Puerto Rico is in dire need of redevelopment. How can Opportunity Zones and other tax incentives help to create a more resilient Puerto Rico?
Jose Torres is managing partner and founder of Monllor Capital Partners and the Puerto Rico Opportunity Zone (PROZ) Fund.
Click the play button above to listen to my conversation with Jose.
- A general overview of Puerto Rico following the hurricanes and earthquakes in recent years, including challenges and opportunities.
- The bull case for investing in Puerto Rico, particularly for those who are able to stack additional renewable energy and manufacturing tax incentives on top of the Opportunity Zone incentive.
- The investment thesis and strategy of the Puerto Rico Opportunity Zone Fund — a diversified portfolio of sustainable businesses, renewable energy, and infrastructure assets.
- The different non-OZ tax incentives available in Puerto Rico.
- Some of the portfolio companies that PROZ plans to invest in, and exit strategies.
- The three top issues for investors who are considering making an Opportunity Zone investment in Puerto Rico.
Featured on This Episode
- Jose A. Torres Monllor on LinkedIn
- PROZ Fund
- OZ Pitch Day Spring 2021
- Puerto Rico issues RFP for 1.5GW renewables and energy storage
- Puerto Rico Act 60
- DLA Piper
- JTC Americas (formerly NES Financial)
- Opportunity Zones in Puerto Rico
Additional Opportunity Zones Podcast Episodes on Puerto Rico
- Opportunity Zone Investing in Puerto Rico, with Maria Rivera (Ep #24)
- OZ Investing in Puerto Rico Tourism, with Lifeafar Capital (Ep #127)
Industry Spotlight: PROZ Fund
Managed by Monllor Capital Partners, the Puerto Rico Opportunity Zone Fund is seeking a capital raise of $20-50 million to deploy into Puerto Rican sustainable businesses, renewable energy, and infrastructure assets.
Learn More About PROZ:
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 we return once again to a discussion of Puerto Rico. As you may know, nearly the entire Island of Puerto Rico is located within an opportunity zone and it’s in dire need of redevelopment in the wake of the devastation wrought by the hurricanes and the earthquakes over the past few years.
Joining me today to discuss this and more is Jose Torres, who is founder and managing partner of Monllor Capital and general partner and fund manager of the Puerto Rico Opportunity Zone Fund, a tax advantage private equity OZ fund focused on ESG investing on the island of Puerto Rico. Jose, thanks for joining me today. Welcome to the show.
Jose: Thank you, Jimmy. Glad to be here.
Jimmy: Glad to have you here. You joined me for OZ Pitch Day back in March earlier this year, and you presented this fund to the large viewing audience that we had live on hand, and you’re back for more. We got you on the podcast now, so happy to revisit with you and get a little more information. To start us off today, Jose, why don’t you paint us a picture of what the island of Puerto Rico looks like?
A lot of our listeners may have their own conceptions of Puerto Rico. There’s certainly a lot of misconceptions floating around out there. Tell us what’s been going on on the island the past few years since the devastation from those natural disasters, the hurricanes, and the earthquakes, and is the island rebounding? What’s going on there? Maybe you can paint us a picture.
Jose: Absolutely. Why don’t we try a little Puerto Rico overview on Puerto Rico 101? First of all, thank you for having me here and for all you’re doing to promote opportunity zones. Puerto Rico is a Commonwealth of the United States. There’s about 3 million U.S. citizens living on the island. There’s a GDP of about $100 billion. Most recently over the last few decades, the economy of Puerto Rico has been declining.
And in 2017 after back-to-back hurricanes, it created more of a vicious cycle to the economy. Puerto Rico is currently also renegotiating its debt through what they call Title III, which is a bankruptcy process that was specifically set up for Puerto Rico. But on the positive side, Puerto Rico also has a significant amount of capital that has been committed by the federal government to rebuild Puerto Rico.
