January 12, 2019

JF1593: An Unprecedented Tax Strategy - Opportunity Zones with Matthew Ryan

In this episode we briefly discuss Opportunity Zones; what they are, how you can invest and how big this one-time tax deferral program really is. Similar to a 1031 exchange but with more leniency and better tax advantages, Matt Ryan has been tracking this piece of legislation before it was written into law. Listen to how he’ll take advantage of this and find out ways you can implement Opportunity Zones investments into any real estate strategy. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!

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Matthew Ryan Real Estate Background:

  • A social entrepreneur, founder of Re-viv, which addresses the market inefficiencies in community revitalization efforts
  • Focused on the multifamily value-add and development space in distressed areas
  • Based in San Francisco, CA
  • Say hi to him at https://re-viv.com/
  • Best Ever Book: Discipline Equals Freedom

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Theo Hicks: Hi, Best Ever listeners, and welcome to the best real estate investing advice ever show. I’m your host today, Theo Hicks, as Joe is traveling to Texas today to look at a few apartment deals. Today I’m speaking with Matthew Ryan. How are you doing today, sir?

Matthew Ryan: I’m doing well.

Theo Hicks: Isn’t Matt Ryan a quarterback in NFL?

Matthew Ryan: Unfortunately, he is. [laughs]

Theo Hicks: I’m guessing you’re not a fan of the Falcons?

Matthew Ryan: Not so much the Falcons, but I need to get to his level of fame, so people can refer to him as Matt Ryan. [laughs]

Theo Hicks: That’s funny… A little bit more about Matt’s background before we get started – he is a social entrepreneur, founder of Re-viv, which addresses the marketing inefficiencies in community revitalization efforts. He is focused on multifamily value-add and development in distressed areas. He’s based in San Francisco, California, and you can say hi to him at re-viv.com.

Matt, before we get started, can you tell us a little bit more about your background and what you’re focused on now?

Matthew Ryan: Yeah, my career focus is, as you said, multifamily value-add and development, specifically within distressed areas in and around primary and secondary markets. Think of these as the census tracks that are the blossoming neighborhoods, the neighborhoods that are – to use an industry term – rapidly gentrifying.

What a lot of Re-viv is focused on is not just the investment, but also trying to pair with non-profits and community entities to create what we call social [unintelligible [00:03:04].13] model, where we’re basically funneling a portion of pre-tax profits into those communities, and also trying to focus on providing long-term affordable housing and workforce housing.

Theo Hicks: Obviously, someone who’s a regular investor doesn’t have to, as you mentioned, work with other non-profits and other organizations, so could you talk about how that works? How do you find them, what do they do to help you with the business plan, and things like that?

Matthew Ryan: Yeah, it’s really at the tail end of what we do. A lot what we focus on is, like I said, the value-add portion, innovative approaches to affordable housing through co-housing – that’s a particular model that we’ve looked at right now. We actually have a project right now that we’re doing… So if you look at, say, a co-housing model, we’re actually providing rents that are 35% below, with no subsidies.

But back to your question as far as the actual funneling into the non-profits – it’s at the tail end. The simplest form right now – we’re just using 1% of pre-tax profits from the asset management company and then finding local non-profits and community organizations and donating directly to them. That’s really the simplest form that we do it right now.

In the long-term we’re trying to focus our efforts in innovation around not only just the affordable housing space, but also around workforce housing and policy, and helping drive positive policy that can actually incentivize developers to preserve affordable housing, as well as develop it.

I think one of the key things that we were gonna talk about on the podcast here, which is a great opportunity, is the opportunity zones, that just came out, which is a provision in the tax code that is directly incentivizing investors to take money and invest in distressed  census tracks.

Theo Hicks: Okay, so opportunity zones – you said it’s a provision in the tax code that essentially incentivizes developers to develop in these distressed areas… What types of incentives are there? Is it just tax breaks? Do they help you fund a portion of the development? How does that work?

Matthew Ryan: It’s very similar to a 1031 exchange, but it’s actually more generous than a typical 1031 exchange… Not only in just the way that it’s structured, but also in the actual deferred capital gains. With the 1031, I have $100,000 capital gain; I invest in a project… I’m just deferring that capital gain, right? Especially if, say, only 30k of that is capital gain and the other 70k was my original basis or my original investment, right? Well, with an opportunity zone, if you have the $100,000 capital gain, you can invest that into another project and actually defer the gains through the investment, through the life of the investment, if you keep it in an opportunity zone fund or an investment within an opportunity zone for ten full years. And if you do it a five or seven-year term, then there’s a 10% and 15% step-down on the actual capital gain that you pay. So again, very similar to a 1031 format. It specifically applies to capital gains and capital gains only, but it’s not just real estate gains; it also applies to stock gains, and other various capital gains that are recognized.

