OZ Pitch Day - March 7, 2024
Who is the prototypical direct retail Opportunity Zone investor?
Erik Hayden is founder and CEO of Urban Catalyst, the largest developer of Opportunity Zone real estate in Silicon Valley.
Click the play button above to listen to my conversation with Erik.
- Securities regulations for Qualified Opportunity Funds, with a focus on Regulation D Rules 506(b) and 506(c).
- Who broker dealers (BDs), registered investment advisers (RIAs), and wealth advisers are, and the role they play in Opportunity Zone investing.
- How QOFs raise money — through the BD/RIA channel vs. directly from investors.
- Who the prototypical direct investor in a Qualified Opportunity Fund is — someone with a capital gain usually from the sale of stock, business, or real estate.
- The benefits of using Opportunity Zones to diversify a stock-heavy portfolio into real estate.
- The different investor personas — day traders with short term gains, tech employees regularly generating gains from stock options, and other stock market investors.
- Stories from some of Urban Catalyst’s early investors.
- The status of projects underway from Urban Catalyst Fund I.
- The bull case for investing in downtown San Jose real estate, in the face of the “mass exodus” from California.
- How the housing crisis in California, and Silicon Valley in particular, makes multifamily a defensible investment.
- Erik’s surfing and foosball skills.
Featured on This Episode
- Erik Hayden on LinkedIn
- Urban Catalyst
- ADISA 2021 Spring Conference
- OZ Pitch Day
- Regulation D Rule 506(b)
- Regulation D Rule 506(c)
- Urban Catalyst Fund I on OZ Pitch Day
- Urban Catalyst Fund II on OZ Pitch Day
- WRNS Studio
Industry Spotlight: Urban Catalyst
Urban Catalyst is a real estate developer focused ground-up Opportunity Zone development projects in downtown San Jose. Their seven acquired projects in Fund I across office, multi-family, student housing, senior housing, and hospitality form a diverse portfolio of assets to potentially minimize the risk to investors. Fund II is focused on development of Icon/Echo, a mixed-use multifamily/office development.
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, and joining me today in person at the ADISA Spring Conference in Scottsdale, Arizona, is Erik Hayden, founder and, managing partner? Is that your title?
Erik: Yeah. Usually, I go by founder and CEO.
Jimmy: Founder and CEO of Urban Catalyst. You’ve been on the podcast once before, and you’ve been on OZ Pitch Say as a presenting partner a couple of times already, so it’s always great talking with you, Erik. Thanks for coming on the show. Welcome back.
Erik: Hey, great talking with you as well, Jimmy. Always a big fan of your podcasts and love doing this with you.
Jimmy: Absolutely. Fantastic. Thank you, Erik. So, let’s talk about the ADISA conference. Let’s pump them up a little bit because they’ve been nice enough to invite us out here and give us a little area over here we can talk for this podcast. What brings you here to the ADISA conference this week?
Erik: The ADISA conference is one of the best conferences for the broker-dealer registered investment advisor industry. It brings together those two selling groups along with a bunch of sponsors like Urban Catalyst so that all of the different registered investment advisors and broker-dealers can learn about the different types of opportunities out there to advise their clients to invest in.
Jimmy: And then, I wanna talk about security’s rules for a second now with you, since that’s kind of what this is all about here at ADISA. Most of the time, the vast majority of qualified opportunity funds will file under SCE regulation D, either under Rule 506(b) or 506(c). You guys are a 506(c) whereas a lot of other funds are 506(b)s in many cases. Why did you go to the 506(c)? You can talk to us about that a little bit.
Erik: Sure. So the major difference between a 506(b) and a 506(c) is that a 506(c) is able to advertise and raise money directly from investors, 506(b)s can only raise money through the broker-dealer RIA network. And, by the way, when we say the BD/RIA network, what we’re really talking about is wealth advisors.
A lot of folks out there across the country utilize a wealth advisor to help them make decisions on how to invest their money, probably 90% of the opportunities on funds out there are the 506(b). Because it’s just been really traditional, it’s very common, only around seven or eight years ago did they create the 506(c) structure, and, we’re one of the first opportunities on funds to be a 506(c). We raise around 50% of the money for our funds directly from investors and the other 50% through the BD/RIA channel.
