OZ Pitch Day - March 7, 2024
Are there misperceptions in the market? Do investors overreact to sentiment? And is there an opportunity for level-headed contrarian view Opportunity Zone investors?
Riaz Taplin is principal and founder of Riaz Capital, an Oakland, California based real estate management firm focused on developing workforce housing in California’s urban Opportunity Zones.
Click the play button above to listen to my conversation with Riaz.
- The investment thesis behind creating workforce housing in urban markets.
- Real estate market fundamentals and misperceptions, particularly in the California Bay Area.
- Early indicators of a return to urban areas: how 250,000 people returning to the Bay Area over a very short period may coincide with a collapse in supply, leading to a price spike.
- The impact that tax reform may have on the Opportunity Zones marketplace.
- How the Opportunity Zone incentive may be ideally suited to capitalize on ongoing demographic macro trends.
- Highlights of Opportunity Zone projects that Riaz Capital is developing and why they appeal to investors.
Featured on This Episode
- Riaz Taplin on LinkedIn
- Riaz Capital
- Episode #119: Workforce Housing in Opportunity Zones, with Riaz Taplin
- “3 in 2”: Bringing Back the Bay Area
- California Policy Lab: People Are Leaving SF, But Not California
- Laffer Curve
- Senator Joe Manchin (R-WV)
- Budget Reconciliation
- California State Density Bonus
Industry Spotlight: Riaz Capital
Riaz Capital is a workforce housing developer headquartered in Oakland, CA. Their development strategy positions them to potentially capitalize on delivering substantial and sustainable returns to long-term investors. With dozens of workforce housing projects in their pipeline across the San Francisco Bay Area’s Opportunity Zones, Riaz Capital later this summer is launching Fund III, which will be a California Workforce Housing Fund.
Learn More About Riaz Capital:
- Visit RiazCapital.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 today I am joined by Riaz Taplin, principal and founder of Riaz Capital, an Oakland-based developer, and operator of workforce housing. He joined me on the show late last year, and he’s back again for a second time. Riaz, thanks for joining me today. It’s a pleasure.
Riaz: Thank you, Jimmy, for having me.
Jimmy: Absolutely, Riaz. Happy to revisit with you. I wanted to start by chatting about what you do at Riaz Capital a little bit and urban fundamentals. Can you give us the lay of the land?
Riaz: Yeah. We are an Oakland-based workforce housing company, which is fundamentally focused on solving the housing problem for single-income professionals. So if you look at the demographics of our country today, 80% of American households are a single-generation household. If you look back to 1955, Jimmy, only 20% of American households would have fit this description. And basically, there’s been a flip-flop in the demographics of our country while the housing supply is virtually unadjusted.
So what we’re trying to do is provide entry-level housing to one and two-person households who are fundamentally the essential workforce in urban markets. So if you’re a nurse, a teacher, a firefighter, or any other entry-level professional, where you’re most likely single or coupled up, in other words, do not have children and you live in an urban market, we want to design a housing solution for you. So Oakland has been our primary focus because of the fact that it sits on the epicenter of the transit infrastructure of the Bay Area, and because we’ve been working in this market for almost 20 years.
So we’ve evolved from being an apartment owner to an adaptive reuse developer to a ground-up construction developer over the course of the last 20 years. So as of today, Riaz Capital owns and operates about 1,500 units and has 1,700 residences in the development pipeline.
Jimmy: Fantastic. So for those of you who may not have heard our first podcast episode together, Riaz, and I took a deep dive into the origin of the nation’s housing crisis, who’s affected by it, how urban planning overregulation has resulted in a lot of the problems that we have around the country and in particularly in the Bay Area. So if you haven’t checked out that podcast episode, I would encourage you to do so. I want to talk a little bit more about the market fundamentals with you today, Riaz.
So what are you seeing in the market and in particular, the real estate market in Oakland and the greater Bay Area right now? And do you feel as though…are there misperceptions in the market? Do investors overreact to sentiment sometimes, and is there an opportunity for level-headed contrarian view investors to find value?
Riaz: So I think the big question that everyone’s asking themselves is what does our life look like in a post-COVID era? And there’s no question that COVID was a catalyst for change. And the question is to what degree do we see a reversion to the mean, and to what degree is it a catalyst for a permanent new paradigm? And I think we, as a country got five years of technological innovation, we saw digital currencies explode. We saw non-traditional ways of doing business become the norm. And so when we think about investing in urban markets, who will return to cities?