Theo Hicks: Is there a list of these opportunity census tracks somewhere?

Matthew Ryan: Yes. If you just google “opportunity zones California”, that will take you to a designated page that will pull up an interactive map that you can go in there and check out the opportunity zones in your area. They typically do that by state. The local governments have designated these census tracks, so… Yeah, this was done as of April of this year, and usually Google is the best way to go about it, for sure.

Theo Hicks: And then would there be actual listings on there, or would you say “Hey, this is the census track”, so any property you buy in this area or any land that you develop in this opportunity zone you get those tax incentives?

Matthew Ryan: Yeah, it is up to you to find the investments, and it is also up to you to ensure that your investment – or if you do an opportunity zone fund, which I know some larger syndicators and investors are doing… That if you’re doing a fund, at least 90% of your assets are located within an opportunity zone.

If you wanna do a one-off investment, Theo, you could basically just invest in one individual home or project, and you just need to make sure it’s in a designated census track. And as far as finding the deals – I think it’s interesting you bring that up… There’s tech companies that are already starting to create specialty software to help pool assets in these areas… So there’s a little bit of tech navigating to that, but right now it’s just really be checking a website, using whatever your favorite lead generation tool is, and obviously working with brokers who know the areas well enough to be able to say “Hey, find me deals in these specific areas.”

Theo Hicks: So how are you finding these deals? Are you using all those strategies you’ve just mentioned? Or what’s your best way to find these deals?

Matthew Ryan: We use a couple different software tools that basically aggregates within specific census tracks. We’re using the opportunity zone overlays that are given to us by the state government, and then from there just using whatever your favorite lead gen tool is, and pooling assets, and then either cold calling, or also, as you said, using broker relationships to say “Hey, I’m not sure if you have some listings that are in and around these areas, but these areas obviously for us make a bit more sense.”

The one thing that I should mention – I’m probably hopping a little bit ahead here – is that there are some strict guidelines as far as how you invest in opportunity zones. What I mean by that is a typical value-add player may have some limiting factors, because what you have to do is you have to increase your basis by whatever you designate the actual property to be. So let’s just take a million dollar property – you say the land is worth $400,000 and the building is worth $600,000. In order to qualify for an opportunity zone, you have to invest at least $600,000 into that property in order to qualify for the tax deferral. Of course, the reasoning behind that is they wanna spur job growth, they wanna spur development in these areas.

And I will say, originally, the original guidance they had given is that you had to do 100% of your overall investment, so you had to invest a million bucks; they’ve actually scaled that back, to make it a  little bit more — not easy, of course, but a little bit more forgiving, if you will, to investors. So really heavy value-add plays, as well as development plays, are really gonna be the only types of opportunities that you would wanna pursue.

Theo Hicks: So you deal with the value-add and the development… Which one do you do more of?

Matthew Ryan: Right now we’ve been mostly focused on value-add, but with this provision, the opportunity zone provision, and really kind of within our thesis, we were tracking this piece of legislation for about two years before it actually came out… Actually using the non-profit, that came out with some of the original distressed community index, the Economic Innovation Group – we were using some of their data to help identify potential markets.

With that being said, we are navigating more towards development plays and actually creating an opportunity fund for smaller development, in the smaller [unintelligible [00:09:54].07] basically anything in the 5 to 20 million dollar range. So we’ll be focusing and shifting our business plan a little bit more towards development, but still trying to focus on heavy value-add, and even smaller value-add plays that may not be outside of an opportunity zone.

Theo Hicks: I know a very common question that I hear a lot is “How do you underwrite these highly distressed properties?” Because typically, for a value-add, it’s gonna have a decent enough occupancy that you can use historicals to figure out what the ongoing expenses are gonna be… But if it’s super-distressed, you can’t really base your underwriting assumptions on the current expenses… So if you wanna talk about what your process is for underwriting these deals and figuring out what the purchase price is?

Matthew Ryan: Yeah… Carefully. [laughs] Carefully. You have to find a local expert, and usually that’s a property management company, someone who’s embedded in the community for a while, who can really tell you what your predicted rents are gonna be once you’re finished. If you’re a heavy value-add player, it’s how far do you wanna push your product, and is there individuals within that marketplace that are gonna appreciate the product that you’re delivering?

