JF2301: OZ Fund Investments With John Rubino #SkillsetSunday
John is a returning guest from episode JF1630, he has extensive knowledge and experience in real estate investment, lending, development, construction, consulting, and marketing. He currently serves as the COO, Founder/Partner at JID investments LLC. He is also a passionate and accomplished United States Naval Officer & Naval Aviator with 20 years of honorable active duty service. Today he will be sharing his experience in starting his first OZ fund investment project.
John Rubino Real Estate Background:
- Founder, COO & Co-Managing Partner of JID Investments LLC (JIDI)
- 15 years of active and passive real estate investing experience
- JIDI portfolio consist of over $14.5M invested in six projects in DC, North Carolina, South Carolina and Atlanta
- Based in Fairfax, VA
- Say hi to him at: www.jidinvestments.com
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Best Ever Tweet:
“As a capital investor, you can take your capital gains and invest them into an Opportunity Zone with deferment” – John Rubino
Theo Hicks: Hello Best Ever listeners and welcome to the best real estate investing advice ever show. I’m Theo Hicks and today I’ll be speaking with John Rubino. John, how are you doing today?
John Rubino: I am doing fantastic, Theo. Thank you so much for having me. I’m excited, honored, it’s a pleasure, and looking forward to talking with you and your listeners.
Theo Hicks: Well, thank you for joining us again. So John is a repeat guest. His episode is 1630. He was on a year and a half ago from this recording, February 2019. That episode was Raising Capital For Completing Big Deals. We talked about raising capital. And this episode, being on a Sunday, is going to be a Skillset Sunday, so we’re going to talk about a specific skill that our guest has. Before we get into that, as a reminder, John is the founder, COO, and co-managing partner of JID Investments. He has 15 years of active and passive real estate investing experience.
The JID Investments portfolio consists of over 14.5 million dollars invested into six projects in DC, North Carolina, South Carolina, and Atlanta. He is based in Fairfax, Virginia, and the website is jidinvestments.com. So John, before we dive into the skillset, do you mind telling us a little bit more about your background and then what you’re focused on now?
John Rubino: Sure can. I’ve been in real estate for over 15 years now. I served in the Navy – you can see some of these cool airplanes behind me – for 20 years. I retired back in 2017 and started my business in real estate back in 2013. I was a little bit of an active investor when I first started. I did some renovation properties, I did some new construction properties… And I really found my niche though after a few years in the business, in the passive investment side, partnering with sponsors and developers, doing a lot of the heavy lifting, and finding real quality projects on the residential, commercial, mixed-used side. I decided that I wanted to be in that world, to passively invest, have less of the risk of the management with the operations piece, the recourse, the guarantees, and a lot of the stress that the developers deal with. I wanted to be more on the sidelines with the money, and be able to help and get them over the hump with their capital stack on the equity side.
So I did that for about seven years while I was still in the Navy, and when I got back to DC for my final tour in the Navy, I started JID Investments in 2013, together with my accountant at the time, who’s now my business partner. And together, we set the business up, and a lot of the information that I shared with Joe kind of covers it on our first episode on how we came about and how we started.
Fast-forward to where we are now with our business, we have about 143 investors that are accredited, high net worth individuals and businesses that we go out to… And I guess you can call it syndication. We syndicate projects with partnered sponsors and developers on the active side, and we bring those projects to our 143 investors, of which David and I are inclusive of, and we raise money for those projects.
A lot of the projects we are investing in, like you said, Theo, DC, Maryland, Virginia, South-East is kind of our backyard. And given what’s going on with COVID and a lot of the unknowns with the economy, I’m really happy that we’ve selected those markets, because they’ve been able to see a little bit of resiliency – more so in DC – than other markets that are really struggling right now. So I think that that’s really given us I guess a knee up, or just a little bit more confidence that our investments are absorbed well. And when we do see recoveries, and again, growth in the economy, we feel that we’re going to be on the forefront, given those markets. So we’re excited, we’re doing really well, we’re scaling the business, we have some really cool and amazing new projects coming in. And that’s what we’re doing.
