How OZ Funds Are Adhering to Policy Intent, with Greg Genovese and Steve Sego

Greg Genovese and Steve Sego

Are Qualified Opportunity Funds living up to the spirit and intent of the Opportunity Zone initiative? And how should social impact reporting be conducted?

Greg Genovese is president of Sound West Realty Capital, a real estate development group based in the Seattle area. Steve Sego is president of the Waterman Group, a community redevelopment, investment, and mitigation company.

Click the play button below to listen to my conversation with Greg and Steve.

Episode Highlights

  • The degree to which Qualified Opportunity Fund capital raising has been successful in 2019.
  • How Opportunity Zones experienced “the best of times and worst of times” in 2019.
  • A brief history of the Opportunity Zone legislative, regulatory, and capital raising process.
  • The two Opportunity Zone trends that Greg has noticed this year: 1) The shift from blind-pool Qualified Opportunity Funds to project-specific funds — and the advantages of the latter; and 2) the investing public becoming more comfortable going forward given the amount of guidance we now have from the IRS — resulting in a strong increase in equity raising in the latter half of the year.
  • Why QOFs should conduct a social impact report and receive a tax opinion on their projects.
  • The spirit and intent of the Opportunity Zones initiative, and whether funds are adhering to it.
  • The accolades that the Sound West OZ Fund has received thus far, and how the Sound West platform is adhering to the spirit and intent of the initiative.
  • The importance of establishing a public private partnership with the community.
  • How the state of Washington requested input from tribes and counties when selecting their Opportunity Zone designations.
  • The goals of a social impact report, and the three steps of reporting: 1) establishing baseline data; 2) ongoing monitoring during predefined phases; and 3) a final report.
  • How not all Opportunity Zones are created equal, and the importance of remembering that the economics of the deal must make sense for 10+ years. Social impact is not enough.
  • How the OZ sausage was made, and why there’s been a two-year delay between legislation and regulation.
  • How taking the time to get into the right Opportunity Zone investment is much more important than rushing into an Opportunity Zone deal by the year-end deadline on December 31, 2019 to achieve the full 15% basis step-up.

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. Their first OZ fund offering — Sound West OZ Fund I — is closing soon. Sound West OZ Funds II, III, and IV are scheduled to open in 2020.

Learn more about Sound West OZ Fund I LP:

Learn more about the Waterman Group:

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. The Sound West OZ Fund I is a project-specific Opportunity Zone fund, building three assets in the Marina in Bremerton, Washington. Sound West President Greg Genovese joined me at the beginning of this year to discuss his fund. And 11 and a half months later now, I have him back on the show to give us the update. And also joining us today is Steve Sego, President of the Waterman Group, a community redevelopment, investment, and mitigation company. Greg joins us from the road in Washington D.C., and Steve joins us from Bremerton, Washington, just outside Seattle. Greg and Steve, welcome to the show.

Greg: Thank you, Jimmy. It’s good to talk to you again.

Steve: Jimmy, thanks for having us on. I look forward to sharing more about our progress and answering any questions that might help keep this wonderful opportunity moving down the road.

Jimmy: Perfect, Steve. Well, thank you. And Greg, welcome back. It’s good to be talking with you again as well. You were one of my first podcast episodes back on January 2, 2019, was when your episode first aired. And now we’re toward the end of the year here 2019, mid-December, and great to have you back on.

So Greg, to start us off, I wanna get a sense from you about kind of what’s transpired over the last year here in 2019. How has the first year of capital raising been going, not just for your fund, but for the industry as a whole? Some of the first Opportunity Zones funds were established, you know, early this year or late last year once, you know, the zones were designated, and we got at least the first round of regulations from IRS. So can you give us a sense of how that first year of capital raising has been like so far and our funds hitting the capital raising estimates that the federal government had forecast?

Greg: Certainly, and that’s a good point to start on. You know, in a word, I would probably say…the overall word I would use is the word interesting. And I’ve been doing a lot of public speaking, and I’m asked this a lot. And what always seems to come to mind is…And because we’re in the holiday season, I’m thinking of Charles Dickens. But if you remember “Tale of Two Cities,” the first line is “It was the best of times, it was the worst of times.” I don’t think it’s been the worst of times, but there’s definitely been some challenges in the marketplace.

And it’s been the best of times because the industry, the Treasury Department, most of the pundits, investors, feel that the Opportunity Zone initiative really is something that is to the benefit of the blighted areas around the country and those areas that are getting a foothold in moving their economics up for the best benefit of their communities.

And so the term that I like to use is the spirit and intent of the initiative has really caught hold for the most part. So that’s really the good part about it. The other good parts are the fact… And I don’t wanna cover the dynamics of it because I’m sure you’ve done that on your podcasts. And, by the way, not to plug you too much, but I do listen to your podcasts often and really respect what you’re doing. So I’m very honored that you wanted me back on the podcast.

Jimmy: Thank you. Thanks for the kind words.

Greg: You’re very welcome. But we’re coming up on the end of the year, the first year of the 15% exclusion or step-up is coming up, and then going into next year where the 10% exclusion or step-up will take place. So, obviously, there are some very good benefits OZ Fund or Opportunity Zone benefits that are out there for investors. But the good of this, and the way that our platform and the Sound West Group, Sound West Realty Capital affiliate have taken this is really from an academic approach. And we’re not the only ones to do this.

