Deal Diaries: Creating the World’s Smallest Qualified Opportunity Fund in Historic Chicago

In this article

When BiggerPockets Pro Member Tom Shallcross purchased this three-unit in Chicago’s historic Pullman neighborhood, he leveraged unrealized capital gains from a previous sale to create one of the smallest Qualified Opportunity Funds out there. The key to success—and a 35 percent IRR? A strong team and decisive action.

Here’s how.

This deal is a three-flat in historic Pullman. Chicago’s Southside is block-by-block, and I love this little pocket east of Cottage Grove and south of 111th down to 115th. It’s a very cool little area consisting primarily of 150-year-old row homes built for the workers of the Pullman Palace Car Company. (Look up the history—it’s amazing and the whole reason we celebrate Labor Day.)

I’m always looking to purchase in Pullman. It’s a gem of an area with great neighborhood pride, and the city and its nonprofit affiliates are pumping jobs, money, and other resources into revitalization. I already owned several units there and was familiar with the area.

Pullman is a small geographical area, and inventory doesn’t come on the market all that often. I manually scrubbed for non-owner-occupied properties to get a small list for cold calls. This property was from that list.

The details

The building is a legal three unit, with two one-bed, one-baths with dens and one two-bed, one bath. The dens were almost second bedrooms—they were a little seven-by-seven room you could use as an office or den.

This deal happened to be in an Opportunity Zone—which allowed me to create one of the smallest Qualified Opportunity Funds (QoFs) out there.

Why this deal?

I love the area and the work being done there. Chicago’s Southside has a negative stigma along with negative macroeconomic data points—but this neighborhood has positive net migration and job growth, plus the backing of city officials.

Here are some reasons I love this neighborhood:

• The Chicago Neighborhood Initiative is heavily vested in the area and has attracted more than $350 million in development investment
• There has been a 43 percent increase in jobs—not including the 500 jobs Amazon plans to bring to the area
• Pullman is Chicago’s only designated National Park, and the American Planning Association labeled Pullman as one of the greatest neighborhoods in America.

Because Pullman is a designated Opportunity Zone, I had unrealized capital gains within 180 days. This wasn’t the driver of the deal, but it was cool and made the deal even sweeter.  

The team

My attorney is Chance Badertscher from Lavelle Law, who helped close the deal. The seller’s sister was on the title—she was in Mexico, so we had to navigate both obtaining her sign-off and releasing an old lien.

Taking advantage of the Qualified Opportunity Fund was top of my mind. I was curious if the fund was actually an option for me—or if it only made sense for large syndicators. I had recently attended the Midwest Networking Summit and heard Neal Bawa talk on the subject. He broke down all of Chicago’s Opportunity Zones, and Pullman was in the upper 80th percentile compared to all Opportunity Zones nationally.

I was already investing in the area and had qualifying capital gains within the previous 180 days that I could defer with the program but had no idea how to make this happen.

Chance and one of his partners at the firm did a tremendous job establishing my QoF. These funds were relatively new concepts at the time—and also not usually done by an investor of my size. Not only did we get it done cost-effectively, but we also pulled it together quickly. The seller wanted to move on this deal, or the property was going to market.

My partner is also my general contractor, and he played a huge role in estimating and executing our budget for this property. These old buildings have a ton of “gotchas,” but we were prepared based on our experience with similar properties. For example, we wanted to eliminate the old boiler so we can provide separate heating to each unit. We had absolutely no space to place the furnace, so my GC figured out a way to get each one in the ceiling of the units. We also needed to paint the front windows to align with the Historic District of Pullman’s mandated colors.

My Property Manager is Mark Ainley from GC Realty. They leased us up in a timely fashion and currently do a great job managing the building.

The long-term plan

Long-term, I believe in Pullman. But for the actual deal, I’m happy it cashflows with the appropriate underwriting contingencies and is within our threshold to recycle our cash, thus producing a great cash-on-cash return and internal rate of return (IRR). (See below for numbers.)

The numbers

Cash flow is important, but the bigger part of my equation is how much equity can I create. In this deal we were able to produce a very nice equity spread: We bought for $65,000, put in $102,000 in rehab and soft costs, and the property appraised out at $235,000.

