Opportunity zone funds are growing at a rapid pace. In 2018, these funds, which came about as a result of the The Tax Cuts and Jobs Act of 2017, totaled $5 billion. By the first quarter of 2019, opportunity zone funds total $20 billion, and experts predict that number will hit $100 billion by the end of 2019, according to GlobalSt.com
Opportunity zones provide investors with significant tax advantages in hopes of stimulating economic development in under-resourced communities. The tax advantages include deferring the payment of tax on an investor’s capital gains until 2026, getting up to a 15% discount on the tax on those capital gains at that time, and then no tax on the investor’s profit upon wind-up of the fund after 10 years.
M31 Capital is one firm that is riding the wave. This week, the San Francisco-based company launched Morpheus 1 Opportunity Zone Fund, which is the firm’s first opportunity zone fund. The fund will invest in the greater San Francisco Bay area.
The Morpheus 1 Fund is expected to invest across a wide range of properties, including off-market multi-family housing, mixed-use properties, empty or neglected apartment buildings, unoccupied offices and vacant land located in Opportunity Zones designated by the Governor of California and the U.S. Department of the Treasury. The greater San Francisco area, known for its soaring real estate values, is home to 80 Opportunity Zones.
The Morpheus 1 Fund is targeting $25 million to $30 million of investment. The firm also has a real estate fund, The Black Rail Fund, that invests in real estate deals. Its first Back Rail fund was $10 million. The firm plans to fully exit that fund by 2020. Black Rail Fund II is expected to be raised later this year and will be double the size of the first fund with a $20 million target.
Talyor Lembi, CEO of M31 Capital, talked with Middle Market Review about the new fund and the industry going forward.
Why did you decide to launch an Opportunity Zone fund?
We looked into this in the middle of 2017 because investors brought it to my attention. We dug into the regulation and it sounded very appealing. We ultimately decided it would be a good fit for us. We are looking to invest in existing multi-family properties that have high rehab needs. We have looked at a couple of deals and we plan to do the renovations and bring the properties back to market.
Our primary target area for investment is the San Francisco Bay Area. We know this area and decided it made sense to invest where have been investing for more than 20 years. We are primarily looking at the East Bay.
There is high housing demand in the Bay Area and lots of vacancies because owners can’t improve the properties for various reasons. We are fully renovating the properties, upgrading them and looking to convert commercial into multi-family units.
Why does an opportunity fund zone fit with your investment thesis?
We have a vertically integrated business. So, for example, we own a property management company that works throughout the Bay Area and we also own a construction company and interior design business that will look at properties and tell us how to make under-utilized space work. We also have a company that can access credit bureaus in China, Canada and Mexico, which is a big help because when people can’t get their credit approved they get charged a lot extra in security [deposits] for rental units.
All of these businesses streamline our process because everything is fully integrated due to our affiliations with these companies.
Everyone knows San Francisco is one of the most expensive places to live, but how are housing needs changing?
People are living differently now. People are coming out of college in many cases with student loans, and don’t want a majority of their money going to a mortgage. They have realized you don’t need that much space to live. A single person will use 250 square feet today, whereas in the past they would say “no way.” Furniture is more compatible now and people are cooking less, enjoying their cities and the nightlife. The majority of the time people are not spending most of their time at home.