Over $61 billion has already been committed to the island. Obviously, that’s on the back of over 3000 lives that were lost to the hurricanes, but some people were 11 months without electricity and over $100 billion worth of damage. But on the bright side, right now, there’s a restructuring of the electric sector in Puerto Rico. There’s capital that’s coming in to make a more resilient Puerto Rico from energy and water perspective. So we can turn our back of the hurricane and the economic situation in Puerto Rico and actually try to make something better.
Jimmy: Good. I want to discuss with you just that. I want to discuss with you what you’re doing to help make Puerto Rico better and your fund in a minute. But first I want to get a little bit of background on you, Jose. Tell us a little bit about yourself, how you got to where you are today, and maybe you can give us a little bit of information on Monllor Capital as well.
Jose: Yes. So Jimmy, I’m originally from Puerto Rico. I was born here but I did go stateside for high school and college and grad school. My thought was to come back to Puerto Rico and really bring my expertise of 25 years of private equity and investment banking. I learned about opportunity zones right when the legislation came out, and have been a fan of thinking that this is a product or a tool that could really help bring capital to Puerto Rico to help the recovery of Puerto Rico. Before moving to Puerto Rico, I spent the last 13 years working in San Francisco for a large private equity firm called Ares Management. While I was there, I was a partner focused on renewable energy infrastructure and midstream investments, and I was also covering Puerto Rico as a whole.
That really gave me the idea of moving to Puerto Rico and starting my own firm. Monllor Capital Partners basically is an alternative asset management firm based here in Puerto Rico. Our goal is really to facilitate tax advantage investing in Puerto Rico, and our focus is investing in ESG assets. In particular, we’re looking at renewable energy, we’re looking at sustainable business and we’re looking at sustainable infrastructure.
Jimmy: So I want to talk about your fund and what you’re doing with your fund, Jose, the Puerto Rico Opportunity Zone Fund. But first I guess, just to back up again and just ask a very basic question, why invest in Puerto Rico? Why do you invest in Puerto Rico and why should a potential LP in your fund invest?
Jose: Yes. Now that’s a great question and it’s not just impact investing and ESG investing. It is that there’s a great opportunity in Puerto Rico. I mean, Puerto Rico basically has a very well-educated labor force, but there is a lot of unemployment. That does provide the benefit of lower labor cost. It is in a strategic location, in the Caribbean, we can be a great bridge between the U.S. and Europe and Europe and Latin America. There’s a bilingual labor force so, you know, almost all the Puerto Ricans do understand and speak Spanish and English.
So you’re in a position that you can naturally also serve as a bridge, not only physically, but also from a communication standpoint to Latin America. And it’s a U.S. jurisdiction. So as a U.S. jurisdiction with U.S. currency you don’t have to worry about currency or political issues that would happen if you go into other Caribbean islands or to Latin America in general.
And there’s tax incentives. There’s a lot of tax incentives that I talked about, but I think the most impactful from my perspective is the renewable energy and manufacturing tax incentives, because those incentives are going to be directly enhancing the investments that we’re going to be investing in. One of the major ones is a 4% income tax rate for those businesses.
And finally, like you mentioned, there is a significant advantage of Puerto Rico from an opportunity zone perspective because over 95% or people say over 98% of the island is under a qualified opportunity zone region, which really facilitates the strategy of the fund. And maybe I’ll talk briefly about the strategy of the fund. We’re really structured as a traditional private equity fund, and what I mean by that is we’re going to be invested in a portfolio of companies rather than the traditional single asset real estate investment.
So Puerto Rico because of the need of capital and over 40% of the GDP of Puerto Rico is in manufacturing, so one of our first investments that I’ll talk about a little bit in a minute is basically manufacturing of seaweed into value-added products. But when you look at what are the benefits of a potential private equity structure for opportunity zone fund is the ability to really manage a fund for the full 10-year life cycle and reinvest capital so we can try to achieve the maximum capital gain treatment, which is really the main benefit of opportunity zone investing. After the 10-year hold period, you get a full step-up in basis and you can avoid any capital gains tax on that appreciation. So the strategy of having a multi-asset private equity fund versus a single asset really gives us the ability to achieve that.