And what we’re seeing are the early indicators of an urban boom. I follow the Bay Area very closely. So I’m like, “I’m sick with that.” But if you look at single-family homes in the six months, from January to June, so single-family homes did not fall very significantly, did not fall and arguably even went up in value in certain markets in the Bay Area but in 2021, we’ve seen prices up 15%. In terms of condo sales, San Francisco hit a 16-year high last month for condo sales. And if you see leasing activity in core buildings in San Francisco and Oakland, you’re seeing leasing activity bringing back I would say our primary properties in San Francisco up to the high 90s in terms of occupancy.
You know, I was joking with a colleague of mine, or a colleague of mine was joking with me that he built a building in mid-market in San Francisco, which I would say was one of the areas most hard hit by COVID. And he was like, “In 2 weeks we did 18 leases. We didn’t do 18 leases in 2020.” And so you’re seeing these kind of, I would say the early indicators of a return to the urban areas. And I think that’s fundamentally driven by three things. The first one is most companies have come out and said that some share of people can continue to work from home, some share of people need to be in the office every day, and the majority of people need to be in the office a certain number of days a week.
And we wrote an article that we called the “3 in 2” and how the “3 in 2” is a panacea for the Bay Area. So Jimmy, if we assume, what does the urban area look like post-COVID, 80% of people working for Bay Area companies have to go to the office some amount of time, with 20% going every day and 60% going 3 days a week. So once you have to go to the office one day a week or two days a week, from a housing demand standpoint, it doesn’t matter whether you go seven days a week because you have to live in a proximate location in order to get there.
The big change, which I think is very positive for the Bay Area, if people are only going to go to the office 3 days a week as opposed to 5, is it’s a 40% reduction in congestion. We’re not feeling the full benefit of that yet, Jimmy, because people are scared to take public transport. So we have less traffic on the road from people driving to the office because they’re going into the office fewer days of the week, but we have more traffic on the road because people are not comfortable yet taking our subway system, our bus system, Uber share, Lyft share, etc.
So in terms of the livability of the Bay Area, I think that the three days in the office, two days at home could be a panacea in the sense that it lowers congestion, increases office utilization, and increases the catchment area for housing, which was a serious problem prior to the pandemic. I think the other big thing that we’re going to see is, okay, a bunch of people left the Bay Area. There was a Berkeley study where…in the business school I think it was, where they studied the relocation data from the mail service. And they found that there was a net migration from what I would call the urban Bay Area, San Francisco, Berkeley, San Jose of about 45,000 people in 2020.
Well, we have 4.5 million people in the Bay Area. So that’s a 1% change. There’s no way that a 1% change in population, Jimmy, can explain a 30% drop in rents. And so I think the explanation is threefold. Number one, those 45,000 people were less likely to have children, were most likely to be young tech and finance professionals who were most likely renting apartments and thus could more easily locate. So it’s disproportionately felt in the apartment market.
Secondly, the data ignored the fact that we in the Bay Area have 230,000 students, which all left. And so what does that look like as you’re coming to the other side of the curve? Well, some portion of the people that will…is that all of our companies on the tech side have done very well during COVID. Zoom is based here in the Bay Area. We’ve all been on more Zoom calls than we want to admit. Everyone is ordering things digitally. So our companies have done very well but the people…our companies said for a period of 18 months you could live from anywhere.
Now, the same companies which have grown in employment are saying you have to be in the office three days a week. So what I see as happening now is that the group of people that didn’t show up to work in 2020 because COVID happened, the group of people that have not yet shown up in 2021, and the class of 2022 are all going to descend on the Bay Area housing market simultaneously, and the student returns. If you add up these groups together based on past trends, it looks roughly like 250,000 people being added to the market over a 6 to 12 month period, because it will most likely happen in the third quarter of ’21 through the second quarter of ’22.
And so that’s more growth in the Bay Area by a factor of four than we saw at any point over the last two decades. So what I’m trying to say in a very long-winded manner is what happened to Bay Area in terms of rent in the late 1990s, again in the 2010 to 2014 period, we now have all the preconditions for, which is that we have a tremendous amount of pent up kind of relocation that’s about to happen because there was delayed household formation to the tune of 200,000 people. It’s bigger than anything that we saw in the late 1990s. It’s bigger than anything that happened in the 2010 to 2014 period, where the Bay Area added an average in the urban markets, let’s call it 50,000 jobs a year.