Theo Hicks: Thank you for sharing that. From your ending there with a very cool project, we’ll transition into the conversation of today. So the skillset we’re going to talk about today is opportunity zones. So I’m going to let you take it away, and then I’ll follow up once you’ve said your piece.
John Rubino: Absolutely. And full disclosure to your listeners, opportunity zones are very comprehensive, large scope type investments, where you definitely need to speak with the professionals in your world that handle your taxes, your broker, your business attorneys, to make sure that they are there for you to go through some of the details and some of the specific legalities and compliance which I’m not qualified to speak of.
What I will talk to you about is a little bit of what the program entails, the process of how it started, and how it’s become a wonderful opportunity for folks to take advantage of tax sheltering, tax benefit investment. Similar to what an active investor does with a 1031, a passive investor can now utilize this as an outlet or a venue to take capital gains and roll into an investment that allows them the ability to defer, to grow, and to still be involved in real estate to see appreciation in their capital and their investment.
So back in 2016, with the JOBS Act that came through through the Trump administration, Senator Tim Scott of South Carolina, and Cory Booker, and a bipartisan legislative bill as part of the 2017, 2016 JOBS Act put the opportunity zone plan together. There’s a lot of leaders inside of that – Secretary Carson, Governor McMasters down in South Carolina, they all came together and they put this legislation. And really what it did is it empowered the states to go out and identify certain parcels of land or pieces of land in urban low-income, potentially affordable areas that needed regentrification and really needed a boost to get their areas growing. And what these governors did is they went out and they identified the properties and the locations and got that back to the federal government, and that became the opportunity zone map for the country.
What that then allowed is it opened the door to have public and private investors come in and to purchase property to take advantage of and to utilize the system and the law within its jurisdiction to then have investments take place.
So the way it works is a passive investor can come in — and this is purely the investment side. There’s a lot of intricacies from a development side, Theo. There’s got to be a percentage of businesses that operate within the opportunity zone for the period of time of that investment. There are other details from the development side, but I really want to get into the investment side. The investment side – as a passive investor, you can take capital gain from the sale of a business, a stock, an investment property, take those gains, and you can invest them into an opportunity zone.
And the benefit is first, you get to defer that gain for the first six years of the investment. The total investment time on the opportunity zone is about 10 years minimum. Over the first six years of the opportunity zone, you can defer that gain and not pay any taxes on the year of liquidation. So that’s the first benefit.
The second benefit is in year five of the investment, there’s a reduction in basis of 10% on the investment to have as far as your capital gains tax on that money. So let’s say you brought in 100,000, Theo, and you’re one of the investment; in year five you get a reduction of $10,000 or 10% on the basis to now have to only pay the deferred gain in year six on the taxes at $90,000. So that’s benefit number two.
And then, of course, benefit number three is anything you earn on an invested gain over the minimum of a 10 year period is tax-free. So let’s say you brought in $100,000, you get the tax benefits that I laid out on the deferral and the basis reduction. And then let’s say in year 10 when we exit, or year 11 when we exit, somewhere in that period – it depends on the investment opportunity – you make a 2X on your money, you make 100% return, and you get $100,000 profit from your $100,000 investment. That $100,000 profit is tax-free.
So in the encompassing investment of the 100,000 that you brought in, and the $100,000 that you’ve earned, the only taxes you’re paying on long term capital gains would be the 100,000 that you brought in on the investment. And that would be at 90,000. So you’re getting taxed on 90,000, for $200,000 of investment growth. So hopefully that gives a little bit of insight into the program.
