How a Tax Rate Increase May Impact Opportunity Zone Investors, with Alex Bhathal

Tax rates could be on the rise under the Biden administration. What impact would a huge capital gains tax increase have on the Opportunity Zone marketplace?

Alex Bhathal is co-owner of the Sacramento Kings and managing partner at RevOZ Capital, a large Opportunity Zone developer headquartered in Newport Beach, California.

Click the play button above to listen to my conversation with Alex.

Episode Highlights

  • The Opportunity Zone assets that RevOZ Capital has purchased so far, and why they see value in multifamily in secondary markets.
  • How the Biden administration’s proposal to substantially increase the capital gains tax rate may impact the Opportunity Zones marketplace, and how investors may react.
  • Considerations for capital gains taxpayers if the tax rates go higher, and why such an increase may make Opportunity Zone investing even more valuable.
  • How the RevOZ Capital Social Impact Council adds value to investors.
  • Deal scouting for delivering investor returns and impact in communities.
  • Lessons that Alex and his RevOZ Capital team have learned over the past three years as a pioneers in the Opportunity Zones industry.
Alex Bhathal on the Opportunity Zones Podcast

Featured on This Episode

Industry Spotlight: RevOZ Capital

RevOZ Capital

Founded in 2018 by Alex Bhathal, RevOZ Capital is focused on urban core development in Opportunity Zones in select secondary markets across the United States. The Bhathal family acquired the Sacramento Kings as principal co-owners in 2013 and has since successfully developed much of the sports and entertainment district of downtown Sacramento, including the Golden 1 Center.

Learn More About RevOZ Capital:

About the Opportunity Zones Podcast

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

Show Transcript

Jimmy: Welcome to the Opportunity Zones Podcast. I’m your host, Jimmy Atkinson, and joining me today is no stranger to the show. I am joined by Alex Bhathal, who is the co-owner of the Sacramento Kings and managing partner at RevOZ Capital, a large opportunity zone developer headquartered in Newport Beach, California. Alex, thanks for joining me, and welcome back to the show.

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Alex: Thanks, Jimmy. Happy to be back.

Jimmy: Yeah. Very good to catch up with you again. You were on the show, I think it was about a year ago or so, so happy to get re-acquainted with you and get an update on what RevOZ has been up to over the past year and what you guys are looking forward to as the opportunity zone program continues to evolve and the marketplace continues to mature.

And to sort of start us off, Alex, why don’t you tell us, you’ve put a lot of money to work in four different assets from your RevOZ Fund III so far. I want to hear from you, what did you buy, what locations they’re in, and why? What’s your investment thesis overall?

Alex: Our investment thesis overall at RevOZ, it’s evolving from before COVID, but the core tenants are consistent. We’ve always focused on up-and-coming secondary markets. We like to invest into multi-family projects, close to the urban core and parts of town that have proximity to sports and cultural amenities, restaurants, retail shops, bars, kind of the place where young people like to move, whether they move into these up-and-coming cities.

That’s only been accelerated since this COVID period where we’ve seen a lot of transition out of the Bay Area, New York, Chicago, and basically, the big global gateway cities. And as they’re leaving those markets, the businesses and people we’re tracking where they’re going.

So, that’s where we invest. We like markets like Sacramento. We’ve done two deals there, Charleston, South Carolina, Indianapolis as an alternative to Chicago. So, those are the markets where we invest in and we look to…as we evaluate our pipeline, our next set of projects, cities like that, whether they be Nashville, Oklahoma City, Phoenix, Austin, Texas, Denver, those markets are the types of cities where we like to invest.

Jimmy: Yeah. That’s great. So, up-and-coming secondary markets that show a lot of promise. I want to talk with you more about how you expect that you’re going to investing in opportunity zones over the next several years a little bit later in the show, but I want to talk with you about federal tax and the new administration.

We’re about three months or about 100 days more or less into the new presidential administration under Joe Biden and Kamala Harris. And there’s been talk about them substantially increasing the capital gains tax rate. And there’s also rumors of possibly them doing away with the 1031 exchange.

And that would shake up the tax code and tax planning considerably, and could have some negative consequences, could have some positive consequences for the opportunity zone marketplace. Alex, turning to you, how has investment activity changed or picked up or how do you anticipate that it may change based on these rumors, these talks, and these plans to shake up the tax code like that?