Jimmy: Plus, a lot of other funds may raise a lot more through the BD/RIA channel or sometimes exclusively through the BD/RIA channel…
Erik: Well, if you’re a 506(b), you have to exclusively raise through the BD/RIA channel.
Jimmy: Got it. Okay, well, we’ll cut that conversation short there. I don’t wanna go too far down the securities rabbit hole, I know we’ve got a lot to talk about. But then that does bring us to our next point with the 506(c) structure that you have, and the fact that you are raising roughly half of your capital from direct investors, not going through the BD/RIA channel. Talk to me about what your prototypical investor looks like. What does your capital base look like of the direct investors essentially?
Erik: So, Jimmy, as we’ve discussed a bunch of times before, you have to have a capital gains event, and invest that capital gains into an opportunity on fund to get those tax benefits. And, really the three primary ways that folks have capital gains events are, the sale of stock, the sale of a business, or the sale of real estate.
Here at Urban Catalyst, over 75% of our investors in our first fund, their capital gains event was the sale of stock. And some of that has to do with our location and proximity to Silicon Valley, as we’re building all of our buildings in downtown San Jose. But, it also has a lot to do with…you know, there’s really never been a safe harbor for investors that have sold stock, they just have to pay taxes. Now, with the creation of opportunities on funds, they get a little bit of a break, a little bit of deferral, and reduction associated with investing.
Jimmy: Other than the back-end benefit, the exclusion.
Erik: Well, everybody likes the back-end…
Jimmy: That goes without saying, right?
Erik: But the ten-year tax rate profits, that’s just the best benefit in general.
Jimmy: Yeah. So, a lot of them are stock investors, some of them have stock options in many cases. Because of where you’re located, a lot of your investors are employees at tech firms that grant stock options, and those stocks have been going up, up, up, the last few years. Talk to us about that stock market investor persona, or that tech options…
Erik: Yeah, I mean Silicon Valley is just full of these big tech companies. In our first fund and even now raising money for our second fund, we have investors from Google, Apple, Facebook, Uber, Zoom, all of the big companies in the Valley, some of their employees have invested into our opportunities on fund. But, it makes a lot of sense to them. These folks a lot of them have regular reoccurring capital gains events as a part of the stock options that they were granted as a part of, you know, their employment with these companies.
Most of the time, they get them quarterly, so we have a lot of repeat investors that keep coming back in every time they have this capital gains event. And, really one of the prototypical type of investors that we see a lot of is, we see someone who has been, say, working at Facebook for 10 years, they have most of their net worth either tied up in the stock of their company or in their primary residence. And they’ve always known that they wanted to diversify their portfolio out of owning just one stock. I mean, anybody knows just having one stock is a lot of risk. So…
Jimmy: Especially if it’s your place of employment as well.
Erik: Absolutely. And diversifying in the real estate has always been a part of their plan, but how do they get over that tax head of 30% to 40% from that sale? It’s really hard to make that up, so they haven’t diversified. Here comes opportunities on funds, and now they have a way to have tax advantages while diversifying into real estate.
Jimmy: Yeah. And you mentioned that they get these stock options quarterly a lot of the time, so they’re realizing a capital gain or having a capital gain event four times a year.
Erik: I mentioned investors from Facebook, and it’s because I’m thinking of a particular investor. He’s made a lot of money from his Facebook stock. He’s been an employee there for over ten years. He invested $1 million into our first fund in 2019, and then had another capital gains event in 2020, again, the sale of Facebook stock, and invested a second million dollars in 2020. So, that reoccurring investment.
Jimmy: Yeah, that’s a nice investor to have.
Jimmy: Any other types of investors like that? Any other anecdotes?
Erik: Other types of investors that we see from the sale of stock as their capital gains events is where the day traders. So we see quite a few folks that have made really a lot of money since March of 2020 just trading stocks, a lot of folks from bitcoin and those other cryptocurrencies coming in. And, I’ll tell you, Jimmy, those folks really have an advantage when it comes to opportunities on fund investment because they have short-term capital gains.
Jimmy: And so the short-term capital gains are taxed as ordinary income, so sometimes as high as, what is it, 30-something, I don’t even know what the top rate is. Is it a 36%, 37%, 38%? Something like that?