And the groups like Sound West Group really deserve a lot of credit for taking what I like to call the spirit and intent of the initiative and moving it forward into an investment-based platform that really goes into public-private partnership with the community. And also being able to deliver investment returns that are accretive, not only to the community but to each one of those investors.

So it’s really… And, as you said, I’m in DC so to quote Benjamin Franklin, “It really is something that you can do well by doing good.” And that’s always been sort of our motto, “Do well by doing good.” And so that’s really what the initiative was intended for. And ourselves, and I would say, you know, a good percentage of the sponsors out there really have taken that spirit and intent and moved that initiative forward.

Worst-of-times side, quite frankly, it has not been a gold rush. I think a lot of sponsors and a lot of folks felt, at the beginning of the initiative, that…as my good friend who is on the phone with us today, once said, you know, “People weren’t backing up a truck full of cash and putting it into Opportunity Zones.” It has not been something that has hit the marks that even the Treasury Department had felt that it was going to hit.

The Treasury Department originally had an estimate of around $20 to $25 billion in the first year. And you had, I think, just recently had Michael Novogradac on the phone, so I won’t go over the numbers in as much detail as he did. But out of the 350 funds that are out there representing about $67 billion of equity, right now 164 of those funds are reporting about $3.9 billion of equity raised. So that’s really only about 5% of the available equity in Opportunity Zones funds that have actually been raised.

So if you look at that number in comparison to the $20 to $25 billion that the Treasury Department had thought was going to be raised, most agencies have been reporting that the Opportunity Zone initiative have raised about 15% to 20% of what the Treasury Department had thought. I like to push that up to probably around 25%, maybe 30% because you also have to account for, Jimmy, the funds that are not reporting their figures. But I don’t think those figures are equal to the ones that are reporting if that makes sense to you.

Jimmy: Yeah, I think what you’re getting at is if you’re hitting your numbers, you’re more likely to report than if you’re not hitting your numbers. You might be more embarrassed to report, right?

Greg: Yeah. Correct. Exactly. So I’m just discounting those by about 25%. So what we believe and just doing our own pencil to paper analysis, we think there’s most likely been…there’s 3.9 that’s been reported. And, in all likelihood, it’s probably really about $6 billion that’s been raised. But regardless of those numbers, if they’re accurate or not, you’re still talking about a differential of 15% to 30% of what the initial estimates were. And it certainly is not because of the Opportunity Zone initiative is not a good thing.

So, as you recall, Jimmy, back in 2018, we all expected in the industry for the permanent regs to come out from the Treasury Department in June of 2018. And what ended up happening, as we all know, is it wasn’t till October of that same year that the then-proposed rules and regulations from the Treasury Department had come out on Opportunity Zones. However, with proposed regulations, it really didn’t affect the private equity firms or the larger institutions. Most of them went ahead and took advantage of the Opportunity Zone tax law.

But the average everyday investor who was looking to get into the Opportunity Zone programs or the OZ Funds, and this is the high-net-worth investors, folks that are in the wealth advisory or financial planning community just didn’t feel comfortable. And the due diligence that they put in front of this was rightfully so to a pretty high degree, and so the comfort level just wasn’t there.

And, as you know, the regs that are still proposed that we’re all relying on actually came out on April 13th, 2019. So really equity raising for Opportunity Zones didn’t really start to happen, didn’t even start to germinate really till May of 2019. And the real traction as far as equity raising started to catch hold around July, August of 2019 and has exponentially grown September, October, November. And, of course, we’re expecting a large amount of equity for the industry raised in December as it’s the last year of the maximum benefit.

Jimmy: Right. So what trends are you noticing lately? You’ve alluded to them a little bit when you went through that timeline just now, but I guess what overall trends are you noticing in terms of both Opportunity Zone fund formation and the capital raising? Are there any trends that you can point to?

Greg: Certainly. I mean, there are quite a few. You know, we have to remember that this is a new asset class. It’s a new industry for all intents and purposes, and, therefore, there’s always going to be, at the very beginning of anything, a lot of turns and twists and, you know, honing and tweaking to get the industry moved in the right direction for all the right reasons. But I think the two major trends that have taken place is…

And if you recall, at the very beginning of this, there were sort of two camps. There was the large blind pool camp, and then there was the smaller project-specific camp, and what was the best structure to facilitate equity raising. And it’s not that one’s better than the other. It’s just that it depends on what your investment objectives are. And for the most part, it was probably about 90% to 10%.

Meaning 90% of the funds out there at the beginning, probably even higher than that, were blind pool funds and a very small minority were project-specific programs or smaller funds that are actually targeting real development projects with pro formers, with entitlement, with buying land, etc., actually had a written plan to execute on. And what’s happened is that’s really moved to almost… Well, right now, from the equity raising standpoint, it’s not quite 50/50. It’s about 60/40, still on the side of the blind pool funds. But as far as the amount of funds out there, it’s now tipped over to the project-specific fund.

Project-specific funds really have been the go-to because you can get a tax opinion. Something we’ll talk about later on the podcast, I believe, is you can get a social impact report. So you can actually prove the spirit and intent of the initiative. And the investor gets to see and understand what they’re investing in and actually do their own due diligence. And that has really caught hold with the investing public.

And so, one, from an equity raising standpoint, it was tough to raise equity in the industry because the majority of programs out there were blind pools. And, generally, those were sponsors with a lot of money to put into the programs. And so it was kind of hard for some of the smaller project-specific groups out there to get a voice. But as time has gone by, that side of the fence has really started to gain traction.

