Multifamily Investor Expo - Feb 15th
During this current economic crisis that has resulted from our response to COVID-19, how can Opportunity Zone funds serve as alternatives for 1031 exchange investors?
Erik Hayden is founder of Urban Catalyst, a San Jose-based real estate Opportunity Zone fund focused on ground-up development.
Click the play button below to listen to my conversation with Erik.
- The key similarities and differences between 1031 exchanges and Opportunity Zone funds.
- Some options for combining 1031s and Opportunity Zones, including the ability to invest 1031 boot into Qualified Opportunity Funds.
- Where the majority of capital gains are derived from (stocks, not real estate), at least among Urban Catalyst investors.
- The three things that Urban Catalyst looks for before beginning development: 1) demand; 2) transportation infrastructure; 3) a municipal government that is pro-development.
- Trends in downtown San Jose’s Opportunity Zones.
- Tech sector and real estate trends during the coronavirus pandemic and resulting economic crisis.
- Why a recession would likely lead to a sizable decline in hard construction costs.
- How Google is expanding from Mountain View into San Jose, and how their community development plan differs from Amazon HQ2.
- The three external pressures that 1031 exchanges are now facing: 1) a tightened credit market; 2) lower volume; 3) the challenges touring properties in a time of stay-at-home orders and social distancing.
Featured on This Episode
- Erik Hayden on LinkedIn
- Urban Catalyst
- Depreciation Recapture Elimination
- IRS Final Regulations on Qualified Opportunity Funds
- Boston Properties presses pause on construction (BizJournal)
- Diridon Station Area Plan + Google Development
Industry Spotlight: Urban Catalyst
Urban Catalyst is a real estate Opportunity Zone fund focused on ground-up development projects in downtown San Jose. Their seven acquired projects across office, multi-family, student housing, senior housing, and hospitality form a diverse portfolio of assets to potentially minimize the risk to investors. They have a unique structure of being both a fund manager and a local developer and have a track record of success in the Bay Area.
Learn more about Urban Catalyst
- Visit UrbanCatalyst.com
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.
Jimmy: Welcome to the Opportunity Zones Podcast. I’m your host, Jimmy Atkinson. Today’s episode will focus on the different options that 1031 exchange investors may have with opportunity zones, particularly in response to the current economic climate brought about by the COVID-19 pandemic. My guest today is Erik Hayden, founder of Urban Catalyst, a real estate equity fund, focused on ground-up development in Downtown San Jose’s opportunity zones. Erik joins us today from his office in Downtown San Jose. Erik, thanks for coming on the show.
Erik: Jimmy happy to be here.
Jimmy: Happy to be with you too Erik. I appreciate you taking some time today to join us and to give us some of your perspective, particularly in regards to 1031s and opportunity zones. So to start us off an easy one for you, can you walk us through some of the similarities and differences between 1031 exchanges and opportunity zone funds?
Erik: Sure, I’d be happy to Jimmy. And I’ll keep this at a high level. Because you can really get down into the nitty gritty when it comes to the similarities and differences of these two programs. But overall, both programs allow you to defer paying capital gains taxes from the sale of real estate. For a 1031 you theoretically can defer paying those taxes until you pass away. For an opportunity zone, you can defer paying your capital gains taxes for 6 years or until you really pay taxes in 2027. The difference for opportunity zone funds is obviously, after 10 years of your money being in an opportunity zone fund all of the profits from the fund itself are tax free, so a little bit different than a 1031 in that respect. Also, opportunity zone funds typically focus on ground-up development, real estate projects, or large renovation, while 1031 exchanges focus more on the acquisition of existing real estate assets, but they are both real estate investments.
One of the major differences between 1031s and opportunity zone funds is, in order to get the tax benefits and the tax deferral, when you invest into a 1031 exchange, you have to invest your original basis, plus all of your gains or at least a portion of your gains. In an opportunity zone fund when you invest, you get your basis back, and you only have to invest your capital gains or a portion of your capital gain. We’ve seen several situations where investors have combined 1031s and opportunity zones where they do a 1031 exchange, but decide not to put all of their gain into their new property and take their additional gain that they didn’t roll into their new property which is called their boot and put that into an opportunity zone fund to defer paying taxes on that portion of their gain. Finally, really the last topic I wanna cover on the similarities and differences is when it comes to depreciation recapture. Typically, when you own a piece of real estate, the government allows you to depreciate that asset over time. And you get that as a write off on your taxes. But when you eventually sell your property, you have to pay back all of that depreciation. In opportunity zone funds, they specifically wrote into the legislation that when we sell all of our assets after 10 years to give tax free profits to our investors, there is no depreciation recapture. And, Jimmy, by the way that came out as a part of the December guidelines that were rolled out by the IRS and the Treasury, December of 2019.