Erik: Yeah, it’s right in that range.
Jimmy: And then if they’re California, it’s another 13%…
Erik: 13% maximum.
Jimmy: Yeah. So we’re looking at close to 50% of the capital gain gets taxed away.
Erik: Yeah. No, those folks need us more than the folks that have long-term stock options with Google, right? I mean, they have this really high tax rate, they’ve made a lot of money, and, I mean, it’s what opportunities on funds were created for.
Jimmy: Yeah, so getting the opportunity to defer recognition of that gain for five or six years, put that money to work, put the full amount of money to work in a qualified opportunity fund, that helps a lot with the returns at the end of the day.
Erik: And I’ll tell you what, they’re some of the most fun investors to talk to because they just made 300% in the stock market end of the last year, and they just feel amazing.
Jimmy: Yeah. I’m sure they do, right?
Erik: Another anecdote for you. When Zoom went public, our office at Urban Catalyst in downtown Santa Jose…we’re in the same building as Zoom. And we met a bunch of their employees in the parking lot because we share a parking garage, and this is right before they went public. And they said, “Oh, we’re going public soon.”
And I said, “You’re gonna have so much capital gains when you sell your options once you go public.” And they said, “Oh, we need to learn about your program.” So we had almost half of the executive suite at Zoom in our conference room about a week after they went public. And I’ve never seen a happier group of people. They were just bouncing off the walls, they were so excited. And we ended up getting investments from several of them.
Jimmy: Yeah. Well, it’s an incredible tax incentive as I have been talking about here over the course of the last hundred-plus episodes of this podcast. My listeners are no stranger to it. It is an incredible program especially when you first hear about it, it almost sounds too good to be true. But yeah, I bet you made some dreams come true in that room that day, getting the ability to take advantage of these tax incentives that Opportunity Zones offer. It must be really valuable for someone realizing a huge capital gain like that of course.
Erik: Absolutely. Another investor that we had early on at Urban Catalyst in our first fund, his capital gains event was the sale of stock in Juul. He’s one of the original investors in Juul, one of the angel investors. And he had hundreds of millions in capital gains from the sale of his stock. And he did a pretty significant amount with us.
But I mean, just hearing him discuss how he figured out what Juul impacts would be and how he invested into the company that incinerates, makes the vapor… I mean, I don’t even know the technology, but listening to him talk about it with such passion and the fact that he’d been so successful, and it was just amazing.
Jimmy: I had to search my brain for a minute to figure out what was Juul was. I’m like, “What is Juul?” I think I’ve heard of it. Is it the vaping product?
Erik: The vaping product.
Jimmy: Okay, yeah. I’m not a vaper myself, so.
Erik: Me neither. But, investors in 2019, Juul started out…
Jimmy: That’s J-U-U-L, I think.
Erik: It started out at like 25 cents a share, and the investors got a massive recapitalization when it was purchased by the Philip Morris affiliate at somewhere in the neighborhood of $63 a share.
Jimmy: Wow. Massive capital gains there.
Erik: Quite a capital gains.
Jimmy: Yeah, I’m sure. And you came along, and you’re the knight in shining armor, basically.
Erik: They were pretty happy that there was a program like this. Early in 2019, but even before the April 2019 guidelines came out, the program was still very unclear. But even with the lack of clarity in the program at that time, it still was a huge benefit for these investors, and they were willing to take those chances.
Jimmy: Good. Yeah, that makes sense. Well, let’s shift gears now and talk about your fund… let’s talk about Fund One first. You just finished fundraising for it. You closed it, I believe, at the end of last year, right?
Erik: That’s right, in December.
Jimmy: And, you pitched it at my Oz Pitch Day in November of last year, and we’ve talked about it on the podcast previously, but for those listeners who may be new to the podcast and haven’t heard from you yet, could you briefly summarize Fund One, the investment strategy there, and what you guys like to do there?
Erik: Sure. Fund One, we raised $131 million, we’re oversubscribed. We had a two-year fundraising period. Fund One is in control of six projects in Downtown San Jose. They’re all ground-up development projects.
Jimmy: And they’re all identified?