And then the second trend really revolves around the rules and regulations, Jimmy, from the Treasury Department. We are still under what’s considered “proposed regulations.” However, those regulations are grandfathered, and it’s taken some time for the investing public and for the wealth advisory community to really understand and feel comfortable with the fact that investing in Opportunity Zones funds with “proposed regulations” is safe and there’s no risk of those regulations being pulled so that their fund or their investment is hurt in any negative way.

So the two trends that I would call attention to is, one, the amount of project-specific programs that are out there now are dominating as far as the amount of funds, not as far as the amount of equity available. Investors are recognizing that as a clear path to high quality or best-in-class Opportunity Zone fund. And secondly, the investing public and wealth advisory community is much more comfortable, I would say, starting in September and October in going forward with the rules and regulations. And so, with that comfort, we’ve seen a pretty strong increase in equity raising.

Jimmy: That’s good. That’s always a good direction to be heading in. So, Greg, you brought up this phrase a couple of times on the podcast now, “the spirit and intent of the initiative.” What do you mean by that exactly? And, in your mind, are the qualified opportunity funds currently out there? Are they keeping up with that spirit and intent?

Greg: Good question. I don’t wanna put my…I think somebody like the gentleman you had on previously, Michael Novogradac, might be a better person to ask that question, and the reason is they do the surveys, as you know, etc. I’m a little bit in a bubble as far as our own programs and our own platform is concerned from an overall standpoint, but I can tell you what my general feeling is based on what I’ve seen.

Right now, there is a lot of negative press about Opportunity Zones and Opportunity Zones programs. A lot of that is most people would agree is politically driven. However, there is some, you know, negative press out there about them. And, you know, the term that I always seem to hear is “It’s a tax break for the rich.” That kind of is the calling cry that you seem to hear a lot about.

And the fact of the matter is, in 30 years of being involved in real estate securities, whenever there’s a tax initiative, whenever there’s a program put into a Tax Act, it’s always ripe for abuse of some sort. And so to say that there aren’t those out there that are abusing it and maybe putting programs together that “would be a tax break for the rich,” I’m sure that those exist.

My own experience has been, at least on the project-specific side, in dealing with the wealth advisory community and directly with high net-worth investors or private investors, is that the majority really has stuck to what I would call the spirit and intent of the initiative. Meaning, these are areas that need the investment. These are areas that welcome the public-private partnership with the developer or the real estate security sponsor like us, so long as we are going to do something that’s an inclusive, not exclusive, but an inclusive development.

In the majority of the programs that at least I’ve seen from my side of the fence have, in fact, done that where you can go out and measure how many jobs are coming into the area, even during the construction phase. You know, our particular site has anywhere from 50 to 100 workers on site that are local, that are not right from the city of Bremerton, but are local and are coming in and spending their money there. You can measure the carbon footprint from the project once it is completed and stabilized as far as is it close to multi transportation hubs, you know, things like that.

And so, although I would say the majority do have the spirit and intent of the initiative in mind, the platforms I would gravitate towards are the ones that are going the extra mile for the investor, meaning they go so far as to get tax opinions on their programs. They’ll spend their money to initiate a social impact report. So that it’s not just something that you’re saying, if you go out there and say you have a positive social impact is one thing, but I think we’re in an era that, especially in the investment community with a new asset class, that we owe it to the investors to “prove it.”

And so programs that will initiate a social impact report spend the money to get that updated on a regular basis and actually, through metrics, show how the project is advancing throughout the next 10 years of the Opportunity Zone initiative as far as how creative has it been to an actual quantifiable social impact for the community. And these are things that, you know, just touting ourselves a little bit, these are things that we’ve implemented into our platform. I don’t think we’re the only ones, but as of right now, we’re the only one that I know of.

Jimmy: Now, Greg, your fund has gone the extra mile, and I think you’re right to tout it a little bit. Your fund has been recognized by Globe Street as a top fund for economic revitalization and social impact, and it was also nominated by “Forbes,” for a top OZ Fund Catalyst recognition. Can you talk about some of those accolades and other recognitions that your fund has received, and talk about your fund a little bit as well now. I would like to hear more about your fund. And please feel free to toot your own horn a little bit here.

Greg: Okay, well, no, I appreciate that. And thank you for recognizing that. I can tell you that in working with Sound West Group, these are folks that I’ve known for many years. In fact, the CEO of Sound West Group and I have been very close friends for about 17 years. And this is the leading developer in Kitsap County, the leading property and asset manager in Kitsap County, which is just outside of Seattle across the Puget Sound. And as I like to talk about this group, they’re a bunch of do-getters. They’re a profitable company. They’re the biggest group out there as far as a development company. So they’re definitely for-profit, but they’re a bunch of do-getters.

And these are the people that, myself, coming from the real estate securities industry, these are the folks that I wanna partner with. As much as we wanna talk about our fund, I like to talk about our platform because, whether it’s OZ Fund I or upcoming OZ Fund II, and III, and IV, it’s going to have the same platform. And that is what we do is always in public-private partnership with the community. Our first program, which is called Sound West OZ Fund I LP, as you mentioned at the top of the podcast, is in Bremerton, Washington, which is the fastest-growing city in the county. Also home of the Puget Sound Naval Shipyard and Naval Base Kitsap. One of the key strategic sites for the Navy nationwide.