Erik: And it didn’t get a lot of press, even though that is just a huge benefit for the opportunity zone program overall.
Jimmy: Yeah, I agree. I think that is an enormous benefit. It’s a benefit that I’ve spoken with a number of people about and I don’t know if it’s come up on this podcast too much, but that is something that maybe should be touted a little bit more, I completely agree with you because that’s a huge, huge tax savings there that kind of gets overlooked. I would say a couple other differences between 1031 exchanges and opportunity zones, the ones you went through are great, but a couple others I wanna point out, you know, a 1031 exchange, in some ways has some more hoops to jump through just because you have to go through a qualified intermediary. With the opportunity zones there’s no such entity that you need to process the investment through. The qualified opportunity fund can be self-certified, and it’s pretty easy enough just to write a check to a qualified opportunity fund. The difference and other differences, maybe the one that might be a knock against opportunity zones, is that it’s limited to certain geographic areas, right? It’s limited to largely low income census tracts, whereas the 1031 exchange doesn’t have that geographic restriction. So a couple other things to keep in mind for investors.
The idea of putting a boot into an opportunity zone fund, that’s an interesting one. Talk to me about that a little bit more and about 1031 exchange investors in general. What are some of their other options when they are looking at opportunity zone funds? And why should they look at opportunity zone funds? And does it provide an interesting alternative for investors potentially, whose 1031 deal may fall through?
Erik: So, that’s a great question. You know, initially when we formed Urban Catalyst back in late 2018… I come from a real estate background. I’ve been a real estate developer for my entire career. And I thought, boy opportunity zone funds, there’s gonna be just a ton of folks that sell property as their capital gains that they’re gonna wanna invest into this type of program. What we found in Urban Catalyst, raising money for our opportunity zone fund is that the majority of our investors their capital gains is that was the sale of stock. You know, right now we have around 120 investors in our fund, and I would say 70% of them, their capital gains event was the sale of stock. You know, why wasn’t real estate a bigger part of that was always a kind of a question in my mind. And since this pandemic has happened, we’ve seen a significant increase in the number of people that have the sale of real estate as their capital gains event, coming to us and talking to us about investing in opportunity zone funds. And really my question was why, why now? Why is it that we’re seeing this type of increase? And this answers your question in a more of a roundabout way, but what we’re finding is that folks are having issues with their 1031 exchanges and completing the transactions for a variety of reasons. And opportunity zone funds create alternatives, because they are similar in the fact that they are a tax deferral mechanism, and there are tax benefits associated with both programs.
People are finding out about opportunity funds. I mean obviously 1031s have been around for 50 years. They’re a tried and true method. They’re the go-to thing that almost every real estate investor does. And opportunity zone funds were newer, we’re a newer program, and people are just learning about us. I mean, the final regulations only came out less than six months ago. So as people are having these issues with their property transaction, investors are learning about opportunity zone funds and how they are similar to 1031 exchanges.
Jimmy: Right. No, I think that’s great. Yeah, I talk about this all the time on this podcast is how there’s still a public awareness problem with opportunity zones, just not enough people know that this incentive exists, as you rightly point out. You know, we’re having this conversation in mid May, the final regs only came out less than five months ago, actually. It really hasn’t been very long. But as public awareness seeps into the consciousness of investors and their advisors, I think more and more, we may see investors use opportunity zones as an alternative to 1031s or as a backup to 1031s if they’re 1031 exchange deal happens to fall through. I wanna turn our attention now to what you’re working on at Urban Catalyst. So Erik, maybe if you can take a minute or two to give us a little bit of background on you and on Urban Catalyst. Walk us through your investment thesis, also, which asset types you investing in. And you’re primarily developing in Downtown San Jose, I believe, but why San Jose? Maybe you can give us the case there as well.