Alex: Well, I think we’re still in the early stages of that conversation as these bills work themselves through Congress. There’s not a crystal ball on what’s going to come out on the other end and I don’t want to get into a philosophical discussion on where the tax rates should be or why, but there’s no doubt that investors are anticipating higher capital gains tax rates.

And therefore, they’re looking more closely at opportunity zone investing as a result. Fortunately, at RevOZ, we’re well-positioned to absorb interest from the marketplace, we’ve really evolved as a firm, we’ve grown as a firm, and we have much better understanding of how the opportunity zone program works, and to the extent that people are interested in the space, we feel that we’re in a good position to be able to capitalize on the moment when people are looking to tax advantage investing opportunities.

Jimmy: Right. So, I wanted to get your take on how do you think investors will react if President Biden and Congress do increase the capital gains rate significantly? On the one hand is kind of a headwind for opportunity zones because, well, now if you have a capital gain let’s say this year or next year, and you could just lock in the current rate and not have to pay a higher rate down the road, maybe you should just do that. Maybe you should just take the current gain at the current rate right now.

What is it? 23.8%. Not that bad considering what it might go up to. Because if you were to invest in an opportunity zone fund, then you’re deferring recognition to that gain until the end of 2026. And at that point, who knows what capital gains rates may be. But if there’s a Democrat still in the White House, you can imagine that capital gains rates could be in thehigh 30s, maybe the low 40s for the highest tax bracket.

So, that’s a bitter pill to swallow knowing if you have a capital gain in 2021 and you’re deferring it until the end of 2026, that’s the pushback that I hear from a lot of investors who are considering investing in opportunity zones. But on the flip side, of course, doesn’t it make the backend benefit much, much more powerful?

Your appreciation in the opportunity zone investment now is as it always has been, it avoids any capital gains liability after a 10-year hold, and that benefit just got a lot more interesting because now you’re not only avoiding capital gains rate at a 23.8% federal rate, you’re avoiding it at a rate in the high 30s, low 40s, potentially.

What are your thoughts, Alex? What do you think? And I know I’m asking you to look into a crystal ball here, but have you heard from any investors, what are you hearing from some of your bigger investors or people who are considering investing in opportunity zones?

Alex: You framed it really nicely, Jimmy, in terms of the implications of an increase in capital gains rate. We’ve always felt that the exemption on the 10-year hold was the most powerful aspect of the tax advantage for investment in opportunity zones to the extent that you believe tax rates on capital gains are going to be higher in the future, looking many years out, then the power of that exemption is dramatically increased because to your point, saving 23%, you’re saving potentially 40% or whatever the number lands at.

So, that’s very powerful exemption and something that isn’t widely available in other aspects of the tax code to have that step up to market value after a 10-year hold period. That said, if rates go up in the short-term, then the power of deferral becomes a little bit less impactful.

We modeled it at least on our side and depending on what the rate is, the difference isn’t particularly meaningful or substantive, especially when you factor in the 10% step up that’s available on the taxes given the required hold period when the taxes are due. So, that’s a bit of a buffer. The next best thing to an exemption on taxes is a deferral. So, to the extent that you can defer taxes and get a step up, even if the rate’s higher, you likely can be better off investing in opportunity zone than paying taxes and those dollars going away forever.

Jimmy: Yeah. That’s a good point. And in a certain respect, it’s a time value of money equation too, right? I mean, you’re essentially getting a loan from Uncle Sam for, what, about five or six years or so, and that’s not worthless, even if they’re asking for a higher rate on that initial gain that you’re deferring, I see what you’re saying there.

Now, you’re paying based on a lower amount, you’re only paying on 90% of the gain if you get that five-year hold before the end of ’26. And, you know, yeah, you’re paying a little bit of a higher rate, but, and this is what I keep trying to tell investors who are considering and who get a little bit spooked by the fact that cap gains rates may increase substantially in the next year or two is I tell them that back end benefit, that exclusion benefit as you refer to it, Alex, it makes it so much more powerful.

So, I hope that this doesn’t pose too much of a headwind for the opportunity zone program. I hope that investors can see the long game here and appreciate that this actually, in my view, it makes opportunity zone investing even more attractive.

Alex: I agree with that. And if nothing else, talk about changing capital gains rates has created focus on opportunity zones as a potential alternative. So, it is creating more interest in the space which that in itself is helpful.