And this something that we did with, like I said, public-private partnership with the mayor of the town, with the City Council of Bremerton, with the county of Kitsap as far as coordinating and having strategic alliance with these folks, with the port of Bremerton, with the local economic alliance called KEDA, which is the Kitsap Economic Development Alliance, and the local tribe because they control the shoreline. And so part of the Opportunity Zone programs, as you know, is keeping to your 31-month working capital on-ramp.

And so, you know, it’s one thing to have a good idea, it’s one thing to have a good piece of property, but you have to execute within the rules and regulations that the Treasury Department has put on you. And you wanna make sure that you’re doing this with coordination with the city itself because we wanna hit those marks. We have not had any problems with entitlements or permitting. It’s been smooth sailing as much as a development project, it has smooth sailing. It has been smooth sailing in so far as keeping to our working written plan. So the program’s done real well. We’ll probably close the fund out here in short order. It’s a $50 million offering with returns between 12% and 16% projected for our investors.

And so putting all of that together with the social impact report that we’ve initiated with the favorable tax opinion, putting together what we consider something that inherently adheres to the spirit and intent of the initiative, we’ve been recognized as a “best-in-class program.” And so, a couple of months ago, we were named by globestreet.com in real estate for magazine as the top OZ Fund in the country for economic revitalization and social impact, which allowed “Forbes,” to nominate us for their inaugural…

We don’t know if we’ve made it on the list yet, but we have been nominated to be what’s considered their top 20 fund catalysts. And what they’re looking for…all of these accolades, what they’re looking for is a cross between sticking to the spirit and intent of the initiative and investment returns with inclusivity of development. And so we’re very proud to say that, not only our program, but our platform, and all of our programs going forward would adhere to the same metrics.

Jimmy: Good. And, Steve, you’ve been very patient. I wanna bring you in here now. Greg, you hired the Waterman Group to conduct social impact reporting for your fund. Steve, can you explain exactly what you’re doing for Sound West and why it’s important?

Steve: Yeah, thanks, Jimmy. Let me do that and kind of give you some background on how we were part of the Opportunity Zone designation process, and why that’s so important to understanding how to identify and then measure social impacts, and why we’re working with Greg in Sound West Group now. In the early days of the Opportunity Zones effort after Jobs and Tax Act was finally memorialized in December 2017, a bunch of us were already aware of the opportunity to explore this further and then quickly moved to trying to figure out where, and when, and why.

And, as you know, there’s a whole inventory of what are called the designated census tracts across the country that were considered appropriate. And this is all based upon the original data and census data from 2010. And so, as we got into that in this state, in Washington state, and in the region learned quickly how the state of Washington was gonna make those designations. And every state had the freedom to decide how to do that.

And there was no real parameters, but, of course, hopefully, the states behaved responsibly. In the most part, they did it the right way. And then our state, they asked all counties to come back with some designated zones based upon their own confidence and proportion by ratio basis to population in each county of qualified census tracts that should be identified and designated as Opportunity Zones.

And they also gave the tribes in our state the same latitude to identify a zone if they felt they wanted to do that. And then the remaining qualified census tracts were a pool of competitive zones. And so when you start that process, and it really does speak to the social impact measurement that we decided to begin at and then evolve over time, you know, it’s not just a question of maybe where’s the most opportunity to make money? Or how are you gonna get a fund established that’s gonna attract the most private equity from outside the region? You know, there’s a lot of those important pieces.

But really, it’s about which census tracts could be kind of catalysts or key components to a more local and regional impact that could be measured through the metric set that were part of the original designation that was made for these census tracts. But then, for the sake of the prioritization of the tracks that we knew were the most appropriate for Opportunity Zones, how do we kind of define that? So our applications in our state at least we’re inclusive of those metrics.

So social impact measurements were part of our application process, and included local community developers saying, “Hey, if, you know, this happens, we’re interested, and we’re gonna engage.” And the local elected officials and the public saying “We’re on board as well, and we think this is the right choice.” So, you know, to kind of circle back, the objective is to be able to establish that baseline data, which was really built around the applications that were made for the designated tracts that we propose to our state’s Department of Commerce as the appropriate designations.

And, in our case, in this region, we had a lot of support from our congressman and from other adjacent counties who were doing the same thing. And in the end, we kind of got really close to what we hoped we would accomplish. And once that was established, then, you know, we were hoping that… As Greg said earlier, there weren’t truckloads of money backing up, but there was the next effort to try to identify what projects and what process would be most effective and most successful to accomplish the objectives of what is…

I mean, if we go back to the genesis of Opportunity Zones out of the original 2014 and ’15 work that was done by EIG, and others, and Michael Novogradac, you know, trying to identify what’s the best path to truly invigorate private equity investment in a responsible way, we started building that structure, and that’s where Greg and his team came in.

And, as they started their work, recognizing what we’d already had on the table, that baseline data was, so how do we measure this? And what does it mean? And how do we speak to a question of, well, you know, there’s clear intent, and it’s not just economic, it’s broader than that? How do we know if we’ve accomplished that? How do we measure that outcome? And that then becomes what we’re going to address, which is the social impact measurement that we’re engaged in now.

Jimmy: Right, exactly. How do you measure success in Opportunity Zones? Steve, actually, let’s back up for a minute here. Can you explain to me and our listening audience what your level of involvement was in the zone designation process at the state level there in Washington?

Steve: Sure. So there was a background in our world that was about, how do we do economic development in a responsible way? And the state took some time to figure out how they were gonna make that selection and recommendation to Treasury. And when that was done, we jumped in. And I say “we,” I worked with local jurisdictions. In some cases, it was a city and their staff or county commissioners, to work with the potential economic investors to find out, how do we identify what is the preferred Opportunity Zone?

