OZ Exit Plans and Structural Risks, with Peter Ciganik

What are the advantages of a Qualified Opportunity Fund that is structured as a REIT instead of a partnership? How does the level of diversification in a fund impact its risk/return profile?

Peter Ciganik is Managing Director at GTIS Partners, a global real estate investment firm based in New York.

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

Episode Highlights

  • How the REIT structure may be advantageous for real estate investments with extended holding periods.
  • Why exit strategy planning is important in determining the bottom line returns that OZ investors realize.
  • How opportunity zone funds are attracting investors to real estate as an asset class for the first time.
  • The potential benefits of diversification when investing in real estate, and the risks associated with single-asset strategies.
  • The structural regulatory benefits that come with multi-asset strategies.
  • Why rising costs pose challenges for real estate development in the current environment.
  • How the opportunity zone program is achieving its objective of catalyzing community investment.

Featured on This Episode

Industry Spotlight: GTIS Partners

GTIS Partners is a global real estate investment firm with approximately $4.7 billion in AUM. Based in New York, GTIS manages funds that are focused primarily on residential development in the Sun Belt.

Learn More GTIS:

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. Joining me today on the podcast is Peter Ciganik. Peter is Managing Director and Head of Investment Strategy and Research at GTIS Partners. He joins us today from New York City. Peter, welcome to the podcast.

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Peter: Thanks, Jimmy. Glad to be here and appreciate the opportunity.

Jimmy: Happy to have you on today. Thanks for joining us. Before we dive into your Opportunity Zone strategy specifically, can you give our listeners the general overview of GTIS Partners? Who are you guys? And what do you do exactly?

Peter: Sure. GTIS Partners is an investment manager. We’re based in New York. Manage about $4.7 billion of AUM across a number of funds, mostly focused on development. And within that mostly on residential development in the Sunbelt, including multifamily, single family homes for sale and for rent, and some commercial as well. We were founded in 2005. And we’re based in New York City, but have offices around the country, managing around 30,000 units or so mostly for home building, as well as rentals.

Jimmy: Good. So 2005, so you have a pretty good track record under your belt. You guys have been doing this for 15, 16 years or so. It sounds like you’ve already come out of a couple of recessions too. So now recently you’ve been layering probably for the past couple years, I would imagine, you’ve been layering the Opportunity Zone incentive on top of your real estate investment offerings down there primarily in the south, as you mentioned. I’m curious, how are you structured exactly? And is there anything that makes your structure different?

Peter: Yes, I think so. We actually started looking at Opportunity Zones when the legislation came out, trying to determine if we could take advantage of the tax abatement ourselves for properties that we already owned, as many of them basically just ended up in zones. Of course, as you know, you have to invest in something new, you can’t just take an asset that you already own and certify it, we quickly realized that. But having studied the legislation and the locations, we realized that we were active in these types of places that became Opportunity Zones. And it’s in some ways not surprising because as a developer, we’re active in places that are underdeveloped, underinvested mostly, basically raw land. And a lot of those have been designated as Opportunity Zones, because they have no households. The criteria is household income. And when there are no households, there is no income. So a lot of overlap there. And we decided basically to make our next flagship fund an Opportunity Zone Fund. We were just about to launch the fourth vehicle doing basically the same investment, residential in the Sunbelt, in 2019, when this came about, and so we just decided to sort of buy our next fund. And we had three properties that we were already working on in Opportunity Zones, we put them right in, and that was the start of our OpZone strategy.

Jimmy: Right. That’s fantastic. Yeah, it’s always a little bit disappointing when I have to tell people that, well, just because you already owned something that’s in an Opportunity Zone doesn’t mean that there’s necessarily anything that you can do to take advantage of these incentives if you’ve owned it for a while other than the ability to sell it, or there’s a few other strategies I don’t wanna get into today. But yes, you’re right, it does need to be new construction or a substantial improvement of a property that is newly acquired. So I’m curious now, you have your Opportunity Zone Fund offering, are you doing non-OZ work as well, or is it…are you solely focused on Opportunity Zones now?