Jimmy: Yeah. And particularly, if the administration is able to do away with the 1031 exchange, which has been rumored to be on the chopping block potentially, that could highlight opportunity zones even further.

Alex: Well, if that would happen, that’s a rabbit hole that would create a very significant ripple effect in the economy in many ways. And we’ll see if they can get that done. I’m not optimistic or my crystal ball doesn’t show that that’s going to change.

Jimmy: Yeah. Still, a lot of things can unfold over the coming weeks and months. We don’t know. So, anyways, thank you for looking into your crystal ball for me, Alex. I appreciate it. I know you didn’t want to. Well, let’s turn our attention now to your advisory board.

I want to hear about your Social Impact Council that RevOZ put together a few months ago. Earlier this year, I had Josh Childress on the podcast and we spoke a little bit about the RevOZ Social Impact Council, but wanted to ask you now, specifically, Alex, how does that council and its presence, how does it translate into adding value for your investors at the end of the day?

Alex: Thanks, Jimmy. I appreciate the question. That’s one of the areas that we take a lot of pride in at RevOZ is the success in building this council and actually implementing the recommendations and suggestions that they come up with. On the Social Impact Council, you mentioned Josh Childress, Derrick Morgan, who’s a former NFL player, as well as two former presidents of the U.S. Conference of Mayors, Stephanie Rawlings-Blake, formerly the mayor of Baltimore and Mick Cornett of Oklahoma City and several others.

They’ve been key assets for us as we ensure that the investments that we make in these communities not just generate positive economic impact, but also positive social impact. And we really are as a firm trying to utilize this program to do things the right way.

And our commitment is more than a surface-level of commitment. We know that we can make good investments that will help communities create the flywheel or generate the flywheel effect of increased capital in these communities, greater economic growth, and also do it in a way that doesn’t negatively impact, and, in fact, creates opportunities for residents of the communities.

And as we’ve gone through this crazy year of COVID, it’s really something that’s inspiring to know that our capital can make a difference in communities that have been hard hit. And the recovery that’s taking place now is not uniform, there’s places that are really suffering in this country.

And then to this extent, our capital can come in and help spark change in a positive way, we’re excited by that. And our Social Impact Council is excited by that, and they’ve been a great resource and sounding board for us to help filter deals, to make sure that the investments that we make are the right ones. And once we make those investments, that we’re doing right by the communities where we invest.

Jimmy: Well, I think it’s great what you, guys, are doing. Yeah. It’s interesting you mentioned this last recession. We just went through this COVID-induced recession that we’re kind of coming out of now as our economy is starting to grow substantially and we’re kind of seeing a V-shape recovery more or less.

You’re right to point out that some areas are getting left behind, and that was really the impetus for the opportunity zone incentive in the first place was that a lot of low-income communities around the country got left behind after the previous recession of 2008/2009. And it’s nice that we have this incentive structure in place coming out of this recession so hopefully, fewer of those communities get left behind.

And I think that your council is doing a tremendous service not just for your own fund, but also for the opportunity zone industry as a whole. It’s really powerful, especially early on with this incentive structure to be able to get support from the communities, get support from government, get support from everybody, have everybody rowing the boat in the same direction.

And I think these stories that you’re telling with RevOZ Capital and the Social Impact that your fund is able to create is a powerful story to get everybody kind of moving forward and to see how the opportunity zones program can work. And it can work as it was intended to work.

I want to ask you now, Alex, what have your investors found to be most compelling about your offering? You’re talking about, you know, real estate investments in up-and-coming secondary markets. What is it about the types of assets that you’re investing in or what is it about your team that your investors like? Why do they write your big checks at the end of the day?

Alex: Well, I think within the opportunity zone space, it starts with expertise. We’ve been in this space since the very beginning, and there’s a term that we use, unconscious competence, and that’s when you know how to do something so well you don’t have to struggle to think about how to do it.

And within the opportunity zone space, I think we’ve done a good job getting to that point in terms of the deal selection, the deal scouting, understanding what are the right investments to make, in what markets, and also how to do it in a way that’s in line with the letter and the spirit of the law.

And again, doing it where we can deliver returns for both our investors and our communities. We’re off to a great start. There’s a lot more that we can do. And we’re excited about the future of the opportunity zone program.