And there’s a lot of folks that are doing it right now, there are groups throughout the country. We are actually getting ready to invest in our first 506(C) offering here in Washington DC with a sponsor that we’ve done a deal with before. We’re very excited. It’s in a wonderful location, and we’ll have the opportunity to participate in their second opportunity zone fund. This will be our first opportunity zone investment. A little bit different from what we usually do, Theo. We usually raise money on a project by project basis for one specific opportunity or project. This will actually have anywhere from two to four properties or projects, which in the opportunity zone world they call it a qualified opportunity zone businesses or QOZBs, qualified opportunity zone businesses; the actual properties we’re going to be investing in on this opportunity. So there’s anywhere from two to four. So it’s like two to four projects in one that we’ll be investing in. So it’s really exciting, it opens so many doors to the potential of utilizing investment capital for a different type of investment, and I think most of all, is that it obviously brings growth and regentrification into areas that need it the most.
Theo Hicks: For the passive investor side, is there still the income tax paid on annual distributions? Or is that tax-free, too?
John Rubino: No. This investment, when you come in, it’s a deferral investment, so you’re not getting paid your money back until the end of the investment. The monies that you bring into the investment can only be a gain; it can’t be income, it can’t be distributions from let’s say multi-family cash-flowing asset… It’s got to be gains. So if you sell an investment property, if you sell stock in Apple, if you sell a portion of your business and you have a realized gain, that gain, that profit is what you can bring in.
Theo Hicks: So I can’t go in my bank account and just say “Hey, I’ve got…” Okay, okay.
John Rubino: No, you can’t. And it’s the same window for timeline than it is for the 1031. It’s six months from the time you liquidate to the time you identify the investment in the opportunity zone. And then you actually invest in the qualified opportunity zone fund or QOF, which is what we’ll have. And that’s your timeline.
Now, with COVID, the federal government, the IRS has relaxed some of those time constraints. So I’d have to go back, but I believe as early as November of 19, all the way through December of 2020, you’ll have the opportunity to bring in gains into an opportunity zone fund, whether it’s with us or any other type of investment that’s out there for OZs.
Theo Hicks: So as a passive investor I [unintelligible [00:14:43].16] the property, I put my $100,000 in this opportunity zone, and I don’t see any cash flow; I’ll just get money at the end once it’s it end once it’s…
John Rubino: It depends on the investment. So our investment will actually get some cash flow because we’re starting at land development, to development of the property, to construct, to pre stabilized, to full stabilized, to tenant move-in, to cash flow and distribution. So the sponsor can be paying out some cash flow to us somewhere at the midpoint of the investment, with the intention of that cash flow being utilized to pay the deferred gain on the invested capital.
So if you bring in the 100,000, you’re going to get a tax bill in year six on the 90,000. Remember, you get that 10% reduction in basis; the cash flow that we’re going to generate in our specific property that we’re going to pay out to our investors will help with some of the burden of the tax you have to pay on the 90,000. And that will be also part of your waterfall and your profits from the investment post 10 years. So since it’s going to be used to pay some of those gains, there are ways to do it legally that you can pay the cash flow and still keep it as part of the end closeout for the project post 10 years. Does that make sense?
Theo Hicks: Could you explain that last part again?
John Rubino: Yeah. Traditionally, if you bring in the investment at 100,000, you have to pay your taxes in year six, and then you’re not going to get any cash flow out until the property finishes in year 10. You close out, whether there’s a recapitalization or sale of the property or the project, you’re going to get your investment money back, and you’re going to get your profits back. It’s considered long term capital gains.
Depending on how it’s structured – and our specific OZ will be structured this way – the developer or the investor that’s running the project may be able to pay, at some point inside of that timeline (the zero to the 10-year mark) cash flow, and capture it as part of the profits when we close out on the back end of the project, with the intention of the cash flow being utilized to pay your deferred gains taxes on the original investment.
Theo Hicks: So will that cashflow be taxed as income is my question.