And, in this case, for example, in the jurisdiction of Bremerton where Greg has his Sound West OZ 1 project is a case where there were multiple other census tracts that were qualified but probably weren’t the best designation. And so we had to make some choices, and I think we did the right thing. And it’s a question of measuring, not just the jobs, and the economic growth, and the benefit that what we do at that track actually benefits the other tracks that weren’t designated but are part of a more regional economy.

And we can talk about that too, how important that is to look at the larger picture when you do that measurement and the social impact statement. But with that said, you know, when we got through the process of the destination in our state, then we knew when the state submitted to the IRS where we were at the point. We started continuing to gather that data and started thinking more regionally about what we’re doing.

I always tell people that my sense of that process over that first year was people outside of the ground zero if you will of the designated zones, people outside of that area, if you could take a concentric circle and work away from it, the farther away you got, the more confident, more interested, more positive investors and equity was about the project. Because people living on ground zero were a little more skeptical, a little bit more…you know, they’ve been through economic downturn after the Great Recession, and there was just a lack of awareness. They were kind of numb to, you know, what the opportunities could be.

And what’s been great about this is as other components of all of our community development have come together is just seen as, Greg can tell you firsthand, over the last two years is really an invigoration beginning, not just in economic development, but also in kind of sense of place and pride in community. And it’s common now, people say, “You know, the town is changing, you can feel it. It’s different. People are moving here. They wanna be a part of this.” And so that’s not a measurable social impact in a way, but, you know, it is in some ways as well. So that’s how we’ve evolved to this point, and that’s how Greg and I started working together on the next phase of how we measure those metrics.

Jimmy: Some of the measurement, obviously, is very objective and data-driven, but there’s also a qualitative component that you just spoke of as well. Just the feel of the community and the sense of place is hard to quantify.

So Steve, what does your social impact reporting typically look like if, you know, Greg came to you and asked you to do some social impact reporting for his fund? You know, I actually think that all of these Opportunity Zones funds should have something like this and outsource it to a firm such as yourself. What are they getting back in return, and what are they able to show to investors? What does the report look like? What types of metrics are you keeping tabs on?

Steve: Well, you know, just like the other discussion we had about the evolution of guidance, there isn’t a specific template that’s been generated by the Treasury to say, “This is what a social impact report should be,” right? So the best path that we’ve found is, you know, we do a lot of work in the area, as I mentioned earlier, kind of environmental restoration and permitting, and we work with a lot of federal agencies, EPA, corps engineers, and fish and wildlife, and tribes, and local agencies. And we’ve developed over 20 years now in doing this kind of a template of our own, which is kind of establishing, I use the word baseline data. Well, that’s already available. That’s what in the original applications for Opportunity Zones.

But just like environmental restoration, there’s a life to it. It doesn’t happen in 1 year or even 10 years in some cases, and so what we do is we do the baseline data report. That’s the first thing that we wanna kick out. And we’re just finishing that up for Marina Square. I went through that last week again with the metrics that we’re using. And then what we’ll do is have that…that’s a report that says, here’s where we started, right?

The next step is what I call monitoring. And monitoring is just taking the temperature of progress. And it’s not gonna be a reflection of the final outcome, which, frankly, won’t really be measured until after I’m gone from the service. I mean, there’s additional benefits and tertiary outcomes that will happen. But we can put it together and say, based upon the funding of this project and a 10 years zone life, or fund life, and how this project has its own construction timeline, and then eventually it’s part of the economy in the census tract and then the region. We can do monitoring to the point where we get towards the end of that 10-year period we do a final report. You know, we close up the permit, if you will, to use the analogy from the environmental side. We end up with a product that is multiple pieces.

It’s a baseline report. It’s monitoring over a period of time, and that’s measured and decided upon based upon the timeline of the project. And when it goes to certain phases and construction, and then, you know, if it’s a residential occupancy, you know, measurements, etc. And then finally, at a certain point in the life of the fund, we do a final report and say, “Here’s where you started, and here’s where you ended up,” based upon those metrics. So that’s the best way to describe it. And we created that template based upon what we think the government’s looking for, and investors are looking for, and the public is looking for, and what we know from our own experience.

And we’re not gonna just stop at the border of the census tract. I mean, that doesn’t make sense. We don’t live in isolation from our jurisdictions or our regional community. We have to look at it from the standpoint of how the other census tracts that were qualified but not designated also had a benefit, and how those metrics that we’re using in the Opportunity Zone that we’re looking at can be applied to a greater area. Because otherwise, we’re kind of ignoring the objective of this program in the first place, which is to reinvigorate these communities, not just small borders. I mean, census tracts can be pretty small, you know, geographically.

And so, in this case, we’re gonna look at…we have two census tracts that were designated, two zones that look across the water at each other across a body of water in the Puget Sound, and they’re complementary. But because of their designations, the synthesis of their connection as jurisdictions and communities is gonna increase substantially because of that infusion of capital in both places that makes them more connected as economies.

And so those are the things that are important to look at too, not just, you know, a standalone measurement for one census tract based on its existing data, then its outcome as a zone. It’s gotta be looked at in a kind of a local and regional basis as well. And to Greg’s point, a lot of what we bounce off of is providing affordable housing and lifestyle choices. And, you know, you could take a foot ferry, fast ferry from downtown Seattle to one of our communities in Kitsap County. And in 30 minutes, you can be in the National Park, or, you know, on a bike trail, on a hiking trail in 5 minutes, or at your backyard. And so it really creates a wonderful connection to a lifestyle that has the kind of infrastructure that’s, you know, being protected pretty effectively.