We’re looking at something like 250,000 residents in 1 year. And you combine that with basically a collapsing housing supply. So basically, the cost of building housing and the politics of the Bay Area made it such that you had a huge reduction in the number of entitlements in the latter part of the decade. To give you an example, in Oakland Berkeley, over the last 3 years, we delivered almost 8,000 units, including 2021. In 2022, that number drops to about 500. In 2023 it drops to 500. In 2024, it’s only 148 units. At the same time, we’re going to have this explosion in demand.
Even if a smaller number of people are moving to the Bay Area, we’re going to have a collapsing supply, which is the preconditions for a price spike. I think the price spike comes 6 to 12 months from now, but I can tell you in our workforce housing product, which is the focus of what we do, we have a building that’s opening on July 1st, we’re 75% lease and we’re 25 days out. So we’re seeing the early return of those people, especially in our category, which is the essential workforce because they’re much less likely to be able to work from home. So their need to get back to work faster is higher. So like in the current group, we have 20 leases coming in from teachers because Oakland Unified is going to go back to school next year. They have to be back to work.
Jimmy: That makes perfect sense. There’s a lot to unpack there but just to recap briefly, essentially, the magnitude of the decline of urban Bay Area housing demand, and we’re focused on the Bay Area here but this probably applies to a lot of urban centers throughout the country, but the magnitude of that decline in urban Bay Area housing demand was very steep. And I think what we’re seeing starting to take shape is we’re going to end up seeing a very steep V-shaped recovery in terms of the housing demand.
A rapid decline, pretty steep bottoming out but then a rapid recovery is coming and coming soon. And you’re already beginning to see signs of it, it sounds like. And at the same time, a little bit down the road, we’re going to be facing constricted supply. And as you said, it leads to a pretty steep pricing spike. Did I get that right?
Riaz: I went and did a study of other markets to see like, to what degree is this a San Francisco problem, a California problem. And when I went around and that was at the beginning of this year, what I realized is that this is really an urban problem. It didn’t matter if you went to Phoenix. Downtown Phoenix was suffering while the suburbs were doing well. Downtown Seattle was suffering while the suburbs were doing well. Downtown Denver was suffering while the suburbs were doing well, downtown San Francisco was suffering while our suburban properties were doing very well. So what we’re going to see now is a reversal of that dynamic but you’re going to have two to three years’ worth of demand happening in one year.
Jimmy: That makes sense.
Riaz: And I don’t think it matters whether it’s New York, Denver, Seattle, or San Francisco. I would say the exemption to that rule is Austin. And I would say New York is a little bit ahead of us here in California because they’ve already opened up more. So there’ll be a linear or even geometric relationship between office openings and apartment demand.
Jimmy: So New York almost might serve as a bellwether for what is to come in the San Francisco, Bay Area?
Riaz: Yeah. Already congestion in the city is back to, I would say it’s not quite pre-COVID levels, but it’s very high in part because people are not willing to use public transport. The downtown area is not busy but there’s clearly a level of activity back in the neighborhoods, whether it’s Oakland or San Francisco, which is reminiscent of a pre-COVID era.
Jimmy: Good. So I want to talk with you more about how investors can take advantage of this trend and, in particular, you know, what you’re working on at Riaz, the types of properties, the asset classes that you’re investing in, and how they take advantage of these trends. I want to talk about that in a minute but first I want to shift gears for a second, Riaz, here. And I want to talk to you about tax reform. It’s been a topic of conversation ever since Biden won the election back in November, and it’s becoming a more and more prominent, the discussion on it, since rumors have been floated around about how the administration may want to increase the capital gains tax rate to as high as I believe it’s 43.4% potentially.
So I’ve been asking this of a lot of my recent podcast guests. With potential changes in the tax code, what do you think it could all mean for the opportunity zone marketplace going forward?
Riaz: Look, I think you accurately identified one of the big changes that has been proposed in the tax code, which is the capital gains tax increase. I would say the not so important is the movement from 36% to 39.6% on the income tax. But the other two big ones as it relates to real estate is the fair market value step-up upon death, number one, and the 1031 exchange. And so what’s been beautiful about investing in real estate over the course of the last 20 years that I’ve been doing it is because of the benefits of depreciation and the 1031 exchange you could create value, transfer it and have your income be sheltered by depreciation.