John Rubino: No, it’s a good question. It won’t be income. I know it’s not income because you’re not earning that inside of the one-year period. You’re earning that throughout the period of the investment, which is over one year. That’s a good question, and I’m going to take a note on that… But the way I understand it, it’s not taxed as income, and you wouldn’t have to pay the taxes on it when it’s distributed. It would be paid when the final closeout is. But again, talk to your tax professional. But that’s a good question. I want to follow up on that. Thanks for asking it.
Theo Hicks: So you said that the OZ is a minimum of 10 years? At 10 years they sell or refinance – this is what always happens? Or will I not see my profits for maybe five years after that or a year after that?
John Rubino: No, it’s really predicated on a 10-year period minimum, and then depending on your specific opportunity, there may be a six or 12-month extension that the developer has available that may take it out to 11 years, or 11,5, or 12 years. But it’s not a 10-year investment and the developer keeps it for 40 years. No. That’s all in the legal docs and your subscription agreements, so make sure as an investor, you read that. And that’s a good question. There’s usually an extension period post 10 years, but that again, is just there for if it’s needed.
Theo Hicks: Like if they can’t sell it, or something?
John Rubino: Well, if they can’t sell it, or it may be better than the market is in a period of growth, and there’s potential to grow more, or there could be some debt on there that goes out to a longer period than they may need… It just depends on the investment.
Theo Hicks: What would be the returns metric that’s used for these? Is it IRR, is it equity multiple?
John Rubino: We typically go out with an ROI, which is a flat out rate interest-only, no accrual. We do answer that question. It’s usually when we see these on the opportunity zones. It’s usually an IRR that can be accrued, 7%, 8% potentially. So that gets you maybe a 12% or 12,5% return on investment. It just depends on how much you bring in, what the period is… But it’s usually treated as an IRR, with an equity multiple that’s disclosed. We like to compute it, again, straight return on investment, and we clarify that with the developer.
And the other thing too is we’ll also show what the pre-tax return is, which is very important, because if you’re a resident of California and I’m a resident of Virginia, and we have an investor and she’s a resident of Florida, your capital gains structure may be different at a state level. So you’re usually paying 15% federal, but California may pay 12%, and Florida may pay 2%. So you want to show that as well in your metrics.
The other thing you need to think about too is depreciation, because a lot of these investments have depreciation. Once these investments start stabilizing and start having cash flow revenue, there’s going to be the potential of depreciation, and the potential for double depreciation, where you get to write off depreciation and as an investor there’s no write-off; you have to take that on as a burden on the back end. And that’s the specific design of a specific OZ. It just depends, yeah.
Theo Hicks: What types of properties are these usually? Are they retail? Are they industrial? Are they multi-family?
John Rubino: Again, it just depends. There needs to be a level of business that operates within the opportunity zone. Again, I don’t have this specific percentage and how long, but I believe it’s 90%. Your listeners can verify that. But there needs to be an element of business that stays within the opportunity zone for the duration, and that percentage has to be that number, while it’s still going through the full 10-year period.
But these usually start out land development with a development piece to build, and then there’s a construction piece, there’s a hold period… And it could be mixed-use, it could be part of a larger grouping of properties that are commercial, mixed-used and residential… It just depends on that specific opportunity.
Theo Hicks: From a passive investor’s standpoint, what are some things that they need to know when they’re looking to invest in an opportunity zone, compared to your typical apartment syndication deal? Not what are the main differences, but just what are the important factors they need to look at and understand to properly analyze an opportunity zone deal?
John Rubino: I think, first and foremost, you need to understand the implications from a tax perspective to see what makes sense. The nice part about an opportunity zone, different from a 1031, is with a 1031 you’ve got to bring everything back into the next property, right? With an opportunity zone you could bring in 1% of the gain that you earned or 100%; whatever you bring in gets treated with the opportunity zone process or the strategies; whatever you don’t bring in, you’re just going to pay long term capital gains on that for that tax year, right?