Peter: Well, in fact, most of our investments are non-OZ funds because historically we have managed capital for institutional investors, large pension plans, estate plans for universities, and so forth. So this is actually our first offering for Opportunity Zones and first offering for the high net worth individual investor universe. We are basically taking the institutional investment model and the type of funds that we manage for endowments and pension plans and making it available for retail investors. And then because our traditional investors, of course, are not as interested in the tax nature of things since they don’t pay taxes, that’s the best abatement you can have, but it’s not available to individuals. This program is really the best way for individuals to take advantage of the same type of incentive.

Jimmy: Interesting. And that makes total sense too. If you’re a high net worth individual investor, you have a capital gain, Opportunity Zones is a great strategy to help mitigate those taxes as my listeners surely know by this point. So you were already developing residential properties primarily in the Southern United States, and is it your strategy, basically just to cherry-pick the ones that are already located in Opportunity Zones within your pipeline and throw them into your Qualified Opportunity Fund? Is that basically what you’re doing?

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Peter: Yeah, that’s a pretty easy way to decide where properties are allocated, so that we don’t have conflict between our institutional funds and the OppZone fund. Essentially, if something that we’re working on happens to be in an Opportunity Zone, it goes right into this fund.

Jimmy: Good. That makes sense. And is the fund that you opened in 2019, is that still the same Qualified Opportunity Fund that is open today or have you rolled out different fund offerings over the past few years?

Peter: It’s still the same fund. It has a two-year fundraising period, which is actually ending in a couple of weeks. And that’s how we structure basically all of our funds, the typical private equity fund, with about 12 to 18 months, sometimes 2-year fundraising period, and then we close it and move on to the next pool. But everything we do is in this diversified commingled fund format.

Jimmy: Oh okay, good. Well, that makes sense. Just so our listeners know, we are recording this episode in mid-June. So I think you’re probably referring to the end of June as the date of close for that particular fund. This episode may not air until a little bit later this summer, for those of you listening, but possibly by then your new Opportunity Zone Fund offering will be open?

Peter: Yeah, this one will close on July 30th, if the episode airs before then, we more than welcome any inquiries, of course. But we’ll be launching our next fund, which will be structured similarly, as a REIT will have about a two-year fundraising period, and again, will be a commingled diversified pool.

Jimmy: Good. And tell us a little bit more about how much capital are you looking to raise? What’s your target equity raise for the OZ fund? And what is the minimum investment amount?

Peter: Sure. Our target funds are always between $300 million and $500 million. This current fund has about $320 million raised so far. We’ll probably end up somewhere around $350 million, which is a good size for us and enables us to invest in about 10 or 12 deals, with the law of large numbers, as you know, that’s what you need to diversify away the idiosyncratic risk of a development. Real estate has a great risk-return profile, somewhere between bonds and equities, but that’s really only true for a diversified pool. One specific development has a higher risk than equities, right? Because you have construction risk, you have delayed, you have permitting problems, it always happens. So we think of it as something that would be of size to accommodate 10 to 12 deals. And that will be the target for the next fund. So pretty similar, just repeating what we’ve done so far.

Jimmy: And your fund is somewhat unique in that it’s structured as a REIT, and I imagine that the next offering will be structured as a REIT as well. Can you tell us a little bit more about that and why you opted to structure it that way?