Jimmy: Yeah, that’s great. And I wanted to just kind of emphasize economic development doesn’t happen rigidly within the arbitrarily set borders of a census tract. There is spillover you know. And I get questions sometimes, I can’t tell you how many times I’ve gotten this question this year. A property owner will email me, and he’ll say, “Hey, my property is located right on the border, it’s right across the street from this Opportunity Zone. Is there any benefit?” And I have to tell them, “Well, unfortunately, no, in the sense that, you know, your property won’t be eligible for direct Opportunity Zone benefit.

But, you know, if you’ll hold on to it long enough, there may be some spillover effect if the adjacent Opportunity Zone does get going and does receive some capital injection.” I mean, there is some economic spillover that occurs. That was kind of a point that I lifted out of what you were just saying there, Steve. Shifting gears now, Steve, what is your high-level view of the Opportunity Zones incentive? And then if you could, zoom into the Bremerton project, and how does that view apply there?

Steve: Sure. Yeah. So, you know, the one thing, and I want your audience to understand something that’s so important is an Opportunity Zone is not a single stroke of lightning that comes out of heaven and turns black and white into color. It doesn’t fix all your problems, even if it’s a good zone and it’s got some potential. It’s really a partnership with other metrics in the community that are related to both economic, and cultural, and social measurements.

And to give you an example, in the community we’re speaking of in Bremerton, part of what we did was also lay the groundwork for some other important pieces. For example, right about the time we were just starting the Opportunity Zone project, we had just completed a very successful project to establish a fast ferry system. Kind of think of, you know, New York’s Water Taxi System or the Bay Area. In fact, we work with those people to really get an understanding of how to really make this a successful venture.

So now Kitsap County, Remington, about 150, 200 feet from where that first project that Greg is involved in, you can walk over, get on a fast ferry and be in downtown Seattle in less than 30 minutes. And that is a game-changer, both in terms of lifestyle and economic growth, but also an optics in terms of being truly a connected part of downtown Seattle with a different lifestyle and a different cost of living benefit. And there’s two other points in our county that are also connected in the same way to downtown Seattle that never were before. So that was an important piece.

So I wanna make that point that that’s an example. There were other efforts in terms of redevelopment along shorelines connecting environmental projects with economic projects that kind of created a pattern for who we are. And that just fell right into this Marina Square project, which is an incredibly valuable asset to connecting the downtown, what was once a deacayed urban core to a revitalized boardwalk, and waterfront, and Marina, and ferry system. There’s car ferries and foot ferries, and local connections. And so it’s just a dance that has to take place.

And, you know, it’s important for people to know that it’s not just a one-size-fits-all Opportunity Zone answer for everything. It’s really an important thing to step back and take a look at, what else is part of that process that compliments? And then they just build on one another, and the momentum, it becomes almost you step back and watch it, and you don’t have to nurture anymore. It’s been cultivated, and it’s up and running. And we’re getting to that critical point, I think, in this community.

And, Jimmy, if I could also, you know, speak to the idea that it’s important to note that this census tract is part of, as I mentioned earlier, multiple census tracts in the area. But if you measured some of the metrics that are part of the baseline data, some of them clearly show the qualification, the need, you know, the legitimate criteria that are necessary to qualify a census tract to be a zone. But there are some that are aberrations. And that has to be taken into account too, not just in the selection process that we went through, but in the measurement process. And I’ll give you an example of that is the census tract that is part of the Opportunity Zone that is inclusive, the Marina Square in Bremerton, is adjacent to a community college across the highway. And next door to that is a Naval shipyard.

Well, there’s two pieces that are part of the measurement process. One is jobs and job security, and the other is, you know, level of education. Well, we might have housing stability issues for students, but we have a lot of people with higher education because they’re going to college, you know. And so you have to take that into account too. You just can’t measure, as in other places, in this region, education level, for example.

And then job stability, you know. It’s federal employment, it’s public jobs, but it’s not the answer to everything. A lot of people commute into the area and they don’t live downtown, and there’s lack housing in the area around the federal facility. And so it’s hard to measure, you know, in a truly consistent way with other census tracts, how you would truly qualify on that metric of employment. Because as I like to say, you know, if the nation, or the region even, or Washington, Seattle, which is thriving in an economic flu like 2008, Kitsap County just gets a head cold, you know. We’re somewhat insulated on the job side. So those are important, I think, measurements to understand as well.

Greg: I was hoping to dovetail on something that Steve just brought up. So, you know, Opportunity Zones are not immune to demographic swings. And so, at the end of the day, where the property is and the demographics surrounding the property, even if it’s inclusive, even if you have a positive social impact to the community, at the end of the day, this is about investment dollars because that’s what this is all designed to do.

And so I wouldn’t want your listeners to think just because it meets a criteria, that it just automatically means, not only is it good fund, but I’ll get my return that they believe that they can hit. So most people believe, and I particularly believe, and my partners at Sound West Group believe, and I haven’t asked Steve, but I believe he believes too, we’re either in the late stable stage or at the top of the real estate market at this point.

