in this program, but may not have experience investing in real estate. So that breakdown of the fee structure is very helpful. I appreciate it. So Greg, a little earlier, you were discussing some liquidity events that you have at key marks in the investment, at the 3, 5, 7, and 10-year marks. Can you talk about other exit strategies that I have as an investor? Or do you have any sort of redemption plan if I need liquidity for any of those time periods?

Greg: Certainly. Actually, that’s an excellent question. You know, in my history in the industry, the liquidity provisions really are an important issue. You know, a lot of investors, especially the ones that will probably come into these programs using capital gains, most likely, you know, you’re, you’re looking at average ages, a lot of cases being, you know, lower middle aged to middle aged. You know, 10 years is a good amount of time and so you wanna make sure that you have the ability to exit your investment. It’s not a liquid investment. So it’s not like you’re being in the stock market or a traded REIT where you can call your broker and sell it, you know, that moment, but there’s good and bad to that.

The good news is that because we’re a non-traded program, it’s in direct investment real estate, you’re not going to be at the whims of a public marketplace so it’s a direct investment. The negative on that sometimes is that, you can’t just call somebody today and just say, “Sell my shares,” and you get a price that day. However, we’ve put in a very generous and very investor-centric liquidity provision. So number one, I wanna make sure that we cover that ground again, that we’ve built into the pro forma liquidity events in and of themselves for the investors. We anticipate in year three, as I mentioned earlier, for refinancing and that will bring some money out of the program for the investors.

And then we’ve established in year 5, year 7, and year 10, which are all the major dates for opportunity zone incentives, that we’ll have liquidity events just in the program itself. Aside from that, once we hit stabilization, and we expect that to be in the third-year of the program, which would give you your first year of the liquidity provision, every quarter, investors can offer back their shares to us. Now, it is up to our discretion whether or not we’ll buy them back because you can’t have, you know, as they say, “a run on the bank.”

However, you know, historically, we’ve been able to do that for the investors and it is in the memorandum. And we are obligated to look at that as a possible exit strategy. So, in year one of stabilization, if an investor offers their, part or all of their shares back to us, we’ll purchase those back, if we decide to, we’ll purchase those back at 90% of their investment amount. Okay. So that would be 90 cents of the dollar that they invest. In year 2, the liquidity provision is for 92.5% of their invested dollar. In year 3, it goes up to 95%. And then after that year, in year 4 onward, it’s 100%, Jimmy.

Jimmy: Very good. Yes. So you do offer some options there. There is a little bit of liquidity built in. As you said, it’s not like being able to sell a stock immediately with a click of a mouse button or call your broker but at least you do offer some options there.

Greg: Yeah. And I’ll mention to you, historically, and I’m sure your investors, if you did a poll they would agree with this. Historically, investors generally do not use the liquidity provisions but it will hold them back from doing an investment because you just don’t know what the future holds for you. So, although, most would agree that they don’t intend on using it, it is good to have it there and know that you have that insurance policy in order to liquidate your investment, you know, for life events, or if things should happen in the future. And so we wanna make sure that we supply that for our investors.

Jimmy: Absolutely. Ten years can be a long time to hold sometimes. So, Greg, what are some of the biggest points of confusion or areas of misconception for investors when it comes to opportunity zone investing? And what can you do to clear up some of these misconceptions for us?

Greg: Well, you know what, thank you very much for that question. Well, you’ve, had a lot of really good questions. I’m not just saying that. But this was a good one, because going around the country the last, you know, four or five months and been on a lot of panels, and have done a lot of interviews, and it’s almost shocking the amount of misconceptions that are out there about opportunity zones. And it’s not anybody’s fault, necessarily, it’s just, this is a new asset class and it takes some time to get up to speed, you know, etc.

So I would say the largest misconception has been that the investor can take any money that they have, whether it’s capital gains, money or not, invested into an opportunity zone program and still get all the opportunity zone benefits. So the opportunity zone initiative is built for capital gains money. Now we have investors that will be putting in, including myself, will be putting in their own money that is not capital gains money. However, that investor would be a strict investor in the deal, to the deal economics in and of itself not the opportunity zone initiative. The capital gains money that goes into the investment after year five, and I’ll just state this for your audience again, after the fifth-year of investment, will get a step up and cost basis on the capital gains money of 10%.

So if they did take their money out, they would have to pay their capital gains tax, but you will have a step up of 10%. In year 7, if they take their money out they’d still have to pay their capital gains tax but they would now have a 15% step up in basis. And in 2026, the investor regardless of whether they’ve been in the program for 5 years, 7 years, 8 years doesn’t really make a difference, whether they’ve been in the investment for any amount of time, they do, in fact, have to pay their capital gains tax in 2026.

So it’s important to remember that the investor is not getting out of paying their capital gains tax. They’re just able to defer paying it using 100% of their return money for a limited amount of time and a significant step up in basis at some point and have to pay the capital gains tax in 2026.

And then lastly, the second misconception is that when they get to the end of the program, that 100% of the gains at the end of the program in year 10 is completely tax free. And that is not the case. The amount that was invested, the returns that the investor receives from the investment in the opportunity zone fund, that investment would be completely tax mitigated or tax eliminated, but not the actual capital gains tax on the original capital gains that was invested. Did I just thoroughly confuse you or was that helpful?

Jimmy: No. No. That is helpful.

So by way of an example, if you sell your stock in Facebook, let’s say, and you have a million dollar capital gain, you can defer that money until 2026. You either get you either get a 10% step up or a 15% step up in basis depending on when you entered the fund and when you sold the fund.

