Qualified Opportunity Fund Investment Portfolio: What Did I Invest In?

It’s been a busy 6 months since I set up my Qualified Opportunity Fund (QOF). [If you missed my first 2 posts, I provided an introduction to the new Opportunity Zone (OZ) tax law and my decision-making process in setting up my own QOF.]

Please note: my discussion of tax law below should not be interpreted as legal advice. As always, you should consult your legal and/or tax advisor for advice on how this law may apply to your personal circumstances.

I quickly decided to deploy my QOF capital into rental real estate. Under the new OZ tax law (Internal Revenue Code Section 1400Z-1 and 1400Z-2 plus related proposed Treasury regulations), rental real estate had the most clarity in terms of what one can and cannot do to qualify for the tax benefits (although Treasury has provided more clarity with respect to other types of “Qualified Opportunity Zone Businesses” in the latest round of proposed regulations issued in May 2019.)

Per those Code sections, a QOF must hold at least 90 percent of its assets in “qualified opportunity zone property,” which includes tangible property used in a trade or business of the QOF as long as the “original use” of the property commences with the QOF or the QOF “substantially improves” the property.

From a rental real estate perspective, a QOF could certainly acquire a fixer upper building located in an OZ, make substantial improvements (in accordance with guidance from the OZ Treasury regulations), and then rent it out or even flip it. Alternatively, a QOF could acquire land, build new construction from the ground up, and rent out the property as “original use.” I took the position (with guidance from my CPA), that acquiring a new construction property from a builder would satisfy the “original use” requirement (assuming the builder had acquired the land and built from the ground up).

Tapping into a real estate investment association (REIA) in my area that has built a network of turnkey rental property agents, builders, and property management companies around the country, I identified and dove into due diligence on new construction properties being built in OZ areas in Cincinnati Ohio, Birmingham Alabama, Ocala Florida, and Palm Coast Florida.

I visited each of the areas where the properties were under construction. Other than being located in an OZ, my investment criteria were the same as for a typical rental real estate investment: a growing local economy (especially growth in employment), where the numbers work for rental income vs. investment amount. I was also focused on single family or 2-4 unit multi-family properties. My thinking was that the long-term appreciation potential would be greater than with apartments, especially since I wasn’t buying a fixer upper at a bargain and then adding value on the front end. 

The cap rates I was looking at were in the 7-8% range with no debt and a rental income to acquisition cost ratio of about 0.8%, e.g. if my acquisition cost was $100,000, my monthly rental income (before subtracting property management and other costs) would be about $800.

I recognize that these are not stellar numbers compared to finding a rehab project, adding value with a rehab, and then renting it out to get into that magical 1-2+% rental income to acquisition cost ratio scenario. However, with OZ investments, if you choose your investments right, the magic happens on the back end when you liquidate after 10+ years and have no federal capital gains tax due on the appreciation. In the meantime, generating some decent cash flow adds to your overall return and provides you with the cash you need to pay the capital gains tax on your original investment (less your 10-15% up front reduction) when it becomes due after 7 years.

Within 6 months of forming my QOF, I have acquired the following properties and deployed more than 90 percent of my QOF capital. All of these properties are new construction properties built from the ground up:

1) Single family home #1 in Ocala, Florida (the county seat of Marion County FL) - rented out at a 0.8% monthly rental income to acquisition cost ratio within 45 days of completion; no debt

2) Single family home #2 in Ocala, Florida (the county seat of Marion County FL) - rented out at a 0.8% monthly rental income to acquisition cost ratio within 60 days of completion; no debt

3) Single family home in Pell City, Alabama (a suburb of Birmingham AL) - rented out at a 0.8% monthly rental income to acquisition cost ratio within 30 days of completion; no debt

4) Duplex in Palm Coast, Florida - currently still under construction

In a future post, I will deep dive a bit on how the OZ areas were selected across the U.S. and Puerto Rico overall and what my first-hand research revealed for the areas that I invested in...