And when you die, because of the fact of the fair market value upon death, you get whatever the value is on the day you die is your tax basis. So this fair market value step-up upon death going away really changes how people think about the assets they hold and about selling assets. So if you assume that that goes away, people’s ability to sell assets goes down. And so if you think about what’s happening in the overall yield environment, yields are at all-time lows. And even if we’re like, “Oh, there’s inflation, interest rates have gone up,” okay, the 10-year is still in the high one. You know, this is not crazy.
And so with that fair market value, some of it going away, have you ever heard this line, death, divorce, and taxes drive real estate transactions. And so in the event that you don’t get that step-up upon death, I think people will be less likely to sell. In the event the 1031 exchange goes away, I think there’ll be less liquidity in the market because people will be less likely to sell. In other words, they’ll be able to draw all of supply of assets and there’s a tremendous amount of capital out there.
And fundamentally the shift, Jimmy, it’s not the end of the Trump era or the George W. Bush era, it’s the end of the Reagan reform. So it’s the end of supply-side economics. It’s the end of this whole umbrella of thinking, which Reagan and the Laffer curve brought to us and the idea that you could reduce marginal rates and have revenues go up. So what does that mean for an investor? I think that the way that people think about investing was very exit-focused, which is okay, how do I get an exit? How do I create value and get an exit?
Well, if you’re going to be losing 50% of whatever you create every time you trade between assets, it doesn’t take Einstein to figure out that you’re going to be losing a tremendous amount of your kind of implied wealth every time you sell an asset. So what’s interesting about that is strategies which are taking a long view, we’re taking the view that, okay, this demographic trend of people getting married later, being single longer, and wanting to be in urban areas, we don’t believe is going away. And that it’s so undersupplied that we could be building this for the next 20 years and have a very sustainable business.
We’re merging that macro trend demographically. And you always, when you’re investing, want to be able to identify what’s the macro that you’re making. And the macro that we’re making is that there’ll be more and more single-income households going forward, both at the early part of the age curve and the latter part of the age curve as life expectancy extends. And we’re merging that with opportunity zone tax treatment in this current cycle of fundraising.
Because basically, somebody who invests in an opportunity zone fund, it gives you a once-in-a-lifetime opportunity to invest in pre-tax dollars, A. And B, that all the appreciation that you get over the next decade or two decades up until 2047 under the current legislation is tax-free. So if you think about, “Okay, what are my options?” anything that I own is going to get taxed at a much higher rate. My income is going to be getting taxed at a much higher rate in column A. In column B, I can invest in this macro trend, which is going to be continuing probably for the next several decades, A. And B, I don’t pay any tax in the process.
So I think for those investors that are able to take advantage of that in calendar ’21, it’s a once-in-a-lifetime opportunity, at the same time, the tax code is going in a different direction. One thing to balance that with, this is simply going to come down to what mentioned in West Virginia thinks the tax code should look like. So Biden may want to do A, B, and C and is talking about X, Y, and Z and it all sounds very consistent with his platform, but if he can’t get the Senate to go along with him, it really doesn’t matter.
And so if you think about like, what’s the larger story here, is that this thing that happened on January 6th with the Capitol, the importance I think of Biden getting a win under his belt, and he’s not going to be able to do anything on anything that does not have a budget component to it, because he’ll only be able to do things through the budget reconciliation process, which means he can do something on infrastructure and he can potentially do something on tax for which he only needs 50 votes.
And so I think at some point, he is a pragmatist that you may get a much more minor move in tax rates than one originally thought in his platform, because, you know, as you mentioned, the idea that tax rates are going to 43%, you can actually have something that goes from 24% to 28% because the importance of getting something through outweighs the importance of getting the perfect thing through.
Jimmy: Yeah, I agree with you. I think that’s probably most likely where we’re headed. I completely agree with everything you said about opportunity zones and the opportunity that it presents for investors in terms of tax mitigation. It is a tremendous tax mitigation strategy. Especially, if we do have a lot of the tax reform that the Biden administration is considering, it makes the opportunity zone incentive all that much more powerful. And there really aren’t a lot of other ways to mitigate taxes in the same manner.
So to bring us full circle now, Riaz, I want to talk with you specifically about your opportunity zone investment offerings. You had a workforce housing opportunity zone fund that you closed, I think what was it, late last year or earlier this year, you closed it and you’re about to open your second opportunity zone fund. Can you tell us a little bit more about your first fund and your second fund and the investment thesis underlying it?