And so when and if there are recessionary pressures, or even a recession, these programs…because you gotta remember, these are 10-year programs, and the vast majority of these are development programs. So, aside from the fact that they have a positive social impact, how is the program going to evolve, and how is it going to stabilize itself over a 10-year period of time? And so you have to look at the demographics around the program. And, you know, just call to a point, Steve had mentioned the fast ferry system. And the reason why that’s in place, or one of the big reasons why that’s in place is you have to look at the major city there, which is Seattle.

And this is indicative of what happened in New York. This is indicative of what happened in San Francisco Bay Area. The same thing happened in the San Jose California area or the Silicon Valley area, when folks, the young executives were all being priced out of the market. And these areas all have the highest housing prices in the country, even areas like Austin, Texas. It starts to create an effect where folks are going farther and farther away from the downtown areas. So what you need is stabilizing forces from the demographic standpoint when these recessionary winds hit.

And so I would suggest strongly to your listeners to look for areas that have those core elements in place from a corporate standpoint. Meaning just using Seattle as an example, you have Amazon, and Microsoft, Starbucks, and Boeing. You have Expedia and Travelocity. And so a number of major international companies who really, even in a recession, are not going anywhere. Yet, they continue to grow, and the need for housing continues to go up. So, even in a recession, what you’ll find, and I think that’s why Steve was saying that Bremerton or Kitsap County gets a head cold when the rest of the economy has the flu.

So my major point is…and it’s not necessarily to hawk or to sell our program. It’s really to say, yes, having metrics and measuring, very important. Positive social impact, very important. Socially responsible, very important. Tax initiatives and saving money on your taxes, very important. But at the end of the day, each one of these Opportunity Zones funds have to perform. And the only way they’re gonna perform is if the economics around the programs themselves actually come to pass and actually have traction, not for this year, not next year, but for the next 10 years.

Jimmy: Right. I think that’s a very good point. And, frankly, the only way that you can even take advantage of the main tax incentive of the Opportunity Zone incentive, that elimination of capital gains, is if the investment produces a capital gain to begin with. So you wanna make sure that you definitely do your due diligence and take into account a lot of the points that Steve and Greg have just brought up when you’re making an investment. If you are looking to roll over capital gains into an Opportunity Zone fund, those were very good points to keep in mind.

Steve, I wanna get back to you for a minute here. So you were clearly involved with Opportunity Zones from the very early going. I wanted to see if I could get your high-level thoughts on how the sausage was made exactly and is continuing to be made. And by that, I mean, you know, in terms of the legislative process and the zone selection process you’ve spoken to already a little bit, but I wanna get your thoughts on IRS rulemaking as well. And just if you can give me your thoughts on what’s happening and what has happened?

Steve: Well, Jimmy, thanks. That’s an interesting question because I think I’ve surmarized and concluded some things. And I might not be 100% accurate, but I think I’m pretty close because I wasn’t in the room when these things were happening. But just for background, I’ve worked in the Beltway. I’ve worked for the senate majority leader years ago and had had a lot of experience in national politics and policy and started a public policy Think Tank years ago. So kinda part of, you know, this process is sausage making.

And here’s my sense of when the President signed the Jobs and Tax Act, you know, in 2017, Congress was home for Christmas by then. And now, all of a sudden, you’ve got all these people in the Department of Treasury who have…when they wake up on January 1st, they have cords of interested investors, and attorneys, and communities at the gates with pitchforks saying, you know, “What do we do? What do we go with this? We need information.” And so there was a lot of pressure.

And so a lot of folks independently were trying to formulate in their own minds based upon the best available information. For example, we called upon what we thought was one of the best tax attorneys in the country to give us guidance on kind of reading the tea leaves, where is this is gonna go. And the outcome for the project that Greg is working on was just stay in the fairway. Don’t try to find, you know, anything on the edge and the rough that might be attractive. Just stay down the middle and as the guidance evolves, you’ll be safe.

And so when the first guidance came out, what I saw from that was kind of a, “We’re not sure what we’re gonna do. We’re trying to address the foundational questions the best we can, and we’re gonna not tell you that these are binding. But we’re gonna tell you that if you use this guidance spirit, as long as you use the spirit of what you see to the letter here, you’re not gonna be in trouble with this.” Then for a lot of, you know, people that were trying to track this private equity investor, that still wasn’t a really comforting place to be. It was, “Okay, we need more certainty.”

And my sense was that, honestly, I don’t think anybody really thought about the guidance until it just plopped on their desk in 2018, and they realized there was incredible pressure to perform. And this is something that, you know, normally might have taken a couple of years to do with the process of developing the legislation. That was my experience in Washington.

In this case, it happened pretty quickly, even though it had been conceptually discussed and had been part of ongoing discussions among lawmakers and Congress, bipartisan, Democrats, and Republicans starting in kind of 2014/’15. It kind of took off after 2016. And when it landed quickly, there just wasn’t anybody prepared to have set up the mechanisms to provide the guidance that was necessary.

And so my sense is watching all this evolve over time, especially as the second set of guidance came out, was I can almost see the learning and the discussing among the colleagues and Treasury going on with their counsel trying to get their hands around. Which is, if you read the legislation, it’s pretty simple. It’s pretty straightforward. It just doesn’t tell you anything about what you can or can’t do, or how to implement it, you know. But it’s more of a policy statement than it is a specific regulatory guidance. And so that’s the struggle.

