AIQ Summer 2019

Q U A R T E R LY

ALTERNATIVE INVESTMENTS QUARTERLY

SUMMER 2019 VOLUME 13 ISSUE 2

Beyond the Hype:

A Cautious Look at First Generation QOFs I Second Round of Regulations Add Some Clarity Around QOF Investments I 5 Questions: Student Housing I The Power of Triple Non-Traded Protection I ADISA News

Q U A R T E R LY

SUMMER 2019 VOLUME 13 ISSUE 2

1 — President’s Letter

ALTERNATIVE INVESTMENTS QUARTERLY

ADISA Thrives

ADISA EDITORIAL BOARD

2 — Executive Director’s Letter

Chair I Brandon Raatikka I FactRight, LLC Peter Magnuson I Ladenburg Thalmann

CONTACT INFORMATION

Rulemaking All Around

4 — Beyond the Hype: A Cautious

ADISA I 10401 N Meridian St., Suite 202 I Indianapolis, IN 46290

Look at First Generation

Direct: 317.663.4180 I Toll Free: 866.353.8422

Opportunity Zone Funds

Fax: 317.815.0871 I E-mail: adisa@adisa.org John Harrison I Executive Director I 317.663.4172

12 — Second Round of Regulations

Tanisha Bibbs I Director of Event Planning I 317.663.4174

Add Some Clarity Around

Jennifer Fitzgerald I Director of Marketing I 317.663.4175

Qualified Opportunity Fund

Tony Grego I Associate Executive Director I 317.663.4173

Investments

Erin Balcerzak I Member Services Coordinator I 317.663.4183 Design I DesignMark I Susie Cooper

adisa.org Copyright © 2019

By ADISA (Alternative & Direct Investment Securities Association), formerly REISA, formerly the Tenant-In-Common Association.

18 — 5 Questions: A Spotlight

on Student Housing

20 — The Power of Triple

Non-Traded Protection

All rights reserved. Readers may copy sections of this publication for personal use. However, it is a violation of U.S. copyright laws to copy substantial portions of the publication for any reason without permission. The Copyright Act of 1976 provides for damages for illegal copying. If you wish to copy and distribute sections of this publication, contact Jennifer Fitzgerald at jfitzgerald@adisa.org.

26 — ADISA News & Events

President’s Letter

ADISA Thrives

By Greg Mausz, Preferred Apartment Communities 2019 ADISA President

ADISA continues to thrive in the alternative and direct investment industry.

Key takeaways from this year’s strategic planning meeting is leading to continued innovation as we try new and different ways to serve our member and grow the use of alternative investments.

Our Spring Conference, held in San Antonio this past April, and was a tremendous success, with more than 500 attendees and included approximately 23 educational sessions that covered qualified opportunity funds, Section 1031 exchanges, private equity, energy, legislative and regulatory updates, real estate investment trusts and more. In addition to the closeddoor Broker-Dealer Advisory Council Roundtable, two new roundtables were introduced for RIAs and product sponsors.

ADISA also conducted its first market prediction survey earlier this year with the participation of approximately 70 due diligence officers from broker-dealer and registered investment advisor (RIA) firms. The results were first reported at the Spring Conference • All but 6% of broker-dealer and RIA firms predict a solid increase in firm revenue during 2019, with more an 30% of respondents expecting an increase in revenue of more than 20%.

• More than 90% of the survey’s respondents predict alternative investment to increase in 2019.

One of goals for this survey, which shows the continued growth and adaptation of a wide variety of alternative investments, is to help ADISA members recognize trends in order to collaborate and create product offerings that serve the investor community. (Read more about the results on page 25 of this issue.)

This year’s legal and regulatory work is turning out to be far busier than we expected. With the SEC rolling out regulation Best Interest and now accepting comments on reforming the fundamental rules around private capital formation. Know that ADISA is working hard on behalf of its members to adjust rules that would allow for improvement in the creation of direct investments and their use in high net worth and mass affluent investor portfolios.