Peter: Sure. Yes. It is perhaps a little bit unusual, as far as Opportunity Zone offerings go. We’ve done a handful of REITs in the past. We’ve also done partnership funds. And when the legislation initially came out, this was really the only way to structure a diverse and commingled pool. Later, about a year into it, things changed with guidance from the IRS that enabled diversified partnership Opportunity Zone Funds. By that time, we were already on the road, but we still concluded that even after that change, it was a little cleaner to run a commingled pool as a REIT for Opportunity Zones. If you think about it, holding assets for seven, eight years after they are completed is a fairly long time and REITs are very good structures for holding assets over the long term in general. They are simpler to administer, you get one 1099 instead of many K1s for each property. They’re actually a little bit more tax-efficient than diversified partnership. They get an automatic 20% reduction, for instance, on the ordinary income that’s generated from rent during the 10-year period. Partnerships don’t automatically get that. And we were also thinking about exits. With the REIT, we have an opportunity if the markets align well to actually take it public in an IPO. And that’s a pretty neat exit for Opportunity Zones, if we could actually distribute liquid shares to our investors and then they decide when to sell those. It could be a tax-free instrument for them that’s liquid for 30 years. As you know, the program doesn’t expire until 2047. So there is a long-term period where they could hold a tax free liquid share. All of those small advantages added up, even after the diversified partnerships became possible with Treasury guidance in 2019. So we decided to keep it as a REIT, and the next fund will be a REIT as well.

Jimmy: Yeah, that’s fascinating. The exit strategy there in particular, is of great interest to me, because as my listeners may know, at the end of the day, there’s a capital gains tax benefit. So you need to consider the exit strategy, how do you dispose of the asset? How do you realize that capital gain on the back end? So that’s really interesting, the ability to take your REIT and IPO it on an exchange. What does that process look like? And when might you undergo that?

Peter: You could actually do it at any point during the lifetime of the…because all we need to do is take a couple of shares public and that could be our shares as managers. So the investors and their investment in the fund wouldn’t undergo any change. And that’s why we could do it even before 10 years is over. But more likely, we’ll be looking at an exit after the 10 years, either as an IPO or maybe even more likely, as a sale of the entire REIT pool to another aggregator fund. Ten years down the road, there may be other liquidity options. Bankers will be looking to certainly help these funds realize their assets. And so I foresee some wave of consolidation, the easiest to roll up these vehicles if they are REITs, in an upgrade structure, for instance, where you can simply receive shares in another company when it’s rolled up together. But with this, we also have the option to just go the classic way of selling each individual property one by one. And that was basically the key decision for us that REITs offered this flexibility, and these multiple exit strategies and exit options that we could take it public, but at the end of the day, we could also dispose of it in the classic fund way, which is selling each property individually to the best local buyer.

Jimmy: Very good. Yeah. A lot of good optionality there, under that structure it sounds like. So I’m curious, now, we talked about this a little bit, typically in the past or for your non-OZ funds, your investors are institutional pension funds, oftentimes, who are your typical investors exactly in your Opportunity Zone Fund? Can you paint us a picture of who it might be?

Peter: Yeah, it actually started in an institutional kind of way, because one of our investors whom we’ve known for a long time is a very well-known family, New York based. The wealth was generated over 100 years. Everyone would be familiar if I mentioned the name, and they act more as an institution. It’s a family office that invests in an institutional style, but they are taxable. And so we structured the fund in cooperation with them to take advantage of the tax abatement. After that, we basically opened it up to a number of distribution channels, and we work with some of the largest private banks. They basically distribute the fund for us to their high net worth clients.

Jimmy: And do you have any direct retail investors, or is it all through distributors?

Peter: It’s really mostly through distributors. Although if people find us, we’re more than happy to take them directly. And that may have some advantages for folks who like to manage their investments by themselves, but obviously, an advisor can help in the process. So we’re more than open. We don’t go out to advertise individually, but if people find out, more than happy to take their commitments.

Jimmy: And what do your investors like about your investment strategy, particularly your Opportunity Zone investment strategy? What do they like about the product type and what you’re doing exactly?

Peter: Well, some investors certainly are coming to this from the angle of the tax abatement and looking to save on the taxes, get the deferral, and then the 10-year tax forgiveness. In an interesting way, I actually always mention first, that this should be, first and foremost, the real estate investment decision. And the tax abatement is a nice benefit and a cherry on top. But if you think about the conditions of the program, and the 10-year hold and the illiquidity that comes with it, that tax abatement to me is just a fair compensation for that illiquidity. There’s no free lunch in the world. The government wants you to put money in some of these areas. Therefore, they’re offering a nice tax benefit, but it’s not free. It’s a 10-year illiquid investment. So at the end of the day, the investment needs to stand by itself and you should invest in this because you’re interested in the real estate.

