The Upcoming Inflection Point for Opportunity Zones, with Nick Parrish

With impending tax policy changes and upcoming investing deadlines, is the Opportunity Zones marketplace nearing a critical inflection point?

Nick Parrish is managing director and head of business development at Cresset Partners.

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

Episode Highlights

  • Recap of the early Opportunity Zones marketplace over the past several years.
  • The state of Cresset’s Qualified Opportunity Fund investment pipeline and process.
  • Concerns of the substantial increase in cost of construction materials, and strategies for mitigating those costs.
  • The bull case for (and challenges of) industrial development, and the location overlap with Opportunity Zones.
  • How Opportunity Zone investor interest has evolved over the first few years of the incentive, and the effect that the COVID pandemic has had on the marketplace.
  • Why Opportunity Zone investing has been episodic and centered around certain deadlines.
  • How the confluence of impending tax policy changes, upcoming investing deadlines, and new market highs may be leading to an inflection point for the Opportunity Zone marketplace.
  • The impact that potential tax policy changes are having on Opportunity Zone investing.
  • Potential changes to transparency, reporting, and accountability requirements for Qualified Opportunity Funds.
Nick Parrish on the Opportunity Zones Podcast

Featured on This Episode

Industry Spotlight: Cresset Partners

Cresset Partners

Headquartered in Chicago and led by Eric Becker and Avy Stein, Cresset Partners has partnered with and Diversified Real Estate Capital, led by Larry Levy, partnered to create the Cresset-Diversified QOZ Fund. Cresset-Diversified QOZ closed their first fund in Q1 2020 after successfully raising $465 million. The team subsequently opened Fund II, which is now accepting new investments.

Learn More About Cresset Partners:

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 us today from Chicago is Nick Parrish. Nick is managing director and head of business development at Cresset Partners. Nick joined us back in May of 2020, and he’s back now in spring of 2021 to give us an update on Fund I and Fund II under Cresset Partners.

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Their first fund raised $465 million across 2019 and 2020 making it, we believe, one of the largest qualified opportunity funds in existence, and they’re already off and running with Fund II, which was launched last summer. Nick, how you doing? Welcome to the show.

Nick: I’m good, Jimmy. Thanks for having me back.

Jimmy: Absolutely. Nick. So, to start us off, could you just give us a 30,000-foot view on how you view the qualified opportunity zone and qualified opportunity fund marketplace as we’re coming out of COVID here? Give us an update on all that has transpired over the last year or so with you and the Cresset team in qualified opportunity fund land since we last spoke.

Nick: Happy to do it. And no doubt, it’s been an interesting and wild ride over the last two and a half, three years. So, Jimmy, as you may recall, we put together an opportunity zone strategy under our real estate business as far back as 2018. So, we were one of the early adopters, launched our first fund in the 2018, early 2019 primary focused on real estate development, core high growth markets, a mix of multi-family mixed-use office.

We were very fortunate with our first fund in 2019, early 2020, and we were able to raise about, as you mentioned, $465 million total real estate value, deployed about a billion too, and committed that to seven projects all in great markets around the country. And we were really fortunate by March of 2020 in the onset of COVID, we had deployed most of that if not all of that capital. We were under construction on the majority of our projects, and we had raised all of our capital.

So, going into COVID, we were in a good position, a very fortunate position in that construction was largely deemed an essential business. We were able to keep projects going and keep people on the job sites and continued on Fund I largely unabated. All seven projects today are under construction doing well. Actually starting later this year, we’ll be delivering on some of that. So, had a very good experience with Fund I.

And I think as we deployed that capital, as we closed out that first fund in the summer of 2020 and looked at the opportunity zone landscape, I think we continued to see, pun intended, the opportunity there for ourselves and our investors, both to deploy capital to attractive investment opportunities, certainly felt that the good opportunities had not…despite some fears have been taken up, there was still high quality, attractive projects available in opportunity zones and saw the benefit to investors.