ADISA’s next upcoming conference is our popular Alternative Investments Research & Due Diligence Forum, which will be held July 18-19 at The Mayflower in Washington, D.C. This event is unlike other industry events: the sessions are not disguised sponsor pitches, but are educational and led by peers and other experts. There is network time, of course, where sponsors will be available in our exhibit hall to explain offerings. Most are real assets and private placements that are not readily available. We hope you join us in Washington, D.C. As ADISA’s 2019 President, I look forward to continuing to grow and advance the alternative investment industry throughout the remainder of the year.

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Executive Director’s Letter

Rulemaking All Around

By John Harrison, MBA, CRCP®,CAE Executive Director, ADISA

Regulators—that is those who come up with the rules the rest of us have to play by—have a hard task. I’m just back from the annual conference of FINRA, our self-regulatory organization (SRO) that governs finance.

It was a good meeting; I kept my FINRA certification current, saw some good sessions, and the reception at the newly relocated International Spy Museum was a lot of fun (interesting to take a group of compliance and enforcement types to see how spies break the rules).

We all know we need rules and no matter your feeling about a certain regulation, it can’t be that easy making up workable rules. Just ask yourself, “what happens when I try to make a new rule in my own house?” Let me report on my own decades-long experiment with making up a rule one day.

The kids started making noises about being pulled away from the television on Sunday mornings when it was time for church. Enter the patriarch (moi) to decree a new rule: no screens of any kind on Sunday mornings before noon.

There you have it, I thought, problem solved.

“I appeal,” came the declaration of the daughter, age 13. Well, in our house we did have an extant process for appealing a non-emergency parental declaration, and it was simple. There were two prerequisites: a good attitude and new information.

“Your attitude is fine, but what is your new information?” I replied to this delay tactic on her part and wondered if I was going to have to pay for law school for this kid eventually.

She replied, “I would have to think that most accidents in the world occur on Saturday nights and that if you don’t see the television or check your smartphone on Sunday morning, you might miss some vital, potentially life-saving or life-threatening situation.” The law school expense was looking like a definite possibility.

“OK, I’ll amend the rule to be no screens except for a quick two-minute check of your phones,” I said. “Remember the purpose is so that you don’t give me any lip about going to church, and you’ll learn that some reflection time, far away from any screens, is good for the soul,” I added. I began to wonder if by all this heavy-handed rulemaking I was picking a battle that may in the end “inoculate” my children against quiet sabbath reflection. Nonetheless, I had made the rule—it was well-intentioned, and having survived the appeal process had been duly promulgated—now we’re simply sticking to it.

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My son, two years younger than his sister, had been happy to sit back and watch the round of summary judgement and posed a dilemma: “Suppose we want to improve ourselves by running on the treadmill and incidentally watch television so as to keep running longer?” he asked. “After all, I did come in second in my age group in the last 5k road race (and here he importantly skipped saying that his father had only come in third), and the family could use a first place trophy next time,” he said; and I knew my third place was a fluke, so he did have a point that he was our best shot.

“That’s too hard to check up on,” I said, “you can run on the treadmill with music, and that’s it,” I said, exasperated, but the rule stood. And has stood more or less for seven years with my weekly vigilance.

My daughter, still eyeing law school, is home from college for the summer and turns on the television big-as-youplease last Sunday morning. I effect a giant throat-clearing uh-hum.

“Oh, be serious, do I need to go hide in the bathroom and watch TV on my iPhone to get around your rule?” she asked. I just looked at her. “I appeal again,” she said, “Surely some statute has run out by now.”

“Don’t you get the origins of my noble rule?” I asked.

“And, yes, I’m sure it’s been seven years at least, so fire away on your appeal. What is the new information?” I asked. OK, maybe I’m paying for law school, but there’s no way I’m buying her an LL.M or any other further study.

The 17-year-old son pops in for his once-a-week, two-minute sighting: “the new information you seek is that you could even cut off the power, and we could still watch a host of online shows directly on various devices,” he said.

“And,” he added as a matter of fact, “your noble reasoning for this rule is the fourth of the Ten Commandments. That would be in Exodus 20,” he said.

“And it’s also in Deuteronomy chapter 5,” added the daughter.

