Even by alternative investment standards, the compliance requirements for Opportunity Funds are rigorous, which underscores the importance of harnessing the knowledge and capabilities possessed by experienced operators.
We believe that possessing a robust experience set should help fund operators:
- Lessen the risk of the fund
- Facilitate compliance
- Optimize tax efficiency
- Differentiate the investor’s experience
Lessen the Risk of the Fund
Compliance is key in the ongoing management and operations of Opportunity Funds. Failure to comply with legislative restrictions and regulatory guidance could potentially cause a fund to incur penalty fees or lapse in its status, putting at risk qualification for the tax benefits available to investors. Specifically, Opportunity Funds are subject to strict guidelines governing the following key elements:
- Speed of capital deployment
- Nature of assets acquired
- Source of income produced
- Manner in which potential asset disposition proceeds are treated
Ensuring ongoing compliance with these parameters is no short order. However, there are ways in which fund operators with robust compliance experience may be able to mitigate the compliance risks associated with this new type of offering and maximize the chances that the fund is able to maintain continuous compliance with a complex and evolving set of regulatory parameters over the required 10-year hold period.
For instance, you may be familiar with the 90% biannual qualifying asset test to which all Qualified Opportunity Funds (QOFs) are subject, whereby a fund may qualify as a QOF only if it invests at least 90% of its capital into eligible Opportunity Zone assets, and proves that it has done so on a biannual basis.
In addition to real estate located in Opportunity Zones, another type of eligible asset is a Qualified Opportunity Zone business, or QOZB. In order to qualify as a QOZB, at least 70% of property owned or leased by the entity must be located within designated Opportunity Zones.
We have structured our QOF so that our real estate investments are held within a subsidiary QOZB). While 90% of the gains invested into our fund must be invested within the QOZB itself, only 70% of the QOZB’s assets must be allocated across eligible real property. While we expect to exceed the 70% threshold, this structure significantly reduces our fund’s compliance risk and improves the likelihood of it successfully passing the biannual asset test to which it is subject every six months.
It’s important to note that the 90% biannual threshold test is just one example of many regulations that Opportunity Funds must adhere to. Other major regulations include:
- The 30-month time limit to substantially improve upon the fund’s assets.
- The 12-month timeframe during which the fund is required to redeploy disposition proceeds across new eligible investments.
- The ongoing crafting of and execution on multiple concurrent working capital plans.
Many of these restrictions relate to the expediency of asset acquisitions and improvement. In other words, we expect that the successful management of a QOF will be heavily contingent upon the fund’s operator possessing extensive experience in timely matching invested capital with high-quality real estate investment opportunities, and swiftly executing on value-add strategies.
We were eager to launch the Fundrise Opportunity Fund, because we saw an opportunity to leverage our unique experience in this area in order to help our investors take advantage of new tax benefits and, we hope, boost their net returns.
By vertically integrating both the capital raising and real estate underwriting/managing components of our business, we have acquired significant experience in the timely and opportunistic deployment of capital. At any given time, we are actively raising funds for more than a dozen separate Regulation A offerings, whose performance is contingent on our ability to quickly allocate newly invested funds across real estate assets. In other words, we’ve spent years refining the balance between minimizing cash drag and maintaining extremely selective underwriting standards, which is experience that we hope to put to work with the Fundrise Opportunity Fund.
It’s also worth noting that compliance with Opportunity Fund investment parameters will require a hefty volume of IRS reporting. Companies like Fundrise who sponsor Regulation A funds are used to this since Regulation A funds are required to meet strict public reporting regulations similar to those imposed on large public companies. For instance, Regulation A offerings are required to furnish annual financial reports containing externally audited GAAP statements, unaudited semi-annual reports, and public filings reporting material events.
To provide context, across our various sponsored Regulation A offerings, we have submitted approximately 1,200 SEC filings since our first eREIT was incepted in late 2015. This equates to an average of more than 300 filings per year. Our real estate, legal and accounting teams have hence acquired substantial experience in communicating financial results and key asset events, and our team has implemented various systems and processes to streamline these filings.
Optimize Tax Efficiency
In addition to general securities compliance expertise, REIT-specific compliance experience is highly relevant in the Opportunity Zone investment space, as we believe that Opportunity Funds may be best optimized through a REIT structure.
Multi-asset funds structured as non-REIT partnerships still face uncertainties surrounding permissible exits, whereas the most recent round of proposed regulations released by the IRS provides clear guidance for REITs. Moreover, REITs are poised to benefit from the new 20% deduction for Qualified Business Income enacted through the Tax Cuts and Jobs Act.
Ensuring REIT compliance is a demanding endeavor, as REITs are subject to strict restrictions governing:
- Types of assets that may be acquired
- Sources of income
- Distributions of taxable income
- Asset divestment options
At Fundrise, our team has significant REIT compliance experience as a manager and operator of more than 10 individual REITs.
While Opportunity Funds have unique compliance stipulations that are new to everyone, we believe fund sponsors with a rich foundation in other forms of compliance may be best positioned to optimize a QOF structure, and better able to navigate the regulatory requirements of this new type of investment.
Differentiate the Investor’s Experience
Another key element of QOF management and operations involves not just compliance reporting, but investor reporting. While we certainly aren’t the only manager of real estate private equity funds with compliance expertise, we feel it is essential for investors to evaluate not only the robustness of a fund manager’s experience, but also its ability and inclination to maintain a high level of transparency and frequent performance reporting.
For instance, at Fundrise, we’ve gone a step beyond legal requirements to provide our investors with granular insight into the individual real estate assets comprised within their portfolios. On the Fundrise investor dashboard, investors can access not only a high-level overview of their portfolio, but also details on the development of individual assets from start to end. We expect to provide this same transparency to the Fundrise Opportunity Fund, such that Opportunity Fund investors should be able to not only track the overall performance of their portfolio, but also pivotal events and benchmark achievements pertaining to individual assets.
At Fundrise, our first priority is to offer low-cost, risk-managed, and accessible real estate investments to our investors, even when doing so requires extensive work in the realms of compliance management and tax efficiency optimization.
Now that Opportunity Zones have been established as a tax-advantaged way to invest in real estate today, we knew it was incumbent upon us to add such a fund to our suite of investment offerings.
For those interested in this type of investment but still trying to decide on a particular fund, we would stress the importance of evaluating an operator’s compliance experience and track record, as well as whether they provide frequent and transparent investment-related communications.
If you’re interested in learning how you can invest in Opportunity Zones with Fundrise, you can find out more about our investment strategy for the Fundrise Opportunity Fund here.