Jimmy: Okay, Jose, yeah, that’s great. And like you said, it’s not a traditional OZ fund that invests in real estate, you’re really focused on business and infrastructure. Can you tell us a little bit more about your investment thesis and the strategy that underlies the fund investments?
Jose: Thank you, Jimmy. And yes, our goal is to invest in a portfolio, a diversified portfolio of assets that would allow us to achieve the maximum capital appreciation over a 10-year hold period really to provide the investor the ability to get the maximum capital gains treatment, which is zero capital gains at the end of year 10. Our strategy is focused on investing in sustainable businesses, renewable energy, and infrastructure. And there are plenty of opportunities in Puerto Rico. And the renewable energy side, Puerto Rico is only generating about 2.3% of its generation from renewable energy. The new legislation and law mandates to get to 100% by 2050, so the amount of capital that is needed just for renewable energy, it’s tens of billions of dollars. Currently, there’s an RFP by the utility seeking about 1.5 gigawatts, which will equate to at least $2 billion of investment. So we hope to be part of that.
At the same time, on the manufacturing sector in Puerto Rico accounts were over 40% of the GDP, and there are many reasons why there’s a lot of manufacturing in Puerto Rico, including the labor force and as well as some of the local tax incentives. So our goal is to focus on the manufacturing so that can form part of a sustainable portfolio of companies. And finally the infrastructure, there is infrastructure from lighting to water, to other services that can be done better in a more sustainable way. So our goal is to really operate in those three sectors.
Jimmy: And there’s tax incentives for a lot of these different sectors that your fund is going to be deploying capital into. Can you tell me more about what those tax incentives are and how do they improve the investment returns on the capital that you’re deploying into these sectors?
Jose: Yes, Jimmy. That’s a very good question and point. What I would like to do is first start with one of the complicated things about Puerto Rico. They passed a new law that they put all of the tax incentives together under one umbrella, which is a great idea because it is good. Then now you can go to one source to find the different tax incentives and how they work. It is basically referred to as Act 60. However, one of the problems is that there is a significant number of tax incentives that used to have a separate tech name or number for each one of those incentives.
So a lot of people are focused on different types of incentives. What I am focusing on is renewable energy and manufacturing tax incentives among others. One of the biggest benefits that they provide in addition to potentially providing some tax refunds for some of the investment that is done on those sectors, the renewable energy, and the manufacturing allow for a flat 4% income tax, which means that all of that free cash flow can flow through our investor or through our fund, versus a traditional tax that would be back on the mainline for a renewable energy deal or for a manufacturing transaction.
The other point that will also help from an investment piece, Jimmy, is the need, right? You actually have a need for new renewable generation, so you’re not replacing existing generation or replacing polluting generation that actually is not compliant with EPA standards. So again, you’re both doing impact investing from that perspective, but from an energy perspective, you’re also investing in renewable energy.
Jimmy: Got it. That makes sense. So tell me some of the portfolio companies that you’re investing in, which…you know, or do you have any companies that you’ve made capital deployment into already, or any that you have an eye on in terms of these different sectors that you’re deploying into, whether it’s, you know, an operating business investment or an infrastructure investment or a renewable energy asset, where is the capital being deployed specifically right now?
Jose: So Jimmy, we are in the early start of our fundraising, although we have closed with one initial limited partner. What we have done is we’d enter into a letter of intent with C-Combinator, which is a for-profit benefit…public benefit corporation in the U.S. and they have a subsidiary here in Puerto Rico called C-Combinator Puerto Rico. That company is focused on basically solving the problem of seaweed, which is known as Sargassum. And the idea is to turn that from an environmental problem into an economic solution for the island and surrounding islands in the Caribbean. What we have done in our strategy here at Monllor Capital Partner is to really have a deep pipeline of potential investments under which we would be doing the due diligence upfront. So by the time that the fund signs an LOI, we have done our due diligence on that potential investment.