So, the idea of investing in high-quality real estate for the long-term in a very tax-efficient way was still attractive. And so, we decided to launch Fund II summer of last year, very similar mandate and target to our first fund, targeting a mix of class A real estate development projects, a high growth markets, a variety of different asset types, $400 to $500 million in capital, and we’re well underway. Today, we have about $170 million in capital committed for projects either under construction, under contract, or under LOI and a fairly strong pipeline beyond that. So, we’re feeling good. We’re in good shape with Fund II, looking to find a couple more projects, raise some capital, and wrap that up end of this year. But we consider ourselves fortunate to have kind of continued to grow and thrive through COVID.

Jimmy: Yeah, it seems like you weathered the COVID storm nicely. You were the beneficiary of some fortunate timing for sure. Been on the end of your fundraising efforts just as COVID was starting to hit this country here in the United States, and so you were able to just continue with the capital deployment and construction on that fund. As you mentioned, and now Fund II seems to be off and running really nicely. Could you tell us a little more about…for those listeners who may have missed our first podcast episode together, Nick, tell us a little bit more about Cresset Partners and the team behind these two funds?

Nick: Sure. Cresset is a business we started just about four years ago. Our two co-founders, Avy Stein and Eric Becker were both private equity entrepreneurs who had long 30-plus-year careers in private equity. And as they retired from private equity and were looking for solutions for their own family capital, they ultimately formed single-family offices, which were ultimately combined to start Cresset. And Cresset, the business has a couple of different arms to it. We’ve created a multi-family office called Cresset Asset Management today.

And that business is about $13.5 Billion, 150 people, I’m sorry, 10 offices around the country, focused on asset allocation, manager selection, financial planning, and then a whole host of non-financial services, estate trust, governance, credit and banking, etc. And then Cresset Partners, which is my side of the business, focused on identifying unique, private investment opportunities for high-net-worth individuals and single-family offices.

So, Cresset Partners, we started about three years ago today has raised and deployed a little over a billion dollars in equity to a variety of private equity and real estate transactions. And what was really interesting about opportunity zones, we have built this real estate business, a team of experienced professionals, multiple decades in the business. We had set up Cresset Real Estate Partners to focus on long-term investments in private real estate.

And so, when opportunity zones came along, it was a very natural fit for us because we were already looking at things through a long-term lens, often 10 years or more just given the nature of our capital. We thought about things through an after-tax lens. So, we were always thinking about the best way to structure those investments. And then last, we are ultimately a group of entrepreneurs who have our own capital to deploy.

We work on behalf of a lot of other entrepreneurs and families all of whom are generating capital gains often pretty regularly. And so, opportunity zones were a very, very natural fit for us and a clear place for us to direct the team. And our history, the team’s history has been largely in same type of investments that we’re doing in the opportunity zone fund. So, class A institutional quality development projects, major urban markets, working with a few key development partners of the, I think, 11 projects that we have underway.

Almost half of those are with Hines out of Houston, who’s a developer we’ve worked with and the members of our team have worked with and invested with personally for better part of two decades. So, very much in line with what we were doing and philosophically, how we’ve approached our real estate investments today. So, that’s the team, call it 15 to 20 people across a number of different asset classes or product types that are focusing on these investments.

Jimmy: In the investment strategy, you touched on briefly class A growth markets. Could you give us some specific examples of projects that you’re working on with Fund I, perhaps? Are you solely multi-family? Are you doing some multi-family and office? Are there any other property types in the mix?

Nick: Yeah. It’s a good question. So, I would tell you we like the benefit of diversification. We don’t have a crystal ball. We don’t know what the world is going to look like in 10 years. And so, the best way to solve for that is diversification. We do that geographically, we do that in terms of the partners we work with, and then to a certain extent by investing in different product types. For a variety of reasons, we like multi-family both in the current environment, as well as in the construct of a 10-year hold period.