And then at the end of the day, though, you do still owe money on that initial million dollar capital gains. But any of the capital gains that are accrued in the opportunity zone fund, those are excluded.

Greg: Absolutely correct.

Jimmy: I think we got it.

Greg: You said it better than I could.

Jimmy: Well, I’ve said it a few times and I still stumbled over it. But, yeah. So if you get any more confused calls from people who don’t understand this, just send them our way, send them to this episode of the podcast.

Plans for future funds, I think you mentioned this was OZ Fund I. Do you have OZ Fund II, III, IV, and so on rolling out? Can tell me anything about those?

Greg: Certainly. I can’t be as specific right now, Jimmy, just because of SEC and FINRA rules and regulations. But what I can tell you is, if your investors do like what they see in OZ Fund I, which is the Marina Square project, OZ II, OZ III and OZ IV are very similar in structure and demographics. And they will be roughly around the same size.

Our sweet spot, we expect to do anywhere from as low as a $25 million offering to maybe, let’s say, as high as maybe $100 million. But I think our sweet spot will probably be around the $50 million raise mark. And just speaking in generalities, at 50% leverage, you’re looking at basically $100 million projects. And that’s really where our sweet spot is gonna be. That’s number one.

Number two, I would look at us…you always wanna, you know, play to your strengths. And our strengths are really in the State of Washington and in particular, the greater Seattle area and even more specific would be in the peninsula, Puget Sound area. And there are a number of opportunities zones here. You know, our economies of scale is that it’s greatest in our regional area.

So as much as we are going to be a national company and we’ll have a national outreach and we’ll probably do, you know, projects on a national basis, I would look at it, you know, sort of almost like the stone being thrown into the lake. You know, we’ll start right at ground zero which will be, you know, here in Bremerton and then kind of branch out as we continue to grow. But we’re gonna play to our strengths and we’re really, you know, starting out… We’re national company with a regional focus. I think that’s probably the best way of saying it.

Jimmy: Very good. Well, I’ll be on the lookout for those future funds coming out in 2019 and beyond. Greg, before we go, one more question for you. Do you have a favorite real estate investment of all time? Anything particularly memorable for you?

Greg: Oh, yeah. That’s an excellent question. Yeah. I think one of my favorite deals where, I used to be with a real estate securities company that we owned, and you’re from southern California, I think, originally told me.

Jimmy: That’s right.

Greg: At one time we owned, it’s called Emerald Plaza, which is the hotel that has all the green lights on top of it in San Diego Harbor. You’ll sort of see it in the background of CNN. And that’s a hotel and office building. And at one time in my life, we actually bought it for investors, sold it, bought it, sold it, bought it, sold it three times for our investors.

And so that was kind of a memorable deal because you really don’t, you know, sometimes you don’t get a second bite at the apple and in this case, we were able to get three. And the investors in all three cases made, you know, well over double digit returns, so that was a big win for our investors. And I’m sure there’s other ones that I can’t think of off the top of my head, but that one always seems to stick out.

But as far as memorable, I won’t give you one specifically, but I think in general, I’ll just kind of maybe leave your audiences with this: Just in my history, you know, the best deals and the most memorable ones, and I think your investors will probably agree with this as well, we’re the ones that allowed you to sleep at night. You know, instead of saying, “Well, you know, this one over here got a 20% return but I only got 15%,” and worrying about the 5%, when it comes to real estate, you know, slow and steady wins the race, we’ve always done well, for our investors, and we, obviously, expect to continue to do so.

But you want to make sure you’re in asset classes and that are going to…you know, the return of your dollar is much more important. And as I always tell people, you invest in people, not necessarily in deals. The deals have to make sense, but at the end of the day, it’s who you’re invested with, especially if you’re not doing it on your own, it’s not your own property, you know, that you’re going out and buying and property managing yourself.

You really need to know who you’re investing with. And so I open it up to all of our investors to say, you know, “Do your due diligence, not just with us, but with everybody.” Because at the end of the day, who’s stewarding your money is really tantamount to the success of your investment. And so I think, you know, you can’t just go by the bells and whistles, you have to go by the people that are stewarding your investment dollars.

Jimmy: That’s great advice, Greg. I can’t disagree with that. Greg, for our listeners out there who want to learn more about Sound West, can you direct them to where they can go online?

Greg: Certainly, happy to. Two websites that I’ll point to. One is for the OZ funds. It goes to the same website, but you can get us at SoundWestOZFunds.com. In fact, I’ll just give you that one. That’s good enough for your investors. We have a Realty Capital one but it’s the same website. So SoundWestOZFunds.com.

Jimmy: Excellent. And so for my listeners out there, if you wanna check out more about Sound West, I’ll have links to SoundWestOZFunds.com and all of the other resources that we discussed on today’s podcast on my show notes page. You can find the show notes for this episode at opportunitydb.com/podcast. Greg, I really appreciate your time today. I had a lot of fun chatting with you. I think this has been an enlightening episode. Thank you for joining me on the podcast today, and I hope to talk to you again soon.

Greg: Happy to be here, and thanks again, and Go Irish!

Jimmy: Go Irish! Thanks, Greg.

Jimmy Atkinson

Jimmy Atkinson

Hi, I'm Jimmy Atkinson... I founded OpportunityDb in August 2018. I'm a veteran Internet entrepreneur with a background in economics and Web marketing. I previously founded ETFdb.com. These days, I am passionate about impact investing and tax-advantaged investment opportunities. At the crossroads of these two ideals is the opportunity zones program, a place-based tax policy intended to economically transform some of the poorest areas of the United States with new real estate and business development.

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