The interesting thing about C-Combinator is that it brings together all of the aspects of ESG impact investing, and we’re adding in the opportunity zone overlay on top of that. This is structured as a more of a traditional project style. We are going to be investing around $8 million to fund the actual construction of a bio refinery that will process the seaweed into value added products. That investment also is going to give us the right to continue to invest in any expansion or other businesses actually coming at our Puerto Rico docks. Again, that’s a little bit of the strategy of a private equity fund versus just a traditional single asset fund.
And then in the second part of the portfolio, we’re in the final stages of negotiating, also another LOI, a letter of intent, to give us rights to fund a portfolio of renewable energy projects, mainly solar with battery storage, for commercial and industrial use. So again, the idea is to have those two businesses as the anchor investments on the fund, and then be able to reinvest distributions from those businesses into those same businesses or expansion of those businesses, or potentially into a third investment as well.
Jimmy: Got it. That makes sense. So that gives you a little bit of flexibility there. You told us a little bit about the status of the fund. Can you tell me a little bit more about that? The fund is open and raising capital now. How much capital are you looking to raise? What’s the time frame looking like? And maybe you could talk about your exit strategy as well. At the end of the day, obviously, this is a capital gains tax incentive, what’s your exit strategy for your LP investors so that they can take advantage of that big exclusion benefit on the backend after 10 years?
Jose: Absolutely. Well, first of all, Jimmy, we’ve tried to create a best-in-class fund. We’ve partnered with top partners like DLA Piper as our legal advisor for the fund, NES Financial as our fund administrator that will help not only with compliance for the OC regulation, but also just general reporting and financial management and back office services for the firm. When we look at the ability to think about an exit, the idea of a portfolio of assets, it’s what makes it attractive. We could exit either each asset individually, or we can exit the portfolio.
From the renewable energy, the idea of continuing to reinvest, most of the deals that we’re going to do will have contracts that are at least 15 to 20 years. So at the end of the fund life, we can still sell the remaining cashflow streams from those projects, and that will provide a substantial capital appreciation for two reasons. One, when we invest in this, we will have first the step-up of the value from the construction, right, with the simple cost of building the project to the value of the cash flows, which is usually two or three times the value of the actual construction cost.
And that’s the unique part about this, because we do have long-term contracts in Puerto Rico for renewable energy, it’s a good fit for a fund that at the end of year 10, once you actually sell those assets and create capital appreciation of that. And in the U.S. many of the deals that are merchant, I mean, do not have contracts or have short-term contracts, it will be harder to try to justify creating a capital appreciation after 10 years, given the fact the actual asset value might be declining as the days pass on. With regards to the manufacturing, we’re actually going to be only a 35% owner and the strategic buyer will be the actual partner.
They will have this first right of offer, it has to be at market arm’s length terms, but that allows us to first basically create a bench price and we can go then and market the asset around, or if we think we’re getting a fair offer from our existing partner, we could exit directly to them. So those are, I would say the two strategies that we would expect to implement for the exit. We also expect the fund to be a 13-year fund, that will give us basically 3 years or 2 years, if we assume that…you asked me that by the timing, we expect to have the fund open through the end of this year. So the idea is that you would have a year of fundraising, nine years of investing, and then another two to three years to actually exit those investments.
Jimmy: Got it. That makes sense. And sorry, did you mention how much capital you’re looking to raise?
Jose: Sorry, Jimmy, our initial target is $20 million and we have a hard cap at $50 million. And this is a balance of trying to show the investors the comfort, that we have sufficient assets on the…both LOI and our pipeline to be able to deploy that capital.