Erik: Sure, so I formed Urban Catalyst in August of 2018. My plan was to form a real estate equity group that was going to focus on doing ground-up development projects in Downtown San Jose. I’ve been a developer in downtown for many years. And about a year and a half, or sorry, two and a half years ago, I really saw, you know, call it the light switch turned on in Downtown San Jose. And it was only after I started the process of forming this fund, that I learned about the opportunity zone program. And then all of Downtown San Jose, or pretty much all of Downtown San Jose, has the opportunity zone overlay, and really decided, well, wouldn’t it be a nice benefit for our investors to get the additional tax benefits that are associated with this program? So that’s how we became an opportunity zone fund. I went about and put together what I’ll call the all-star team of Downtown San Jose developers, folks that I’ve been doing business with and known for many years, tons of experience primarily in Downtown San Jose, and really with that, we were able to acquire seven projects here in downtown.
And that is our real strategic advantage in Downtown San Jose is acquisition. We’ve been here for so long we know all of the downtown property owners. And that allowed us to acquire projects off market in general for below market pricing in order to do ground-up development, in real time. So we started Urban Catalyst. We acquired our projects, we started fundraising. Downtown San Jose, why is it where we’re located? Why do we wanna be here? Well, there’s a few reasons. You know, what Downtown San Jose really had, and what we’re looking for whenever we do ground-up development, is three things. The first is we wanna make sure that there is demand for all of the different types of projects that we’re gonna build. And here in San Jose, that demand is generated by the Silicon Valley job engine. The next thing that we wanna see is we wanna see if there’s transit and physical infrastructure already in place. Downtown San Jose is really the only true urban environment in Silicon Valley. And it already has fantastic mass transit options. So that box really is checked.
The third thing, and probably the most important thing is we wanna do business in a place where local governments are pro-developers, where they wanna see development happen. And that is absolutely the case here, at Downtown San Jose. They have put into effect a streamlined pre-construction process to really allow you to go through…to get your building permits in less than 12 months. So a lot like…you’re probably more used to in Texas unlike California, where projects typically take three to four years to get your building permit. So, from that perspective, that’s why we’re here in San Jose. But from a more macro perspective, what we saw happen is kind of like the why now is what is happening in Silicon Valley is this migration of the large tech company. You know, 20 years ago, Google was a big company. Everybody heard of Google.
Google now here in Silicon Valley has over 25 million square feet of office. I mean, for example, in the city of Mountain View, Google owns or leases 95% of the office space. And what the big groups like Facebook, Amazon, Apple, and Google have figured out is that traffic is so bad in the Bay Area now. You know, for example, like San Jose and Palo Alto are 15 miles apart, but during rush hour that can take an hour and a half. And because Facebook’s employees can’t afford to live in Palo Alto in general, because the median home price in Palo Alto is $2.5 million, they have to live further away, and San Jose is a bedroom community that has more affordable housing than places up further north in the peninsula. So, these groups have realized that their employees are spending three hours a day in their car. And, it used to be really cool when Google came out with their private buses. And boy, wasn’t it awesome, in 2003 those buses have Wi-Fi. And now they’re looking at it as, “Okay, our employees are spending three hours a day on a bus with spotty Wi-Fi.” That is not how we attract employees. That is not how we increase employee productivity. What we need to do is something I’m calling a decentralized headquarter strategy, where they move their major office, campuses closer to where their employees live.
They still wanna be in Silicon Valley. So what they’re doing is they’re slowly migrating southward. In the last 10 years, if you think maybe that Palo Alto and Mountain View are the center of Silicon Valley, the center of the tech universe, the next city south is pretty Sunnyvale. And in the last 10 years the city of Sunnyvale, all of the big companies have been acquiring office. They’re buying existing office, developing new office, leasing office, to the point now where Apple and Google owned or lease more than 50% of the office space in the city of Sunnyvale. And now that Sunnyvale is completely built out, it’s really a question of, “Well, what’s next?” And literally the next stop on the transit is Downtown San Jose. And we’ve already seen big moves by Apple, Amazon and Google, especially Google, taking large chunks of office in Downtown San Jose. And that trend is expected to continue. And what that’s done to supply and demand and of course, this is looking at it from an office perspective, what that’s done to supply and demand at Downtown San Jose in the last 10 years, office rents have doubled and vacancy rates which had hovered around 20% to 25% for almost 30 years have gone down to less than 10%.