It’s almost as if…think about being an apartment manager in the 1960s, when REITs came about, right? The Congress created a tax break for managing assets in a REIT. And if you were an apartment manager, you would have put them into a REIT as the best tax structure. But you didn’t become an apartment manager just for that reason. And I don’t think anyone should really become an Opportunity Zone investor just because the Congress now created a tax break for this. It’s a very generous one, but again, not the reason to get into it. Now, if you are already a developer in these type of areas, and if you’re already doing this type of work, you almost have to consider this. It’s the best tax abatement we’ve seen in decades for this type of activity, which is normally very highly taxed. So it’s almost obligatory if you’re a developer to at least consider this.

Jimmy: Yeah, if you’re a developer, I agree with you, I don’t think you should get into this industry just for the tax benefit. But what about on the LP side? I hear stories about LP investors, high net worth individuals, who are primarily stock market investors haven’t really had any experience with real estate investing, but this program turns them on to the potential that real estate investing offers and the diversification that it offers in their portfolio, particularly with the stock market running up to new highs. Do you see that at all with your high net worth investors that are coming to you directly, or the clients of the distributors that you’re working with? Are there investors like that who are playing into real estate for the first time?

Peter: There certainly are, but they also should consider how to play this. And it’s very accretive and very important to diversify your portfolio, especially with equity valuations so high into something that’s an alternative asset class, and fairly inflation protective one as well. Real estate is good in a time like we’re facing right now, to protect against some of the inflationary pressures that we’re going to see. However, I would say for those investors who are doing it for the first time, or are just trying to generally diversify, a commingled pool and a diversified structure is all the more important. And there are many great single deal offerings out there that are a great deal on their own terms. But we’re seeing a lot of investors thinking about that and entering into single deals where I have to scratch my head. If you don’t dive deeply into Apple’s 10-K or Amazon’s 10-K every time you invest in their stock, why do you think that you will be digging deeply into some small real estate individual deal to make sure that you’re on top of what the developer is doing, and that you’re making the right investment choice? If you invest in equities through an ETF, why would you not do that in real estate where the diversification is all the more important? So that’s why I would say that a structure that, you know, has a commingled pool is fairly important from an investment diversification perspective, but also structurally from a regulatory perspective in OpZones in particular. And what I mean by that is, as you know with a single deal, you could fail in terms of certificate. If it’s delayed, or if you simply make some kind of a mistake, that deal could disqualify as a QOZ or a QOF.

In a pool, only 70% of a pool really needs to be qualified. So if there is a deal or 2 in a pool of 12, it’s not a big problem if something happens. But if it’s a deal of one that fails to certify, you’re out of luck. There’s no such thing as 70% of a single deal. And it doesn’t have to be a failure or a mistake really, just think of an example like this, you do a single deal investing in an office development, let’s say, in an Opportunity Zone, you build it, it performs well, you lease it, you have a great tenant for five years. Five years is over and their lease just simply ends. And you need to put in some tenant improvements to find the next tenant. What do you do in a single deal structure? Either call new money from your existing QOZ partners, which would reset their 10-year clock, or you admit a new partner or partners into that same deal. But that creates an inherent conflict. Who should benefit at the end when you liquidate the deal? The people who first put up the money and put their investment at risk originally, or the people who “came to rescue it” five years down the road. There’s an inherent conflict there. In a pool where you have different reserves and pockets of capital that you could use, you never have to call on your investors again for money. You can refinance deal A, to put money into deal B. You can even sell one deal to fund another. And you can certainly use the rental income from one deal to another. So in addition to diversification, it has this, I would say, structural regulatory benefits protecting against some kind of problem.