So, I would say we’ve skewed more heavily toward multi-family development, but that said, we have a couple of projects that are mixed-use with some office. We’ve been looking at industrial. Just to give you a sense, our first project, the very first opportunity zone project in Fund I is a multi-family highrise development in Downtown Houston. It’s a partnership that we are in with Hines.

The property is called the Brava. It’s a 46-story apartment tower. That project is under construction. I think it’s somewhere in the high 30s in terms of floors. And we expect it to top out this summer. That was again kind of an example, a good example of the types of projects that we’ll do. So, very high quality, great development partner, major urban market in the form of Houston. We’ve done some mixed-use. We’ve got a really exciting project in Nashville. I’m sure it’s no surprise to your listeners. Nashville is a great market to be in. We’ve assembled a fairly sizeable property there. A number of different parcels and we’re doing a mixed-use development also with Hines that will ultimately when finished include two different residential developments, as well as an office component.

And the office uses a technology called T3. It’s a model Hines developed for an all-timber office building, but really creative, unique. It’s in a neighborhood called Wedgewood-Houston, really unique up-and-coming area there. And I’ll tell you, we’ve only just broken ground on that and already have significant pre-leasing activity and interest in the office component there. So, really excited about that mix. And I think that’s, again, what we’ve done in Fund I, I think you’ll largely see that continue into Fund II as well.

Jimmy: Very good. This is my first time hearing about T3. I’m not too familiar with that side of the business so much, but it sounds like it might use a lot of lumber. Correct me if I’m wrong. Is that a concern of yours with how lumber prices have skyrocketed over the last 12-plus months?

Nick: It’s a very good question. I’ll tell you that’s probably the area that we are spending the most time is on the cost of materials, not just lumber. I would tell you lumber and steel are the two inputs that have increased materially in price. Overall, I would tell you there’s been some pros and cons or gives and takes over the last year. Certainly, financing has probably come down from where it was two years ago going into that. So, we’ve actually picked up a little bit on the fundraising side…I’m sorry, on funding, so the debt side. That’s coming back a little bit, but that’s been a pickup. Labor prices have largely been flats, which is good. And then certain supplies yes, are increasing a little bit. So, we’re certainly watching that.

We can mitigate some of those risks by both guaranteed maximum pricing on these contracts or GMP contracts with the general contractors. That’s one way to do it. Working with larger developers who have some ability to buy in bulk and scale certainly is helpful. And then building contingencies in our models, which I also think is important is we’ve certainly in our underwriting for these projects build in a lot of cushion because these prices of inputs do fluctuate. But it’s very much a focus and something we’re very mindful of. In new projects as we go forward, we’re really trying to build in a lot of cushion to account for potential increases.

Jimmy: Good. So, product types, we talked about class A multi-family, some mixed-use and office, any industrial?

Nick: Yeah. Industrial is an interesting area. We are very bullish on industrial. In fact, I’ve built outside of opportunity zones, a separate industrial strategy. I’ve hired somebody. Our team has a lot of industrial experience, but actually hired somebody dedicated in the industrial space. So, I think we are very interested in it. We think there’s some compelling supply-demand dynamics occurring there, not just as a result of e-commerce, but I think a broader change in the way supply chains work today.

So, we’re very keen on it. I think there are some interesting overlap with opportunity zones if you think about opportunity zones aren’t always places you want to live and work, but they often make great industrial locations. So, particularly those things near highways, ports, rail terminals. So, it lines up very well. I will tell you the challenge has been thus far, that there is such demand for these projects that just frankly speaking, at least in the context of a 10-year long-term hold, they are not underwriting to the types of returns that we would otherwise seek and that we can get in multi-family and office.

So, I think that’s been our biggest challenge. We’re going to continue to look, and my hope would be that you will see something from us in that space in current opportunity zone fund, but, you know, ultimately, we want to be disciplined about our investment approach and we’re targeting a certain return and we can earn that elsewhere, it’s a trade-off that we just can’t make. So, certainly interest, but haven’t yet seen that the right opportunity for our fund.