For workforce housing, we’re finishing a project right now in Sacramento where we may have overdone the finishes a little bit, but I think you have to just be careful about understanding who your actual tenant base is gonna be. I think that’s really one of the key things, a property management company who can help you with that.

As far as the underwriting, there’s really no silver bullet. You really have to be diligent. I come from a construction background; I owned a construction company for five years in Charlotte, North Carolina, so I have a lot of that experience that I carry with me, that is very beneficial in the underwriting process, and we now have people that we’re working with in our marketplace that are well-seasoned [unintelligible [00:11:38].20] general contractors who have almost ten years experience. Being able to have those partners is really key to your underwriting, because as you know, from an investor, you’re the conductor, and you need to have a good orchestra who can go out there and give you all the bits and pieces you need so you can assemble a good underwriting proforma.

Then from there I think it’s just a matter of being — I was having this discussion with a property manager yesterday for a project… You really have to embed little pieces of conservatism in your underwriting. I joked with him, I said I kind of embed little nuggets of money everywhere within my underwriting proforma, so I know that I’ve got some juice in my proforma that if things go wrong, we write in good contingencies, and I’m just very conservative in that, so that way I never feel like I’m running up against the wall as far as our underwriting is concerned, because there’s so many things that can come up in a heavy value-add play.

The only thing I would add in the end is really spending your time in due diligence to walk the building. And not just walk the building, but spend time in the building. Look around. By the third or fourth time that you’re actually in a building, it’s amazing to me because many times in the hundreds of homes that I’ve spent inspecting, I’ll come back a second, third or fourth time and I’ll find something new, I’ll find something interesting that I didn’t see before. That’s so invaluable… And you can’t just count on necessarily someone who’s a hired inspector to have that diligence.

Theo Hicks: Oh yeah, seriously. Best Ever listeners know my experience with inspectors, so I totally understand what you’re saying there. How are you actually funding these deals? Is that what that opportunity fund is, or is that something different?

Matthew Ryan: Yeah, so we’ll be launching an opportunity fund for everything that we do from a value-add position; it’s mostly just been the 506(b) and 506(c), working with accredited and non-accredited, and syndicating our deals as one-offs. Then I’ve also done a lot of personal deals and grown a personal portfolio, and most of that has been through family and friends, or  in most cases taking on the debt myself.

Theo Hicks: So when you’re raising money from accredited investors and when you’re doing it yourself – that’s different from the opportunity fund…?

Matthew Ryan: Well, opportunity funds are absolutely going to be investor-led. So we’ll either be doing one-offs investments through syndications, but as I said, we’re looking to create a fund – more of a semi-blind pool than a true fund structure. We’d like to get a fund structure that makes sense, it’s just the rigidity of that, and the time and the energy, as well as the money… We have to see how much – for fear of redundancy – opportunity or how many deals are out there in these areas that really pencil. There’s been a lot of (of course) people excited about them; a lot of naysayers are saying “Hey, be careful. These are gonna be dangerous deals. These are gonna be deals that people are gonna stretch themselves on.” I think there’s some truth to that, but obviously, you wanna be conservative, and from our perspective, we’re really gonna get out there and raise some capital and then be aggressive about what we can do, as far as when a fund structure makes sense, or individual one-off syndications.

Theo Hicks: Okay. Essentially, you’re just raising money like everyone else, but you [unintelligible [00:14:37].09] opportunity fund, and it’s used to purchase these properties in these opportunity zones.

Matthew Ryan: Exactly. And I’ll just highlight again that the opportunity zone fund is really a setup for those individuals who have capital gains. If they wanna defer their capital gains, they can invest in an opportunity fund, and they have 180 days to take their funds and put them into an opportunity fund. Once the money is in the fund, then you have 31 months to deploy the capital and to actually invest and improve the property.

Again, 1031 I think is 45 days to identify, 180 days to close? So you’re seeing a greater level of flexibility; a great level of flexibility as far as the type of capital gain that can be put into an opportunity fund, and that’s why I think it would make a great investment mechanism for us… If we get the fund put together and raise enough capital for it, I think it can certainly make sense, but we’re still gonna be looking for investments, and if we had an investor who could bring a lion’s share, a couple million dollars, and do a heavy value-add or a development investment, I think it also makes sense to do one-offs and give them that opportunity, because the reporting structure for this is so simple. They literally have already put out a sample two-page tax form that basically you have to fill out every year for every investment. So they’ve really tried hard to make this easy.