So I would say it’s important for someone to sit down and talk with their CPA, talk with their financial advisor, say “Look, I’ve got a two million dollar gain because I sold X amount of shares of Apple, and I’m thinking about putting it into an opportunity zone. How does that impact me from a tax perspective? How does that impact me from a risk perspective?” Because this is a riskier investment, and you have to take into consideration your risk versus your return. So I would say that, to me, the taxes are really a big thing. And also, you may have older investors that may not like the timeline, right? 10 years, 11 years if you have an older investor… But it could be a way to have as part of your estate to pass down to your children or your grandchildren, right? Which is also another benefit. But it’s definitely a lot more intuitive, and the scope of it is a lot more complex. That’s why it’s a 506(C). You’ve got to be able to get your arms around it and understand it. We do our part explaining things, but it’s definitely important to go out and look at the legislation, look at the information that’s out there on it, so you understand it better.
Theo Hicks: Perfect. So is there anything else that you want to mention, as it relates to opportunity zones or anything else?
John Rubino: Yeah. We’ll have more information about our specific opportunity here in the next two to three weeks. Our website will have a page dedicated to it. Again, I’m not a legal expert on it or compliance, but I’m happy to answer any questions that your listeners may have, and try to point them in the right direction if I don’t have those answers. So thanks for the opportunity to share that.
Theo Hicks: Absolutely. So two to three weeks from today, because we’re recording this in the middle of August… So if you’re listening to this in September, and after, until you said — what, December of 2021?
John Rubino: Yeah, we’re looking at keeping our opportunity zone investment out to as long as December of 2021. The nice thing about ours is that the level of investment is a lot lower in the threshold. Typically on these investments, the minimum could be anywhere from 100,000 to a million. We’re looking at setting ours at around 20,000, so you can come in at $20,000 with a gain and be able to invest on a potential 10 million dollar overall investment, which is what we’re trying to raise inside of the 150 million dollar fund that the sponsor has, which is very attractive to folks, and it gives them some flexibility and leverage.
One other thing I’ll say about it is obviously we have presidential elections coming up, so there is some information that’s being disseminated about what the implications would be, pending which administration comes in. So you definitely want to read about that. Do I think that the program is going to be eliminated? From what I’ve read, no. It won’t be eliminated regardless of who the next president is going to be. But what I’m reading is that there could be some changes made to it. So you definitely want to understand that, read that and be able to comprehend that before jumping into one, especially as we’re getting closer to the election.
Theo Hicks: That’s a good point, John. Well, thanks again for joining us and going through opportunity zones. Perhaps you’ve heard of these before, because I’ve looked through [unintelligible [00:25:03].17] and seen terminology, but I’ve definitely learned a lot in-depth and definitely learned the advantages of the opportunity zones, the benefits from the perspective of the passive investor [unintelligible [00:25:11].01] the taxes you went over, that you’re able to defer taxes for the first six years; there’s a 10% reduction in basis after year five… And you said anything earn is tax-free.
John Rubino: That’s correct, after that period.
Theo Hicks: After the 10-year minimum. It’s kind of similar to the 1031 exchange for passive investors. And then when you’re looking at these types of deals, you said talk to your CPA, your tax guide for how it will benefit you, and what potential risks there are.
You mentioned that it’s 506(C), so it’s a pretty complicated, sophisticated investment, so you need to be credited… And then kind of pay attention to the various pieces of legislation regarding the opportunity zone. So, John, I appreciate you coming on. Make sure you check out his website, it’s jidinvestments.com. And then, as you mentioned in the intro, you can learn more about the beginning of his business; that is Episode 1630. I appreciate it, John.
John Rubino: My pleasure. Thanks, Theo. Great talking with you and your listeners. My best to Joe, and thanks again.
Theo Hicks: Absolutely. And Best Ever listeners, as always, thank you for listening. Have a Best Ever day and we’ll talk to you tomorrow.
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