Jimmy: Yeah. That makes sense. The numbers don’t add up the way that they do for multi-family or office than… That’s perfectly understandable. Wanted to shift gears and talk about investor interest in opportunity zones. So, you mentioned a few minutes ago that a lot of the investors that you work with regularly are generating capital gains, oftentimes not as just one-off events, but they are regularly generating capital gains. What has been investor interest in opportunity zones or how has investor interest and opportunity zones evolved over the last 12 to 24 months?

Nick: Yeah, It’s a good question. I’m gonna tell you, obviously, out of the gate, there was a lot of interest in opportunity zones. It was interest, not necessarily action. So, I think the program garnered a lot of talk, a lot of interest early on, you know, some of that came through in 2019 and early 2020, and then I think COVID put some ice on it for a period of time. I think the period of time where people didn’t know what was happening in the world, and frankly, with markets down, with people less active, they just weren’t generating gains.

So, I think you saw a general kind of lull in fundraising, in interest. We’ve seen that slowly, but materially come back over the last, I would say six months somewhat into the end of the year. And I think the other important dynamic that we’ve learned in this two and a half, three years in the opportunity zones space is there’s a big element of opportunity zones that are deadline-driven. And that’s around the 180-day deadline for investors, the year-end deadline.

And what we’ve learned is we’ve learned a lot about human nature. I think human nature is such that people respond to deadlines. They wait till the last possible minute around deadlines. So, what we’ve seen is that fundraising and investor interest has been very episodic, and it tends to be centered around these deadlines. Well, there was a deadline somewhat at the end of this year, however, the IRS has on more than one occasion provided relief and pushed out some of those deadlines. And so, over the last kind of 9 to 12 months, we’ve not seen a material and meaningful set of deadlines that are going to drive investors to opportunity zones.

So, I think there’s been a lot of interest and probably increasing interest. I’m sure we’ll talk about tax policy and what’s happening there. There’s certainly a lot of focus and increasing focus on opportunity zones, but thus far, there hasn’t been a deadline to force investors from the sidelines and force them to invest.

So, we’re seeing capital flow, we’ve seen the number of increase, I think pretty bullish on the remainder of the year. I think you’re going to see a confluence of those events happen that it should shape up for a pretty busy second half of the year for opportunity zones. And again, I think as long as we can continue to do good projects and prove out the thesis, then there will certainly be demand for it.

Jimmy: Yeah. That makes sense. I think you’re spot on with that, Nick. I feel like we’re approaching an inflection point for the opportunity zones incentive in many ways. And one, we have these potential impending policies coming down from the Biden administration with capital gains tax rates going up, possibly going up substantially, maybe a rewrite of the tax code, potentially 1031s being in trouble. How may that drive more interest to opportunity zone investment?

But your other point is we do have a few deadlines upcoming. We have the annual deadline of September 11th coming up, which refers to K-1 gains from the previous year, or put another way, 2020 gains recognized through a partnership Schedule K-1. Investment of those gains, the deadline is September 11th, 2021. So, that’s coming up in a few short months here. But I think possibly the bigger deadline coming up at the end of the year is a one-time deadline, unless the IRS extends it like they have with some other stuff. The 10% basis step up is expiring after December 31 of this year.

And then we also have the market reaching new heights. It seems if not every week, then every day possibly, we’ve got the market going up, up. And many markets going up. The stock market is going up. The real estate markets are heating up. And a lot of cryptocurrency or rather speculative investment, but plenty of gains being generated from crypto lately as well. Let’s focus in on one of those points right now. Nick, talk to me about what you’re seeing in terms of the potential impact of some of the policies that the Biden administration has been floating, particularly around raising the capital gains tax rate.

Nick: Yeah. Obviously, that’s generated a lot of focus on tax rates and capital gains. I think even going into the election, a lot of people knew it was likely taxes were going to go one direction as a result of a Biden administration. But I think the announcement a few weeks ago on his specific plan and some of the rates he proposed caused a lot more attention to be focused on programs and ways to decrease some of that potential tax exposure if capital gains rates have been increased. So, naturally, opportunity zones are part of that conversation and we’ve done quite a bit of analysis, it’s in a rising tax rate environment. Even given the way opportunity zones are structured today, you still have a tax payment that you have to make in 2027. That 2027 payment is made at the then prevailing rates.