Erik: At this point, we’ve purchased all of the land for all six of them. And it’s a variety of different asset classes. We have a couple of office projects, a student housing high-rise, an extended-stay business hotel, a traditional multifamily apartment building, 184 units, and we have a 170 units senior living facility which is assisted living and memory care. Highly successful in that fundraise. We start construction on our first project in that fund next month, and we plan to start construction on all six of those projects in the next 12 months.
Jimmy: Oh good. So they’re off and running now at this point.
Erik: Off and running.
Jimmy: Good. And tell us why you like San Jose specifically. That’s where your focus is. Hyperfocus in that one particular Downtown region of San Jose, California, is that right?
Erik: That’s absolutely right. I’ve been a developer in Silicon Valley for many years. And my partners, we have a ton of development experience. I would call us almost an all-star team of Downtown San Jose developers. But it was really only around three and a half, four years ago that we saw like the light switch turn on in Downtown San Jose. It was like the wave of development that had been rolling through Silicon Valley, south from Palo Alto down through Sunnyvale in Santa Clara, was finally gonna hit Downtown San Jose.
And we formed Urban Catalyst because we wanted to get in on the ground floor and really take advantage of this massive wave of development that was coming. And that’s exactly what we did with the acquisition of our Fund One and Fund Two Projects
Jimmy: Good. So let’s talk about Fund Two now. Because you closed on Fund One, construction is starting on all of those within the next 12 months, that one is off and running, you’ve raised all the capital you can for that one, it’s closed. Fund two, you just launched, I think just within the last few weeks here. It’s a little bit different, it’s in San Jose, but it’s a single asset project. Tell us about it.
Erik: Sure. We launched Fund Two on February 17th. Fund Two is a $200 million fundraise. We’re doing two projects in Downtown San Jose. They’re both ground-up development projects. And of course, Fund Two is an Opportunity Zones fund. Those two projects are called Icon and Echo. Icon is a 420,000 square foot office building, and Echo is a 300 plus unit multifamily building. I mean, sure, we were able to control almost half of an entire Downtown San Jose city block right across the street from city hall and next to a future BART station. So one of the best locations in all of downtown. So it’s really just the perfect place to build office and multifamily.
Jimmy: Yeah. And I refer to it as a single-asset project because it is on the same piece of land, I think, right? But technically would you call it a two-asset project?
Erik: I would call it a two-asset project mainly because we’ll be using two different financing packages, one to build each of the buildings.
Jimmy: Got you. That makes sense. Now, I’ve been reading in the media for the last several years about this mass exodus from California. And, so I wanna know, what’s the demand like for office, particularly post-COVID, and for more residential, particularly in regards to the fact that everybody seems to be leaving California for Florida or Texas or here in Arizona?
Erik: That’s absolutely what the news has been forecasting. I’d like to kinda put in a little bit of perspective that every year for a hundred years, California has had a massive population increase. And then during COVID for one year, we lost about 1% of the population. So not like really that big of a deal, but, lots of big headlines because people love saying mass exodus.
What we really found is that when folks were not legally allowed to go back into their offices, groups like Google said, “We wanna tell everyone you’re not coming back into the office for a year, so you can go move somewhere else and sign a year lease.” Because, why would you wanna have to pay the extraordinarily high rents like in Mountain View and Palo Alto, if you don’t have to commute to your office every day there? So, that happened. Rents went down a little bit, around 10% in San Jose. We’ve already started to see that rebound as people are coming back into the office.
But, when you look at the overall residential market in Silicon Valley, it’s a very simple story. Which is, for the last 30 years, we’ve been creating five jobs for every housing unit that we’ve built, and that has created what they call in California and especially Silicon Valley, ‘A housing crisis.’ We have some of the most expensive rents both for sale and for rent really in the entire world.
And, just to give you some statistical numbers, if we wanted to meet supply and demand from a housing perspective, we would have to build 150,000 housing units in a single year in Silicon Valley. We’ve never built more than 5,000. So we’re never going to meet supply and demand, literally, we can’t build multifamily fast enough to meet that demand. So, as far as from an investor perspective, it’s a very safe asset class to invest in because the demand is extremely strong.