And the problem is, and Greg is probably the one that has to endure most of the challenge here is, you know, it’s taken about two-year delay to get where we should have been two years ago with this legislation. We should have been able to start with the product, if you will, with a certainty that when we talk to investors and the communities that we’re working in that we know where this is gonna end up. And I think that the path is narrowing. There’s more certainty, but I don’t see it there yet. It’s just getting really close.

Jimmy: Yeah, I agree. We are getting close, but we’re not quite there yet. Greg, I wanna turn back to you now. So how has it been going with OZ Fund I? It sounds like, I believe you, you spoke at the top of the show about how you’re actually gonna close the fund pretty soon because you’re close to hitting your capital raising targets. And do you have plans for OZ Fund II, and III and beyond? Maybe you can tell us some of your future plans.

Greg: Yeah, certainly. And I couldn’t agree more with Steve’s points, and especially his last point, as far as really the catch up in the industry and investors feeling comfortable with Treasury and the guidance that’s out there now.

And so we’ve been a part of that. We were early adopters. We were one of the first in the marketplace. And as I mentioned earlier, we took a very academic approach to bringing out our first product and developing the entire platform. But as you’d mentioned, as far as the equity raising on our first program, we had actually launched…officially, the memorandum came out at the end of February, so let’s say March 1st. But we really couldn’t sell the program until there was clear guidance. And that guidance really didn’t come out until April. And it takes some time for the learning curve, and so really May is when we started raising equity in any type of earnest fashion.

And so our offering is a $50 million offering, and we’re about $18 to $20 million away from hitting that. The numbers are growing exponentially every month with our raise. So we’re on target right now to an end of the year close, but it may tip into early January as far as closing out the fund. So there’s definitely some opportunity there for investors still available, which actually brings up another point. As far as the exclusion, there tends to be this feeling that there’s a mad rush to get the money in the door by the end of the year.

And that’s true from the standpoint of maximizing your Opportunity Zone benefit. But as we’ve discussed on numerous occasions on this podcast, you know, getting into the right program with the right dynamics, with the right demographics to foster success in the program is much more important than the 5% additional tax benefit you may get to rush to make a decision in 2019.;

And so we have not seen actually much in the way of folks feeling like they’re pressured to get the money in by the end of the year. It’s probably a natural effect. But to the investment community’s credit, most people are really doing their due diligence, which I actually applaud. So we don’t think there’s gonna be much of a downturn in the equity race going into 2020 because the industry is understanding that a good program is going to perform. And whether it’s at a 10% step-up or 15% step-up, that really is not going to make or break the program or that particular investors tax initiative. So we think we’re gonna be able to close this out most likely by the end of the year or early January.

And with the success of our Opportunity Zone 1 platform, and now being recognized nationally as a best-in-class platform and program, we’re going to take that same overlay and apply it to our next program. So we are in the process now. We’re bringing out what we’re going to call OZ 2, and OZ 3, and most likely an OZ 4 in the near future. And really, they’re going to have the same dynamics as OZ 1 in the sense of they’re local communities, they’re around the Bremerton area, which is our expertise.

In Kitsap County, we’re in discussions right now with a substantial group for a master plan in a town just across our water called Port Orchard, which has the same dynamics and demographics as Bremerton. And then also assemblage of properties in Bremerton that really have the same demographic dynamics of Marina Square, which is in OZ 1.

So we’re really excited, you know, we’ve gone through the headaches and the heartaches of what we call OZ 1 over the last, you know, year, year and a half of building the platform. The traction is there. We’re now being recognized nationally as best-in-class platform and program. And it’s just simply finding that same recipe and overlaying into our next programs. And we’re very happy to say that, you know, right under our noses, in Bremerton, Washington, we actually have those assemblage of property that we can launch our next program. So I would look for early to mid 2020 for our next offerings.

Jimmy: Well, that’s great, Greg, and congratulations on the current fund offering seems to be going well, the capital raising component to it. And best of luck to you in getting OZ Fund II, III, and maybe even IV off the ground in the coming year. Before we go today, where can listeners go to learn more about you and Sound West? And Steve, you can chime in as well and tell us where our listeners can go to learn more about you and the Waterman Group.

Greg: Certainly, Jimmy. For Sound West, our website is soundwestozfunds.com. So, soundwest and then O-Zfunds.com. And you’ll find all the information on our program and our platform. In fact, you can even see the construction progress of our latest OZ Fund I called the Marina Square Project in Bremerton.

Steve: And Jimmy, you know, I may just give you my email address and that links to our sites as well. And I can point you in the right direction if you’re interested. And that is Steve [email protected], Michael Paul. watermanmp.com. So [email protected] is where I live, and look forward to hearing any questions or help anybody find a path to doing what we’re doing. And it’s exciting to be a part of this.

We’re thankful that people like Sound West and Greg have stepped into the fray and taken this on. You know, I only see it from the perspective of local heroes what we’re doing. I don’t know what else is happening to the degree that you do, Jimmy, around the country. I see some of it, but we’re really excited about what the future ahead lays for us. So, we’re excited.

Jimmy: Perfect. I’m excited as well, and I know that my listeners are as well. And for our listeners out there, I’ll have show notes on the Opportunity Zones database website for today’s episode, and you can find those show notes at opportunitydb.com/podcast. And there you’ll find links to all of the resources that Greg, Steve, and I discussed on today’s show. Greg and Steve, thanks for the time today. This has been great.

Greg: Thank you very much, Jimmy.

Steve: Jimmy, thanks for the time. We appreciate it and look forward to hearing more from our colleagues around the country that are working with you as well.

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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