Jimmy: No, tremendous. There’s been a lot of momentum built up over the past couple of years, two or three years now despite some start and stops along the way. We had the issue with the regulations, taking a very long time to get finalized, and then we finally get final regs and then COVID hits.

And I think maybe we’ll finally see some light at the end of the tunnel and can shine some positive light on the industry as a whole, as we’ve got a lot of tailwinds now in terms of the economy heading in the right direction, we’ve got regs fully out, we’ve got funds up and running. I think the program is going to start to really hum along and the operators within the program should hum along very nicely here throughout 2021 and beyond.

You mentioned that you’ve received some accolades, Globe St. recognized RevOZ as an opportunity zone investor of the year in 2019. You guys are one of the pioneers in the industry, obviously. And I want to ask you, I think you probably struggled along the way when you first got going just because it was a newer type of investment vehicle, a newer asset class. And as I mentioned, the regs weren’t even fully out yet I don’t think when you got underway. As a pioneer in the industry, Alex, what are a few of the lessons that you’ve learned over the last few years?

Alex: Great question. Patience, first of all. I know from experience in business in other areas that everything is harder and takes longer than you think it should, and the opportunity zones space is consistent with that theme. A lot of people thought when this law was passed that it would be this big explosion and waterfall of capital flowing everywhere.

But the reality is it’s a niche, it’s a large niche, and there’s tremendous opportunities, but you have to know what you’re doing. And to your point, there’s a timing of regulations, there’s how the capital markets flow, and there’s how the deals get done.

And then you layer on top of all of that, COVID, and the crisis and the setbacks to the country that occurred last year. And we’re really proud of our team and how we’ve had the resilience and the grit to be able to come out the other side and still execute our business plan and accomplish a lot of what we set out to accomplish. At the same time, we’re just getting going and we think that there’s a really bright future ahead for the firm.

Jimmy: I think there’s a really bright future ahead for you guys as well and for the industry as a whole. I want to ask you, where do you see RevOZ investing in opportunity zones going forward through the rest of 2021 and into the next year and beyond, what’s your plan going forward?

Alex: Well, I can’t wait to get going and get back to deal-making. As you mentioned, we closed four investments at the tail end of 2020, and now we’re back in the marketplace getting deals, and we’re actually taking a road trip next week to the middle of the country, a few markets out there. And to be able to get on a road trip again and see some cities and meet with developers and policymakers is something that I really miss, being able to be on a plane and shaking hands.

So, first and foremost, there’s the people aspect of it. And then as we have this next pool of capital to invest and getting back to deal-making and importantly, we have our Social Impact Summit coming up in early June. And that will be a great opportunity to highlight some of the successes of RevOZ to key stakeholders in the opportunity zone space, as well as developers and capital.

And we’re very fortunate to be able to bring in a very high-quality list of panelists and speakers. Our board advisor, Chris Cox, who a former SEC chairman is going to be there, as well as Stephanie Rawlings-Blake and Mick Cornett, who I mentioned, the mayors of Baltimore and Oklahoma City respectively.

And it will be a great event. We have a headline, I’m not sure I’m able to release it here but stay tuned for more details. It will be something that will be very exciting for everybody involved in the opportunity zone industry.

Jimmy: Well, that’s quite the cliffhanger you’re leaving us with here. Alex, I ought to follow up with you on that and we’ll make a little announcement perhaps on my newsletter when that speaker does get announced. So, that sounds great. Well, thanks for joining me today, Alex. It’s been a pleasure as it always is talking with you. Before we go, can you tell our listeners where they can go to learn more about you and RevOZ Capital?

Alex: Sure. We are at RevOZ Capital, and that’s revozcapital.com, we’re also on LinkedIn, and those are the best places to find us. And I’m a big fan of your show, Jimmy. I listen to just about every episode. So, thank you for all the hard work that you are doing to help expose the great program of opportunity zones to a broader audience.

Jimmy: Well, that’s awesome. Thanks for the kind words, Alex. I wasn’t aware of the fact that anyone other than my mom was listening to all of my episodes. That’s impressive. Thank you for listening. And for all of my other listeners out there today, as always, I will produce some show notes on the Opportunity Zones Database website for today’s episode. I’ll be sure to link to revozcapital.com and their LinkedIn account as well.

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 Alex and I discussed on today’s show. Alex, again, thank you for joining me today. It’s been a pleasure.

Alex: Thank you so much, Jimmy. Appreciate the time.

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