And we saw this change happening around two and a half years ago. And that’s why we decided to form Urban Catalyst and do ground-up developments. It’s really buying land and getting in on the ground floor of this wave of development. So in Urban Catalyst, we have seven projects, very diversified asset classes for our projects, and that was to create diversity to minimize the risk to our investors. We have two multifamily projects. We have an extended stay business hotel at the Marriott TownePlace Suites. We have a student housing high rise right next to San Jose State. We also have a senior living facility, which is an extended stay memory care facility. So a variety of asset classes all have a massive amount of demand here for those types of projects in Downtown San Jose.
Jimmy: Yeah, Urban Catalyst, being in the right place at the right time, it sounds like. I wanna bring in current events though now. We’re currently in the midst of the COVID-19 pandemic, and our economy is suffering because of that, and because of our response to it, locking down a lot of the country, and people being afraid to go outside and go into restaurants and a lot of the economy is shut down, essentially. So, historically, the tech economy has been strong, particularly since the dotcom bust at the end of the last century. How is it responding to the current crisis?
Erik: You know, it’s responding very well. As far as the overall tech economy, you know, it’s a lot of programmers, a lot of software folks, they’re used to working from their computers. They’ve done Zoom conferences before and working from home comes more naturally to them. It’s not like we have a tourist based economy or a manufacturing based economy. Silicon Valley is very resilient to this type of a slowdown. And what we’re seeing out there it’s a mixed bag. There’s a lot of groups that are saying they’re putting new acquisitions and properties on hold. But then at the same time “The Business Journals” here in San Jose did an article this week, interviewing a bunch of downtown developers and larger tech companies who all said, “We’re still going full speed ahead. This type of demand has not stopped whatsoever.” And that was even more heartening, when yesterday it was announced Google purchased just another property to add to their giant collection of properties they’ve already purchased in Downtown San Jose.
Jimmy: And what about real estate? How have real estate values changed since this crisis began unfolding or how do you expect them to change? Do you anticipate that we’re gonna see distressed values?
Erik: You know, that’s such a great question. You know, real estate values typically lag overall market shifts by six to nine months. Because what we see out there is if people can hold on, they’re not gonna sell their property in the middle of a pandemic. They’re gonna wait until the economy improves. So you’re only gonna see folks that have distress things happening to them come out and be forced to sell their asset. You know from a real estate perspective, the first thing we saw at the end of March was the mortgage rate, having to liquidate portions of their good existing portfolio in order to create liquidity to pay some of their capital calls and to pay down some of their investor dividends. We saw that happen at a pretty large scale at the end of March. People are expecting that traditional real estate…you know, REITs are gonna have some distressed assets as tenants don’t pay rent, as they still have debt service payments that they need to make, but we haven’t seen that en masse yet. Here in Silicon Valley, I don’t expect to see a lot of it. Really looking at it from a historical perspective of the last recession, real estate values didn’t go down significantly from 2007, 2008, 2009. There just weren’t a lot of transactions that were occurring. I remember I was doing a project, and I was getting an appraisal for an apartment building that I was planning to build. It was eventually constructed starting in 2011. But in the year 2008, there were only 2 multifamily transactions in all of Silicon Valley. And that was it. And we were trying to determine what the cap rate was, and we were unable to successfully do that because they were a distressed deal. And it was a very interesting time.
Now, looking back at that, I would have loved it if I could have acquired a bunch of property in San Jose prior to 2008. Even if I bought a bunch of property in 2007, property values appreciated around here so much in the last 12 years that I would have had fantastic land value. Now, the same I’m expecting is going to be true during this downturn. I don’t see land values decreasing significantly. And I specifically wanna talk about ground-up development when it comes to land values. You know, when we look at buying land there isn’t any raw land here in San Jose. Everything is a redevelopment. So we’re looking at knocking down some older types of buildings in order to build new buildings. But we look at it from a pure land perspective. If we’re buying a half acre or an acre, what can we build on it? How do we build our pro-forma model to back into the land value of what we can pay? And what I’m anticipating seeing right as existing assets where you do an income capitalization approach to determine the value may go down when you start seeing these distressed sales so you can see the comparison values go down is that we’re also going to see construction cost decreases.