As I said, the fund structure makes it a little bit more complex, but they’ve ironed that out. They’ve given investors a great deal of flexibility with the 180 days and the 31 days to deploy the capital.

Theo Hicks: So for someone who’s listening to this podcast and they’re saying to themselves, “Hey, this sounds like a great investment idea”, what is your best real estate investing advice ever to that person to get started in these opportunity zones?

Matthew Ryan: Are we talked about are they already a real estate active investor, or a passive investor?

Theo Hicks: Let’s say they’re an active investor.

Matthew Ryan: Okay. So if they’re an active investor, you definitely need to understand where your opportunity zones are, first and foremost. Secondly, you need to think about structure – what your capital stack looks like. Can you raise enough equity to do a fund? Do you have the experience to put a fund together, or does it make more sense for you to try to find a building or one-off investment in an opportunity zone, and then try to syndicate that deal? That would be where I would start first and foremost, and I think another thing that’s been fruitful for us is finding other individuals that you could potentially partner with, who may be good JV’s, and maybe you guys can pool your money together and get into a bigger investment, or be able to set up a fund yourself. I think those would be good starting points for anyone to be interested.

Theo Hicks: Is there a go-to website, or book, or a  blog where people can learn more about this investment strategy?

Matthew Ryan: Yes, we’ll be posting a webinar that [unintelligible [00:17:20].18] here in San Francisco – we just did a webinar series on it… And to be honest, we’ll have that on our website and on our blog here shortly. If you just, again, google search “opportunity zones” right now, you would be hard pressed to not find a plethora of information. And anyone who has specific questions, feel free to reach out to me; I’ll give you guys my e-mail address at the end, and I’ll give it to you right now again – it’s matt.ryan@re-viv.com.

Theo Hicks: Are you ready for the Best Ever Lightning Round?

Matthew Ryan: Yeah, let’s do it.

Theo Hicks: Alright. First, a quick word from our sponsor.

Break: [00:18:01].18] to [00:19:09].23]

Theo Hicks: Alright, what is the best ever book you’ve recently read?

Matthew Ryan: That’s always a tough one, and I’ve debated this one a lot in my mind before I hopped on here… I’d say one of my more recent favorites – and I’m reading his second book right now – is a guy named Jocko Willink. Are you familiar with him?

Theo Hicks: Yeah, I know who Jocko Willink is.

Matthew Ryan: Discipline Equals Freedom – that was one of the books that I read at the beginning part of this year, and it’s funny, I can almost hear that guy screaming at me through the book… For those of you who don’t know him, he’s an ex Navy Seal, and now does a ton of business training, as well as Navy Seal training. There’s a simple way and format in which he institutes his philosophies, not only in business, but in the military. It’s just been very profound for me, and something that I really enjoy.

Theo Hicks: And if you follow him on Twitter or Instagram too and see him post a picture of his watch at like four o’clock in the morning, covered in sweat…

Matthew Ryan: Oh yeah, yeah… He’s one of those guys. And this second book – gosh, of course I’m drawing a blank now… Extreme Ownership. He’s one of those people, he exudes leadership. I don’t know how you feel, Theo, but when I see that watch, or if I see a post of his, it kind of motivates me to wanna get up the next morning. It makes me feel like a big wuss for staying in bed, versus getting up at 5 or [5:30].

Theo Hicks: What is the best ever business decision you’ve recently made?

Matthew Ryan: Wow, that’s a tough one… Recently? I’ve kind of thought back to my original investment. My first ever investment was a duplex that I did in Charlotte, North Carolina, and that was really the catalyst for me. It was at a time when I was still in my construction company, and it allowed me to really pivot and think about real estate as a career. It also led into the thesis behind what Re-viv is, by way of experience of a community member there, Ms. Pam, who was a community member and was in a gentrifying neighborhood, worked two jobs, took care of her grandkids, took public transit to her night job… At the time, she was one of those people that I thought of that said “What happens to this person as these neighborhoods continue to turn over?” For her, she was kind of an inspiration person to me, to think like “Well, we really need to rethink about how we do value-add and how we do investment and community revitalization. We need to find a way to keep  these people as part of our community, while also bringing growth to these communities.” That was the one that kind of set the tone for me, and really gave birth to the idea of what Re-viv would be.

