By Clark Spencer, Managing Director, Investments
Experienced investors know that tax season doesn’t end on April 15. Tax planning is a year-round process, particularly in this year of volatile financial markets and global economic uncertainty.
If you or your tax advisor are considering incorporating opportunity zones into your tax strategy, the choices can be overwhelming. We’ve developed this list of ten questions to ask any potential opportunity zone manager as a guide for the decision-making process.
Q1. Has the sponsor completed development projects in QOZ locations before?
A. You will want to know how much experience the sponsor has in QOZ locations. QOZ locations are, by definition, low-income Census tracts, which inherently makes them riskier investment locations than traditional market locations. While many QOZ locations are in path-of-growth areas and present great investment opportunities, knowing how to navigate the needs of an emerging and changing community is critical.
Q2. Is the sponsor a fund manager, developer, or both, and what is their track record?
A. A fund manager who also takes accountability as the developer provides another layer of certainty in QOZ markets, especially when their track record is transparent, and you can see how well they have performed. A “boots on the ground” approach to QOZ investment is important to maintain control in a project and to ensure both that the requirements of the QOZ program are met and that the investment achieves its anticipated returns. If the sponsor is not a fund manager and a developer, understanding how they are engaged with the asset to ensure compliance and return is imperative.
Q3. What are the ongoing tax requirements for the investors – will they receive K-1s or 1099s?
A. When investing in a QOZ fund, investors must consider their ongoing obligations for tax reporting, particularly if they are using the program as a tool to diversify their portfolio into real estate. Many funds are structured as partnerships which produce K-1 tax obligations at the federal level and often require tax filings in states where properties are located, even if it is not the investor’s state of residence. These obligations can be time-consuming and expensive for tax preparation. Other structures, including REITs and other corporate structured entities, will produce 1099s, a much simpler tax form, though they may not get the benefit of partnership tax treatment. Understanding these differences and how they fit into your portfolio is important for you and your tax advisor.
Q4. When will the QOZ fund close and what does that mean for investors’ holding periods?
A. QOZ funds that are set up to take in capital over multiple years can create a longer realization timeline for investors if the fund’s strategy is a portfolio sale after all investors have achieved their 10-year hold. Alternatively, such funds may leave it up to the investor to sell their investment after achieving their own holding period. Such strategies can provide flexibility for investors, but also increase their management responsibility. In contrast, a “vintage year” fund in which all investors invest in the same calendar year can provide a more hands-off approach for investors when it comes time to realize their investments.
Q5. How does the QOZ fund’s strategy take into account its investors’ deferred tax obligations?
A. It is important to ask if the fund intends to have a refinance or other cash event in late 2026 or early 2027. Investors will owe their deferred tax obligations with their 2026 tax filings, and, based on the generally illiquid nature of QOZ investments, investors won’t be able to count on selling their investments to pay tax on their deferred gains, and any such sale wouldn’t get the 10-year benefit of the program if it were sold. As an investor, you will need to know if a fund does not intend to create a cash event around the time taxes are due and will need to be aware of any deferred tax obligations and prepare accordingly.
Q6. How many projects are targeted and where are they located?
A. The construction of the QOZ fund is critical. Understanding the investment strategy, approach, and methods used by sponsors and fund managers to build the fund’s portfolio is one of the most important aspects of the investment. If the investment is in a single asset, is the investor confident enough in the asset and strategy to take a non-diversified risk? If the fund intends to invest in multiple assets, is there diversification in the markets the fund will target to create a well-rounded portfolio? Knowing the answers to these questions will help you assess what works best for your portfolio.
Q7. What is the QOZ fund’s projected return?
A. Is the fund manager promising a return that seems too good to be true? Internal Rate of Return, or IRR, is a common measure for evaluating real estate investments and is heavily influenced by the amount of time an investment is held. The same project with the same return profile held for five years versus ten years would result in a very different IRR. It should be a red flag for investors if a manager is not adjusting its IRR targets for a longer-than-normal holding period. Additionally, long-term appreciation, often represented by an equity multiple, can be more powerful in the QOZ program based on the tax forgiveness for gains realized after the 10-year holding period.
Q8. What are the terms of the QOZ fund – what types of fees are charged to investors and what is the manager’s share of profits?
A. Real estate funds will almost always have an asset management fee and carried interest. These are the primary ways the manager is compensated. The asset management fee is a small, yearly fee generally seen as supporting the manager’s ongoing operations, while the carried interest is a performance-based incentive earned by the manager for passing pre-defined return targets. If a manager is charging higher fees or taking more carried interest in a QOZ investment than one of their other funds or investments, the investor should understand why. Additionally, investors should look out for QOZ investments that charge additional fees, such as acquisition and disposition fees, and understand fully how the manager is getting compensated.
Q9. Which service providers does your QOZ fund manager use?
A. Has your fund manager engaged sophisticated legal and tax counsel with relation to their investments? The QOZ program is still relatively new and remains an evolving area of investment with a complicated set of rules and requirements. Receiving proper counsel in navigating the program is just as important for the fund as it is for its investors. Make sure to review who is associated with a particular QOZ fund offering and check that there is appropriate representation from experts.
Q10. Transparency – How often does your QOZ fund send updates and what types are they?
A. Good, responsive investor relations and quality reporting are important aspects of keeping track of your investment and understanding the QOZ fund’s value. Make sure reporting is comprehensive, transparent, and regular so that you are informed about your fund’s performance.
To learn more about Grubb Properties’ Link Apartments Opportunity Zone REIT, click here.
Managing Director, Investments