Jimmy: Safe assumption to make that you won’t have problems renting out new multifamily development.
Erik: That’s right. We’ve never seen an issue a lease at 20, 25 units a month, every single time I’ve done a project over my entire career which has been, you know, quite extensive in the residential field. Now, office demand is a little bit different. In Silicon Valley, we can build offices fast enough to meet demand. And we can talk about COVID and its impacts on the office market, but, overall, the way it’s shaking out is COVID is not gonna have a significant impact on office demand in Silicon Valley.
What’s going to drive that demand is really the same thing that’s always driven the demand which is, that Silicon Valley job engine. I’ll give you some numbers to put in perspective. In Silicon Valley, there’s 104 million square feet of office. A little side note, Google currently occupies 26 million square feet of that. So 25% is just Google. Over the last 20 years, you think the Pets.com was a big thing? Google was just a startup? Now Silicon Valley has these extremely established and really large tech companies. So it’s a much different market than it was back then.
But, to that point, when we build new office, we have to make sure that we’re going to be able to attract that top-quality tenant. So our buildings have to really have these three characteristics that we look for every time we do ground-up development for office, which are, we wanna build projects in the best location, we want projects that are perfectly functional. When we deliver that cold shell to a tenant, we better have the right amount of parking, the perfect 40,000 square foot floor plates, 14-foot floor-to-ceiling heights, and, we wanna see extensive indoor, outdoor, spaces and rooftops decks. Now that’s…
Jimmy: It’s got to look good, right?
Erik: Well, that’s the last thing, it’s got to look amazing. I mean, you have to have that, they call it, architectural aesthetic beauty. We’re utilizing WRNS as our architects, one of the premier architects in the Valley and worldwide. They just finished doing a Microsoft’s big campus in Mountain View. So, they’ve designed just an amazingly beautiful project for us, and we expect to really garner that top-quality tenant.
Jimmy: Fantastic. Well, this has been great, Erik, and it’s been great getting to meet you in person here over the past couple of days, because we’ve chatted many times over Zoom and on the phone, and this is the first time we’ve ever met in person. So I’ve learned a couple of things about you over the past few hours here. One, you’re a big surfer, right?
Erik: That’s right.
Jimmy: We talked a little bit of surfing at dinner last night. So, how’s your surfing career going right now?
Erik: Surfing has really ramped up especially during COVID, my wife is a big surfer, I have four kids, my two older boys are huge surfers, much better than I am. But I am a good enough surfer, now that I don’t embarrass them when we’re out on the waves.
Jimmy: That’s fantastic. And then the other thing, I just learned, like, literally, just before you got here is you’re a foosball player.
Erik: I am a foosball player, Jimmy. I’m really happy that you just mentioned that. In college, went undefeated in my fraternity one-on-one for four years straight.
Jimmy: That’s impressive.
Erik: I have entered several professional tournaments and gotten just smoked, so I’m not that good.
Jimmy: And another thing I just learned today is that professional foosball tournaments exist.
Erik: I think… Do you know how much money the number one foosball player in the world makes these days?
Jimmy: Do not. Do not.
Erik: Like $35,000 a year.
Jimmy: Okay. So it’s not a very lucrative career.
Erik: Not at all.
Jimmy: But it sounds like a lot of fun. Well, I’d like to challenge you to a game of foosball when I visit you in your office at some point later this year.
Erik: Absolutely, Jimmy.
Erik: Of course.
Jimmy: All right. Erik, it’s been a pleasure talking to you today. Before we wrap up officially here, and thanks for indulging my goofy questions at the end, let our listeners know where they can go to learn more about you and Urban Catalyst.
Erik: Absolutely. Please visit us at urbancatalyst.com.
Jimmy: Fantastic. UrbanCatalyst.com. And as always for our listeners out there today, I will have show notes on the Opportunity Zones database website for today’s episode. You can find those show notes at opportunitydb.com/podcast, and there you’ll find links to all of the resources that Erik and I discussed on the show. Be sure to link to urbancatalyst.com. Maybe I’ll throw in a link to professional foosball tournament, I’ll see what I can find there. Erik, a pleasure as always. Thanks for visiting me today.
Erik: All right. Thank you, Jimmy.
Jimmy: Thank you.