After stabilizing the property, I pulled out my initial investment—so the cash-on-cash is technically infinity, as I have no cash in the deal. Depending on what appreciation-related assumptions you want to make, the IRR is also very substantial. This is all before taking into account the tax benefits from the QoF.

My net worth has increased by roughly $65,000—the equity spread from day one of stabilization—and will continue to do so as the tenants pay down the mortgage and the property increases in value. This is all in addition to the monthly cash flow.

The total yearly rents equal $30,688, breaking down as such:

• Gross rents: $32,640—I signed leases at $995, $925, and $800.
• Late fees: $400, at $50 per occurrence.
• Vacancy: -$2,352, assuming seven percent vacancy each year.

And my expenses were $13,810, as follows:

• Taxes: $3,208, which I’m currently appealing to drop.
• Insurance: $1,950
• Electricity: $0 (paid by tenant)
• Water and trash: $1,800, breaking down to $60 per unit per month
• Heat: $0 (paid by tenant)
• Property management: $2,352, or seven percent of gross rents
• Landscaping and snow removal: $1,500—that’s $40 per month for landscaping in the summer months, and the snow removal normalized based on historical averages
• Maintenance and small repairs: $1,500 at $500 per unit
• Operating reserve: $1,500 at $500 per unit.

Combined, the rents and expenses created a net operating income of $16,878.

My annual debt for this property is $11,328, or $944 per month—that’s assuming a $170,000 mortgage at 4.5 percent, amortized over 300 months.

Initial investment

• Purchase: $65,000
• Rehab: $102,000, including permit
• Soft costs: $8,000

I had private funding for $140,000 and a $25,000 promissory note—so my actual cash was just the contingency factor and fronting the holding and soft costs.

Budget

My GC walked the property beforehand, so we had a good grasp on rehab. We thought we’d spend $95,000 but ended up at $102,000. However, a good chunk of that overage was the conscious decision to add the storage units in the basement.

We also thought we could get away without supplying appliances—that’s kind of a case-by-case situation in the Southside—but to rent this out, we ended up buying a basic appliance package for each unit.

Current return on investment

We technically have no or minimal money in the deal, so the return on investment is infinite. The IRR is over 35 percent, assuming three percent appreciation—which I expect to be much higher. It also does not account for the QoF tax benefits.

The number is so high because we created such a high equity spread on the front end. 

Here’s an intangible return on investment: I grew as an investor because I stepped way out of my comfort zone to set up the QoF. I now understand the process much better and I’m set up to successfully invest in Opportunity Zones.

Data I wish I had

It was tough to evaluate the potential rents on the one-bed, one-bath units with the additional bonus rooms. I owned one-bed, one-baths and two-beds, one-baths in the area—but nothing quite like this unique arrangement. There also weren’t any finished units of this size listed on the market, so we were slightly off on the expected rent.  

Closing the deal

Getting the QoF established was tricky and intense as I needed to align with my accountant and attorney, establish the new LLC, and ensure my existing unrealized capital gains conformed to the appropriate paper trail.  

In addition, we had title issues and needed to get the seller’s sister to sign off who did not live in the area. Once involved, she questioned multiple aspects of our deal… without really understanding the deal.

Surprises

Here’s a good surprise: Finding out I could establish a QoF to defer and eliminate a portion of capital gains from a previous investment—and enjoy potential tax-free gains on 10 years of property appreciation. This was a great deal before that benefit, and the tax benefits made it even better.

Bad surprise: These are smaller units, so we spent a little extra to add nice individualized drywalled storage units in the basement. Extra storage space—great, right? Only one of the three tenants actually uses the storage area!

Rehab required

• Demolition
• New three-story back porch
• Repair flat roof
• New kitchens
• Gut all bathrooms
• New flooring
• New trim and doors throughout
• Paint throughout
• New HVAC
• New electrical fixtures
• New storage lockers in the basement
• Masonry repairs
• Paint window exteriors and replace older windows

Advice for investors

1. Action is the cure to uncertainty
2. Leverage others

I didn’t know how to set up a QoF, but I just kept taking the next baby step and reaching out to people who could help me move forward.

Ask yourself: What’s the next step I can take to get me to the desired outcome? Then do it.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.