So, there’s a chance that you actually have to pay a higher out-of-pocket rate in 2027 should capital gains taxes go up. However, the ability to shift assets into a portfolio that is then held for 10 years or more eliminates that capital gain more than offsets that. So, it’s a very valid and helpful program should rates go up. You add to that, so you referenced earlier the 1031, not clear what happens with that.

However, I think just the sheer perception that that goes away as a tool for real estate investors to roll their real estate capital gains. Should that go away, opportunity zones would be one of the last programs standing. And so, that has garnered a lot of interest. I will tell you we are hearing about, and now starting to see some people who are, I don’t know if I’d say prematurely, but thinking about when and how to trigger capital gains, that might be in stocks that they own, selling those now in order to trigger the gain and be able to invest it into an opportunity zone program before any capital gains increase. Or even people talking about pulling business sales forward into 2021 to be able to get invested before that step up goes away at the end of this year.

So, we’re actually starting to see even the uncertainty around that program in tax rates causing investors to think about and act on that concern. And so, again, that should all benefit opportunity zones program. Any program that’s designed to defer capital gains taxes in a rising capital gains environment is going to be beneficial to investors.

Jimmy: Yep. I couldn’t agree more. And then let’s get back to those deadlines that are upcoming. You mentioned that a lot of opportunity zone investment activity is episodic, or I might say there’s a lot of seasonality involved with capital gains investing and opportunity zone funds. I think we typically see a flurry of activity toward the end of the year, particularly last year, where the IRS essentially did away with the 180-day window for a lot of investors and simply pushed back the deadline for a lot of people to year-end 2020. We don’t have quite something like that this year, but we do have the September 11th deadline looming and the December 31 deadline looming. Could you discuss a little bit more the effect that these deadlines have on the psychology of investors and what do you anticipate seeing in terms of investment flows into your funds over the rest of the year?

Nick: Yeah, we’re pretty optimistic. If you remember back to last year, you obviously had a very volatile period of time coming out of COVID, uncertainty around things. Then if you recall kind of summer of last year into the fall, you really saw markets rebound and rebound significantly. And so, in that call it September to November, even September to December timeframe, there was almost some pent-up sales activity, whether it was businesses, real estate, securities that people had been sitting on. And then as the markets rebounded, you saw a lot of people selling things and realizing capital gains.

And so, anyone who did that in the form of a partnership or other pass-through entity and generated a you know, second half of the year gain, their deadlines have all been pushed out to September 11th. So, a lot of that activity has just not been subject to a deadline yet.

And people have had the luxury of kind of thinking about other things. You made the comment earlier about the confluence of events. Well, I think you’re going to have a confluence of events, both that deadline on September 11th coupled with the talk around capital gains rates’s making people very aware of the various programs that they have available, and how and when they need to utilize those. So, we would expect a fair amount of activity, and I’ve already seen some of that ramping up.

Frankly, some people who are…not everybody waits till last minute. We’ve seen some material upticks in the last month or two people actually invest in gains in opportunity zone funds, but we would expect through the summer and going into the fall in advance to September, a lot of those kind of late triggered 2020 capital gains coming into the system.

And then, again, I would envision the year-end being as big or even bigger. And it will tell you in modeling out the whole QOZ program, the deferral benefit of it is nice. It’s good to have another five, six years to do what you want with your money. The 10% step up is nice, but it’s a way of effectively getting a discount on the tax bill, you have to pay in 2027. The real benefits in the 10-year hold and the ability to own good high-quality real estate without any tax implications, that’s the real benefit of this.