Riaz: Sure. All of our work for almost…since 2012 has been focused around solving one problem, which is how do we create more moderate-income, missing middle, entry-level, small format type housing in the very expensive market of the Bay Area? So, one thing that’s different from us from a lot of other opportunity zone funds, the area where we work predominantly is the same neighborhoods that I’ve been working in since the late 1990s when I first started buying workforce housing in Oakland.
So we’ve basically been approaching the same problem where we were doing workforce housing stuff in the ’90s, and then we became much more strategic about how to scale it about a decade ago. And so the fund that we did, which was our 2019 fund, which went all the way through 2020, was focused on how to build new construction, small format, entry-level housing, which is not subsidized in urban markets. And as of today, we’ll be probably about eight projects in great locations in Oakland.
So one thing about the opportunity zones, they were supposed to be in areas that are not necessarily Beverly Hills, but that they were low census tag districts. The reality of the way these got formed is many of these overlay with great locations. And since we were of a neighborhood, what we’ve been able to do is we have one project in the first fund that’s in the waterfront neighborhood of Jack London Square. We have another project that’s effectively in Emeryville, less than three blocks from Pixar campus.
We have another project which is in downtown Oakland, a few blocks away from the FinTech hub that’s developed in Oakland over the last year or two. So the next fund basically will be a California-focused workforce housing fund with a focus still on the Bay Area because it’s our backyard. And what we’re using is a law that was passed in 2019, which is called the California State Density Bonus, where we’re using the state’s supremacy clause to deal with local entitlement issues. So just in the last month, in our fund two, we got three different projects entitled.
We got our project entitled that’s near Emeryville. We got our project entitled that’s near downtown Oakland. And we got a third project entitled in an area called West Oakland. All of them using the small format strategy, all of them using what I would call a small lot exemption, and all of them using small lot exemption. And we’re working on several projects now using the density bonus. So it’s been super cool to see in the first fund is, we’re starting construction next week on our first project, is we’ve seen the thesis play out very positively.
We were able to get permits in roughly 12 months and because we already have built this type of building before, we can build these buildings in 12 to 14 months. So one very key distinguisher. But the two distinguishers of our strategy are, A, we’re going after a very underserved market so we should have much more stable revenues and, B, we have a much shorter development cycle because we can get a permit in 12 months and build it in 14 months.
Jimmy: That’s great. And why do your investors like your product type so much? Why are they following you into your fund? I’m curious what you’re hearing from them.
Riaz: Broadly speaking, I would say we have two groups of investors. So you have investors who are basically investing to solve a problem. And fundamentally people have three financial problems in life. How do you pay for your first house, how do you pay for your kids’ education and how do you pay for your retirement? Where we fit really well is helping people not…invest for their retirement. In other words, start investing in capital now, start buying real estate and you’ll get this very stable cash flow, which is very tax-efficient, building up over a series of years that can become an important part of your retirement package.
The second group are investors that are, let’s say a little bit wealthier. So their focus is portfolio management. Because we’re based in the Bay Area, we have a very large number of both real estate investors because of our contact with the community. And our largest investor is an almost 100-year-old San Francisco construction and development family, but many of our investors have very little real estate exposure. So they invest with us in order to get all the benefits of real estate to offset the rest of their portfolio.
I would say within both of those groups, what’s the biggest problem that the Bay Area had pre-COVID, it was our inability to provide entry-level housing. So it’s one of those win-wins. We’re investing with a firm that has a great track record, almost 40% IRR, and exited deals. We’re investing in a strategy where the market is undersupplied. And if this company is actually able to do this, we’re contributing to solving a large societal problem. I would say that most of our investors don’t invest for the impact reasons but it’s a nice to have on top of what we’re already doing financially.
Jimmy: Sure. That makes perfect sense to me. You’re off to a great start, Riaz. I know your first fund was successful and I wish you nothing but the best of luck with your second fund. Where can our listeners go to learn more about you and Riaz Capital before we call it quits on today’s episode?
Riaz: You can find out more about the company at riazcapital.com. And we will have a new offering launching in late July, early August, which will be our fund three, which is effectively a consistent repeat of our existing strategy with a broader geographic reach.
Jimmy: Perfect. Looking forward to hearing more about that, Riaz. Thank you. And for our listeners out there today, as always, I will have show notes for today’s episode on the Opportunity Zones Database website. You can find those show notes at opportunitydb.com/podcast, and there you’ll find links to all of the resources that Riaz and I discussed on today’s show. Riaz, thanks for joining me today. I appreciate it.
Riaz: Jimmy, thanks so much for taking the time to chat.