This is another thing that happened in 2007 and 2008 here in Silicon Valley. We went back here, all the developers at Urban Catalyst, and looked through our past projects to find out what happened to construction costs during the last recession. And what we found in general, was that across the board, our project costs, that’s in hard cost constructions went down about 20%. And just to give you some perspective on what that would mean to us, if that same trend happens during this recession, is we have around $600 million in hard construction costs with our 7 projects in our portfolio here at Urban Catalyst. That’d be $120 million cost savings. And you can look at that cost savings when you’re, say, valuing raw land and say well, because pro forma models and the future of what you can build on this site dictates what the value of raw land is, because construction costs have gone down so much, the price of raw land, theoretically would increase throughout this whole process.
Jimmy: Right. That’s interesting. That’s really interesting. But do you suspect that construction costs go down because fewer properties are being developed?
Erik: That’s correct. You know, really for a variety of reasons. So, recently in the news here in Downtown San Jose, Boston Properties, which started construction of a million square foot office building, they stopped construction. And they decided that they want to push pause during this pandemic until they can accurately assess the future. And I kind of thought, why are they doing that? They already started construction. They already have their financing lined up, why are they stopping? And I can only think of two reasons why they would wanna do it. The first is they can’t justify to their investors on their quarterly reports because they’re a publicly traded company, why they’re continuing to build into a market where, possibly rents will go down and their building won’t be as valuable as they had initially thought. But the second reason, which is much more likely in my thoughts is that they haven’t finished buying out all of their contracts for their subcontractors for the construction. And they think if they wait six to nine months to continue construction that they can buy out those contracts at a much lower rate. And that’s why they pushed pause.
But overall, I see a lot of these companies for whatever reason stopping. I also see a lot of the developers out there that are not as well capitalized as others are unable to get financing from traditional banks or from third party equity providers to build their projects. It’s really the supply and the demand of labor that drive construction costs. And labor is the major issue here in Silicon Valley. People just can’t afford to live here. You know, they don’t make enough money and the construction workers are in that category. So we just don’t have enough construction workers to build the projects that we have in our pipeline. That has driven construction costs so high here that we have one of the highest construction costs in the world in the Bay Area. And, frankly, that has caused a lot of developments to be put on the shelf in the last five or six years as those construction costs have just skyrocketed. So it would make sense if less projects are moving forward, whether it’s from a corporate perspective of we’re just going to hit the pause button, or for some other reason, there will be less demand for those contractors. And in essence, that is why construction costs will go down.
Jimmy: Which gives you an opportunity for huge cost savings if you do continue with your construction projects. That’s an interesting silver lining to all of this. Do you have any properties that you’re currently leasing and how is the market responding? Are you still collecting rent at the same levels or have you seen a dip there?
Erik: So, we do have some leases. Of course, that’s not our business plan. I mean, we bought these projects, these properties as raw land and they just have some tenants that are left over from the acquisition. So, for us, it doesn’t make as much of a difference if we give them a couple of months free rent or not, because it’s not what drives the monetary value of our projects. So we have a few tenants and we have given them some relief where they needed. A lot of them…in particular, I’m thinking we have a woman that operates a nightclub, we have a group of renters and it’s a lower income building and we’re giving them some rent relief. Also, some of our tenants, which are very happy with us right now is a couple of our projects. We’ve moved into nonprofits, into some of the storefronts to operate for free over the last couple of years so that they can do their good work in the city without having to pay leases.
Jimmy: Okay, that’s interesting, Erik. You know, you spoke a little bit before about Google’s plans and how they’re kind of running through Sunnyvale. And then San Jose, Downtown San Jose is kind of the next step south, coming down from Mountain View. What insight can you give us into their specific plans? And has it changed at all?
Erik: Sure. So in the last four years, Google has been acquiring and putting together property in the Diridon Station area, which is in Downtown San Jose, and it’s right next to Diridon Station, which is just one of the West Coast major train stations. They have acquired roughly $450 million worth of property, over 80 acres, and they have submitted their plans to the city, and what their plans show is that they wanna build 7.5 million square feet of office and roughly 5500 residential units. They plan to build it over 10 years. And when it’s complete, it’ll be Google’s largest campus on Earth. So we can expect a significant number of people to the tune of around…you know, people are talking about 100,000 additional people because of the Google campus being in Downtown San Jose. And that’s the type of demand that drives increased prices and rents for residential so that those employees can live by their jobs. And it really helps out ground floor retail because people will be shopping and eating in Downtown San Jose.