Jimmy: Yeah, risk diversification on the investment side, but also, like you mentioned, for lack of a better term, diversification in terms of regulatory risk of a property just not working out for whatever reason. That’s a really good argument in favor of a commingled or multi-asset fund versus a single asset deal, which carries a lot more risk. It’s akin to buying one or two individual stocks versus just buying a mutual fund or an ETF, a basket of stocks, gives you a lot more diversification, maybe a little bit less upside, but limits your downside significantly as well. That makes sense.

What about challenges, Peter? What have been some of the biggest challenges that you’ve faced with regards to Opportunity Zone investing and getting your fund off the ground, raising capital for it, and deploying capital? What have been some of the biggest challenges that you’ve faced?

Peter: Sure. The program and the structure is a bit complex. And so explaining it to everyone in a way that’s both full disclosure, accurate, and exciting, is I would say, maybe not a challenge, but an exercise. People get it, but you have to walk them through it. The biggest challenge or risk, frankly, that we have is not related to Opportunity Zones, is just the inherent risk in real estate development at this point in the cycle. When you have costs rising pretty dramatically, and you have to select markets where rents are growing fast enough to overcome those cost increases. And that’s not specific to Opportunity Zones. That’s just the fundamental, a real estate development risk that we need to mitigate.

Jimmy: Right. More structural risk than anything else. To wrap us up here next few minutes, I want you to gaze into your crystal ball if you don’t mind. I ask you a question about the future of the Opportunity Zone marketplace and your fund in particular? What do you see unfolding over the next few years?

Peter: Well, I certainly hope that the program will continue. I think it’s proven that it works. And despite some media attention to a few high-profile projects that may not fit the actual spirit of the program, which is to improve communities, I think there is a lot of capital that’s been invested exactly in the way it should be. There’s not enough coverage of that, that’s unfortunate. Most of what we do is housing that’s affordable or attainable for normal people with jobs in the local area. But that’s somehow not exciting for media to cover. Be that as it may, I hope that it won’t prevent the Congress from considering the continuation of this structure and strategy, especially in light of 1031 exchanges probably going away in some other adjustments. So this may be the only effective tax abatement program to channel capital to underinvested communities.

And if it’s extended, and if it survives, it’s certainly a part of our long term business strategy and vision. This is not a hobby for us, as I mentioned. We made our flagship fund an Opportunity Zone Fund once the legislation was clarified. So we will continue doing that, launching the next vehicle sometime this summer, and certainly hope that the program goes beyond 2026. But again, our investment strategy hasn’t changed, we’re doing the same thing we have been doing for 16 years, if the structure goes away, we’ll just unfortunately have to go back to structuring these pools differently. But if you don’t hang your shingle on this specific notion that it’s all about the tax abatement, you just do your job. And that’s what we’ll continue doing, whether it’s under this structure or another. Again, I certainly hope that it can survive and that it can be extended, because it’s a great banner. So we are now proceeding fully with the vision that this will be a series of funds for us into the long-term future.

Jimmy: And I’m hopeful of the same. I hope it gets extended well past 2026. Time will tell. Peter, it’s been a pleasure speaking with you today. Before you go, where can our listeners go to learn more about you and GTIS Partners?

Peter: You can certainly visit us on the web, which is just simply GTISPartners.com, and there is a section on Opportunity Zones. You can request on that website an access to our research room where we have a lot of information about this fund, and where we will also put up information on the next one. We also have presence on LinkedIn where I like to post little videos of our projects and assets they were working on, so you can get a real feel for what we’re doing. And that’s just under GTIS Partners on LinkedIn as well.

Jimmy: Excellent. And for our listeners out there today, I will, as always, have show notes for today’s episode on the Opportunity Zones database website. You can find today’s show notes at opportunitydb.com/podcast. And there you’ll find links to all of the resources that Peter and I discussed on today’s show. And I’ll be sure to link to gtispartners.com and their LinkedIn profile as well. Peter, again, thank you for joining me today. It’s been a pleasure.

Peter: Well, thank you for having me. Have a good day, everyone.