Theo Hicks: What is your best ever deal besides your first deal and your last deal?

Matthew Ryan: Wow, that’s an interesting one. I’ll default actually to the first house that I ever bought. It was the only investment that I didn’t make money on, and everything that could have gone wrong in that seven or eight year period that I owned it went wrong, to the point where — I actually had a realtor who was listing it for me who passed away. I went through two more realtors after that before we actually tried to sell it, and then I actually ended up selling the deal myself, after getting a tenant in there and working with the tenant… And they had seen all the work that I had done, the blood, sweat and tears and how I managed the property… But they bought it from me.

I sold it at a breakeven. Obviously, if you did a financial metric on it, it was not a breakeven… But it was one of those things that really taught me the lesson of sticking with something, staying true to doing the right thing, which at the time was very difficult. There were so many times I debated just cutting it loose and selling it at a loss… You know, it just kind of taught me how to persevere, and like I said, stay consistent and stay true to what you’re trying to do.

Theo Hicks: What is the best ever way you like to give back? …besides your overall investment strategy.

Matthew Ryan: Yeah, you took that one away from me… I was gonna say it’s one of the things I enjoy about being in a social-based enterprise – you can kind of have a twofold mission; you can make money, but also do good.

I’d say on a personal basis I try to find non-profits that I enjoy, that I feel have causes that are near and dear to me. I’ve just gotten in a habit of putting them on a reoccurring donation every month. That’s been cool to me, because then I don’t feel like I have to constantly do it… And it’s nice getting the occasional thank you card, or receipt, or note from people. I think that’s been a good, positive thing for me.

Theo Hicks: What’s the biggest mistake you’ve made in real estate?

Matthew Ryan: Yeah, over-emphasis on finding the deals, and not the investors first. That would be the biggest one, and I think you hear it all the time. It was one of those pieces of advice that I’ve foolishly felt like “Oh, I can do this differently. I can find a deal, and I’m sure if I’ve got a good deal, I can find the investors.”

I think the problem with that, especially for those of you who are just getting started, is that it just doesn’t give you the confidence that you need to proceed aggressively with a deal, and it really takes away from all those important factors that you and I are familiar with as far as the due diligence period, and putting your team together… If you have that anxiety and that fear of trying to get the investment, you’re not gonna be able to focus and do your due diligence properly, the way that it needs to be done… And I would say that’s probably one of the most hindering factors, by not having your investor pool worked out.

Theo Hicks: That is really good advice. Very good advice. What is the best ever place Best Ever listeners can reach you?

Matthew Ryan: You can always check me out on Twitter. I’m not terribly active there. E-mail, matt.ryan@re-viv.com, and you can also call me at 415 805 8933. I’m always open to chat with people… And we’ll be posting some more information to our blog around opportunity zones.

Theo Hicks: Well, Matt, I really appreciate you coming on the show today and talking about opportunity zones. I’d heard of them before, but I wasn’t very familiar, but now I am. You talked about tax incentives for people to develop and buy properties in these opportunity zones, which you can find by literally just googling “opportunity zones” and then your state.

You mentioned that there are a few guidelines, one of them being that you need to invest the same amount as the property value into the property. If it’s a million dollar property and if the land is worth $400,000, then you need to invest at least $600,000 in order to qualify. You mentioned how if you wanna get started, you first need to understand where the opportunity zones are, and then figure out how much capital you’re capable of raising, to determine whether you should put a fund together or start off by doing a one-off deal in that area. Then it’s gonna be important to make sure you find other individuals to partner with.

Then we also went over your strategy for finding deals, which is there’s some tech out there now that pools together these properties in these opportunity zones… And then just your regular lead generation strategy and working with brokers.

Then we also talked about how to underwrite these highly distressed deals. It’s similar to underwriting any deals – making sure you’re very careful and conservative, so putting in a lot of contingencies, although I’m sure there’s an emphasis on the contingencies for these types of properties, because a lot more can go wrong, as you mentioned.

It’s important to find a local expert, so work with a property management company who knows the area very well, and then an experienced general contractor to help you estimate the construction costs. Also, you wanna make sure that the types of product you’re offering is actually gonna be in demand, and then make sure that you walk the building multiple times and spend time in the building, because each time you visit the property you’re likely going to find something new.

Again, Matt, thanks for joining us today. Have a best ever day and we’ll talk to you soon.

Matthew Ryan: My pleasure, thank you for having me.

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