Jimmy: Got it. Okay. Very good. So a little bit of flexibility in terms of how much capital you’re looking to raise. I suppose if you’re only able to raise $20 million, that limits you a little bit, but maybe you’d raise up to $50 million and it would allow you to deploy more capital into more projects like the ones that we’ve been discussing here. We’re getting toward the end of our show today, Jose. But wanted to ask you a question about Puerto Rico-specific issues. What are some Puerto Rico-specific issues regarding taxation of OZ funds and investing in Puerto Rico in general, whether you are a mainland investor, or if you’re a resident of the island? What are the different considerations that you need to have?
Jose: Jimmy, probably the first one that people need to be aware is that Puerto Rico is a separate tax jurisdiction from the U.S. which means that if you think about it, if you’re doing business in Puerto Rico and you’re generating Puerto Rico-sourced income, you would have to file taxes in Puerto Rico, okay? So that’s the first difference.
The second was that Puerto Rico…if you were a Puerto Rican investor, you couldn’t take advantage of the opportunities on law because you’re not paying enough federal taxes. Puerto Rico did go ahead and passed its own opportunity zone law back in May of 2019, but those regulations for that law only came out on October of 2020. So that’s another reason why you haven’t seen any…one of the many reasons why you haven’t seen more opportunity zone funds and why you will probably start seeing some now that the regulations have passed. But that law basically, there’s three things, the most important one from my perspective, is it created the ability to have the U.S. investor being able to take the capital gains treatment at the end of the tenure.
So they basically make sure that the federal law works in Puerto Rico. So without that, there would be no opportunity zone investing in Puerto Rico. The second one is it allowed to have Puerto Rican investors to benefit from the mirror image of the federal opportunity zone law in Puerto Rico. So all of the same benefits that a U.S. investor can have with this federal taxation, a Puerto Rican investor can achieve that with the Puerto Rico taxation system. The only requirement is that it can only be a qualified opportunity fund that invests only in Puerto Rico.
So that’s also another reason, Jimmy, that we’ve decided to focus our investment, at least on this first fund, only to Puerto Rico. We want to give Puerto Rican investors the opportunity to come into the fund and get the local version of the tax incentives for opportunity funds.
The third aspect that they added to the law, which kind of complicates things is they added that first of all, a Puerto Rico opportunity fund that is in Puerto Rico can get certain tax benefits. Well, we’re not doing that since we’re going to be a Delaware partnership, but those tax incentives also will flow to what they call priority projects. Priority projects can get approved by the government and get tax incentives that are not available under the regular Act 60 tax incentives. So those are the three main points that the Puerto Rico Opportunity Zone Law created.
Jimmy: Perfect. Okay. Got it. That makes perfect sense. Thank you for explaining that. Well, Jose, I think our time is winding down here. We want to thank you for joining me on the podcast today and telling my listeners and me a little bit more about Puerto Rico. We’ve covered Puerto Rico on a handful of other episodes over the course of this podcast series. I think, you know, one of the reasons for that is because there is a lot of excitement about opportunity zone investing in Puerto Rico for a couple of reasons.
One is the fact that we pointed out earlier is that, you know, while all of the other states and territories were limited to identifying only 25% of their low-income census tracts as opportunity zones, Puerto Rico was granted an exception to that rule and as a result, nearly the entire island of Puerto Rico lies in an opportunity zone.
So there’s lots of opportunity for opportunity zone investing on the island. And the second reason is because of the damage that’s been done to the island over the past few years by the different natural disasters that we’ve spoken about at the top of this episode, there’s a real great need for this type of investment to flow into the island. So anyways, I want to thank you for joining me today, Jose, but before we go, can you tell our listeners where they can go to learn more about you and the Puerto Rico Opportunity Zone Fund?
Jimmy: Perfect. Thank you for that, Jose. And for our listeners out there today, as always, 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 I’ll be sure to link to proz.fund and have that email address [email protected] as well. And you’ll also find links to all the other resources that Jose and I discussed on today’s show. Jose, again, thank you for joining us. Appreciate it.
Jose: Thank you, Jimmy.