So a lot of major benefits of Google coming to San Jose. You know, one interesting thing I think about when I think about Google’s plans to come here is I think about how Amazon when they were looking for their HQ2 they went across the country, and pretty much said, “Hey, what are you gonna give us if we move our offices to your city, or your county, or your state? You know what tax incentives, what kind of breaks?” And that really backfired on them when they went to New York and the residents were like, “Get out of here. We don’t want this here. We don’t wanna give you all of that.” When Google came to San Jose, it was like the opposite. They said, “We really wanna be in San Jose. This is the place that we wanna be. This is where our employees live. This is where there is culture. This is where we can have our millennial workers have that urban environment experience that they want.” And San Jose said, “Oh, yeah? What are you gonna do for us? And Google said, “What do you want?” And San Jose said, “We want you to build a bunch of residential units, not just a bunch of office. We want 25% of those residential units to be below market rate. And we want you to build parks, and we want you to build a grand boulevard to connect our city together.” And Google said, “Absolutely, we can do all of that.” So really, a huge benefit that Google is coming here to downtown and really the downtown is looking forward to it.
Jimmy: Wow, that’s really interesting, the difference between those two different headquarter developments kind of flipping the tables there. The company was demanding tax breaks from the city and now instead with Google, the city demanding certain benefits from the company. That’s interesting. That’s an interesting perspective there. I wanna talk about your projects a little bit. Now you spoke about them earlier toward the beginning of our conversation. They’re all in pre-development. How is the city of San Jose responding to COVID-19 in terms of their process and timing? Maybe you can give us some examples of what you’ve experienced.
Erik: Sure, and this is really one of the silver linings to what’s been happening with the pandemic is the city of San Jose has just been fantastic to work with throughout this entire process. You know, they immediately went to a working from home just like all the other businesses. But I remember the first Tuesday after the shelter in place orders came out, I got a call from the head of the planning department saying, “Hey, I just wanted to let you know, we’re all here. We’re all working on your projects. If you need anything or if you need an additional help, feel free to call and I’ll talk to my staff, make sure you’re getting what you need.” And I thought that was just a fantastic sign. And it’s proved to be very true. Our processing timelines, we’ve been hitting all of our milestones as we advance our projects towards building permits, and it has had almost no noticeable effect whatsoever on our schedule.
Jimmy: Oh, that’s good. Yeah, that is a good silver lining with all of this. So Erik, we’re coming toward the end of our conversation here, but I just wanna kind of bring this back full circle now and bring 1031 exchange investors in here again. What is your advice to them specifically, if someone’s listening and has experience with 1031 exchanges, maybe they’re considering opportunity zones, maybe you can give some specific examples of some 1031 investors that you’ve seen coming to your fund, maybe you can tell some of their stories and why they’ve found opportunity zone investing worthwhile?
Erik: Sure. So the first thing I wanna say is something that we mentioned earlier is that the opportunity zone fund program is now completely vetted. All of the regulations have come out. We completely understand it. It was a new program, and now it’s been solidified. 1031 exchange has been around a long time, and folks that are doing them more than likely will continue to do them. But I do want folks out there to know that opportunity zone funds are a great alternative to a 1031 exchange in general. Opportunity zone funds can provide for higher returns because opportunity zone funds are ground-up development typically, while purchasing existing assets. That’s what 1031s are typically. Investors that are having issues with their 1031s, they definitely should learn about opportunity zone funds.
And there are really three things that I’m seeing out there in the market of folks that are coming into our fund. What they’re saying to me is, what their issues are, why they decided to pursue an opportunity zone fund instead of a 1031, the first is that they’re having an issue getting a loan to buy the property that they’ve identified. You know, they have 45 days to identify 3 properties after the sale of their real estate asset. And then, in total, they have 180 days to close on a new asset. So in a lot of cases, they have identified these 3 properties, they are in contract to purchase 1 of them, and those renters because of the pandemic, only 50% of the renters paid rent, and the bank says, “Hey, we just looked at the April rent rolls and we’re not comfortable giving you 70% loan to the cost like we were before. We can only give you 50% or 40%.” And hear these real estate investors now saying, “Well, now I don’t have enough cash to complete this transaction. What am I gonna do? Am I gonna be forced to pay capital gains taxes?”