That being said, 10%, 10%. And so, for a lot of investors, they look and say, okay, this is maybe, it’s a security I’ve been sitting on for a while, I think you referenced to the market environment. You’ve seen a lot of people who have owned stock for a very long period of time. Markets have run 40% to 50% in the past year. People are looking at that and saying, “I’ve got a fair amount of capital locked up in a security or an asset now might be a good time to take a little bit of that off the table while I have this extra 10% and set some of it aside in a QOZ program and benefit from that extra 10%.”

So, we think those two things are going to drive a lot of activity at both September and year-end. And then what remains to be seen, what happens in 2022 and beyond. Again, we’re firm believers that 10% step up is nice, but it’s by no means the sole driver. If you still have the ability to own real estate for 10 years on a tax-free basis, that’s still a very attractive program. So, I don’t think it will necessarily change the QOZ program, but I do think we’ll see a lot of people try to push forward decisions into 2020 to take advantage of that.

Jimmy: Yeah. And I’m a like-minded believer in that as well. I don’t believe the 10% basis step up is a huge driver, but it’s a little cherry on top if nothing else. And I think you’re absolutely right. I think if you haven’t rebalanced your investment portfolio in the past 6 to 12 months or so, there’s a good chance you may be overweighted in stocks and maybe now…I don’t want to give anybody investment advice, that’s not what I mean to do here, but I think there’s an opportunity for a lot of individuals who are sitting on a lot of unrealized capital gains to potentially take a little bit off the table and diversify into a different product type within opportunity zone investment.

Getting back to Biden, one more thing besides just increasing taxes that his administration may be planning to do, although we haven’t heard much from his administration on opportunity zones, there’s a lot of thought that at some point, he or his administration are going to put their own stamp on the program. Maybe put some guardrails around the program, regulate it a little bit more tightly, and possibly require some more reporting from qualified opportunity funds such as your fund. Nick, what are your thoughts on that? And what would you like to see in terms of reporting requirements? What do you think would be fair?

Nick: Yeah. That’s a good question, Jimmy. There’s been talk about that for a while now, right? If you’re going to have a program based on social impact and the change that we’re making in these communities, one would think that you want to monitor and track the impact that you’re having. And so, that’s been discussed for a while. We are supportive of that. I think a lot of market participants are. I think that could be tracking dollars deployed into these areas. That could be tracking job creation. It could be around social and racial equity.

So, by and large, we’re very supportive of that. I think it’s a logical evolution to the program. We’ve actually been gathering data from our development partners for a while now in anticipation of that. And we think that’s, again, if we’re going to make the case for this program to continue, even in some cases grow as there’s been some proposals around expanding the scope of this, you’ll only be able to do that if you can prove that the capital is getting deployed into areas, it’s having an impact, it’s creating jobs, it’s creating economic activity.

And so, I think, again, we’re supportive. I would envision that something like that will be implemented. The Biden administration has no shortage of things it’s working on. So, to a certain extent, the opportunity zone program despite some criticism, it’s largely working the way it was expected. And so, it’s probably not the brightest burning fire for him and for the administration, but we would anticipate at some point something around transparency, reporting, and accountability to get folded in the regulation.

Jimmy: Yeah, I agree. I don’t think it’s coming down the pipeline immediately, but eventually, at some point down the road, we should see some changes coming. I think that’s right. Well, Nick, it was a pleasure speaking with you today. Pleasure catching up with you. Before we go, can you tell our listeners where they can go to learn more about you and the Cresset Partners opportunity zone funds?

Nick: Yeah. We have a website out there, newly redesigned. Give you some good information on the opportunity zone program, our projects, our background. You can look for either Cresset Partners or I believe it is CressetDiversifiedQOZ.com. That information is all out there. And please feel free to look at it and reach out to us through there.

Jimmy: Fantastic. CressetDiversifiedQOZ.com, and for our listeners out there today, we’ll have show notes on the Opportunity Zones Database website, as I always do. You can find links to all of the resources that Nick and I discussed on today’s show by heading on over to opportunitydb.com/podcast. And there you’ll find links to all the resources that we discussed today. Nick, appreciate you joining us. Thank you very much.