And that’s where opportunity zone Funds can come in as a great alternative, because we also have a tax deferral mechanism as a part of our program. The next thing people are saying is that there are less properties out there in the market. And obviously, people aren’t selling so they’re not finding the same types of opportunities for returns that they were finding before. And this is for people that have not identified their properties yet. And then the last thing is a lot of buyers, and I see this is true especially for folks that are selling residential properties that are non-owner occupied, they just don’t feel comfortable buying a new property that they can’t tour and see and because of the shelter in place, they haven’t been able to go and look at the property. Those are the main three reasons why they’re looking at opportunity zone funds. From our perspective we’ve had around 20 or 25 folks that have chosen opportunity zones over a 1031 exchange. Some of them have called us on day 179 of their 180 day period and said, “I can’t complete my exchange. I just learned about opportunity zone funds. Can you help us?”
Jimmy: Yeah. Please, please help me.
Erik: Right. And we say, “Yeah, we can do this in 24 hours. It’d be better if you’d given us maybe a couple of days.” But we’ve successfully transacted with them because it’s a lot easier to invest in an opportunity zone fund. You sign a subscription agreement, you wire money to the fund bank account. It’s just how long does a wire transfer take? Around 24 hours. The next group that we see a lot of is we see a lot of folks that they may have sold one property… And I’m specifically thinking of this couple that sold a condo in San Diego. They’d inherited the condo when their parents passed away. And they don’t own any other real estate. They don’t wanna have to manage property. They have to sell the condo because they have to pay some inheritance taxes and, you know, spread the money out with a couple of their siblings. But they do have this capital gains event and they don’t wanna pay taxes, they thought, “This is gonna be perfect. We’ll put it into an opportunity zone fund. We have access to professional developers, institutional quality real estate projects, and we get tax benefits. This is great.”
That was one example. We recently had the example that I mentioned before, we had somebody say, “Yeah, but lenders pull back on what they would loan me to buy my new property and now I’m stuck.” Until we solve that investors problem through, he’s investing into our funds. And finally I would say that the last group is we have folks that just say opportunity zone funds provide better returns. We understand the San Jose story. We know about this tech migration, how Downtown San Jose…what the vision is for and what it’s gonna be in the next 10 years and how amazing it’s gonna be. And we wanna be a part of it. And so they have forgone investing into individual properties and instead invested into our opportunity zone fund.
Jimmy: And then you can manage it, you’re the developer… You can be a little more hands off, right, if you’re investing into a managed opportunity zone funds, such as yourself.
Erik: That’s right.
Jimmy: So really, I think, you brought about 3 external pressures that have been put on 1031 exchanges due to COVID-19. If I could recap, one was the credit markets tightening, financing just being less available. Two is volume, there’s just fewer properties on the market these days due to the economic crisis. And then three, just the logistics of looking at properties, being able to go out with your broker and tour the properties and see them on site because of the stay at home orders, particularly in some states still a little bit tighter than others. We’re starting to reopen in some parts of the country but it’s still a challenge in certain states, California being one of those states still with some pretty tight stay at home orders. So yeah, it’s really interesting. I think that there certainly existed a case for opportunity zone funds to be a great alternative for 1031 exchange investors prior to the Coronavirus pandemic, but especially now, with all these external pressures that the pandemic is putting on 1031 exchange investments, now more than ever is a good time for 1031 exchange investors to look at opportunity zones as a great alternative.
Erik: That’s right.
Jimmy: So, Erik, thanks for coming on the show today, providing your perspective, walking us through 1031 exchange investing versus opportunity zone investing, and telling us a little bit about the story about your investment thesis in Downtown San Jose. It’s been great catching up with you and listening to you tell your story. Before we go though, can you tell our listeners where they can go to learn more about you and Urban Catalyst?
Erik: Sure, please visit us at urbancatalyst.com to learn more information.
Jimmy: Perfect. All right, and for our listeners out there today, I will have show notes on the Opportunity Zones Database website. You can find the show notes for today’s episode at opportunitydb.com/podcast and there you’ll find links to all of the resources that Erik and I discussed on today’s show. Erik again, thanks a lot.
Erik: Hey, thank you, Jimmy. Take care.