“I am still stickin’ with the damn rule,” I announced although the expletive I used might in itself have been a big problem.

“Fine here. Yep, we’re good,” came the reply from both of them. And it seemed at least we had learned something about rulemaking all around.

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Beyond the Hype: A Cautious Look at First Generation Opportunity Zone Funds

By Brad Updike, JD, LLM; Kyla Ehrisman, JD, MBA Mick Law P.C. LLO

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Mick Law P.C., based in Omaha, Nebraska, is a specialty firm comprised of full-time and of-counsel attorneys who each possess a concentrated area of expertise and in-depth knowledge. In addition to their law school credentials, the attorneys also have professional and educational credentials, including MBAs, LLMs and securities industry licenses (inactive).

The Congressional intent and hype surrounding the income tax benefits of Qualified Opportunity Zone Funds (“QOFs”) is well known within the non-traded investment program universe, and for good reason. The underlying law was intended to motivate taxpayers holding $3.8 trillion in unrealized capital gains to redeploy their resources in several neglected areas of the U.S. in an effort to create jobs and businesses, redevelop properties, and to stimulate economic growth in such areas. To accomplish the aforementioned purpose, Congress adopted Internal Revenue Code (“Code”) §1400Z, a close cousin of the Code’s like-kind exchange provisions.

While Code §1400Z does not allow for an indefinite deferral of capital gains, it provides a compelling set of financial and tax-related advantages that include the ability to: (i) redeploy unrealized capital gains into strategic investments, while deferring the pre-existing gains underlying the redeployed capital through December 31, 2026; (ii) realize partial tax forgiveness of 10-15% on pre-existing gains after 5- and 7-year holding periods in the new investment are reached; and (iii) achieve complete forgiveness of the capital gains tax on future asset related growth generated from the new investment. On its face, one could argue that the advantages of Code §1400Z are more compelling compared to that of its cousin.

As much has already been written about the benefits and requirements of Code §1400Z, this article will discuss QOFs from a different perspective, one that focuses upon the economics and structures of the first generation of QOFs that are being syndicated to accredited investors.

It is our hope in doing so that readers will come to appreciate the risks that the initial generation of products present in an effort to improve the products going forward.

While Code §1400Z does not allow for an indefinite deferral of capital gains, it provides a compelling set of financial and tax-related advantages.

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Structure and Strategies While QOFs can be either corporations or pass-through entities, pass-throughs such as limited partnerships and limited liability companies are the entities of choice for the programs reviewed thus far. The predominant domicile state for the QOFs marketed to date within the retail channel have been Delaware entities.

The retail syndicated QOFs to date have been structured in a manner whereby the QOF endeavors to pool capital from several accredited investors for the purpose of enabling the QOF to acquire equity in pass-throughs that hold real estate alongside a co-owning sponsor affiliate and/or development partner. The size of the offerings varies greatly, from as low as $3 million involving an identified single asset, to as much as $300 million for a diversified portfolio of properties (with $25-35 million being a median target raise). Minimum subscriptions likewise vary greatly, with some funds accepting $50,000 investments, whereas others require $100,000 to $250,000 to invest in the fund.

The interests sold to investors at the QOF level are almost always preferred equity interests designed to provide investors with a 6-8% annual preferred return on capital from operational cash flow, and a return of capital and 50-80% split of remaining sales proceeds from capital transactions. In cases where the sponsor must bring in a development partner at the property entity level to manage the construction and stabilization of the underlying real estate, there may

The retail syndicated QOFs to date have been structured in a manner whereby the QOF endeavors to pool capital from several accredited investors for the purpose of enabling the QOF to acquire equity in passthroughs that hold real estate alongside a co-owning sponsor affiliate and/or development partner.

be two levels of carried interests and distribution waterfalls intended to compensate the sponsor at the fund level and the development partner at the property entity level for management related services. Where two levels of promote are involved, please note that the same could limit the QOF investor’s ability to achieve an economic return beyond the 6-8% preferred return target. As such, those programs whereby the sponsor can internally source, develop, and manage the assets would arguably provide better opportunities for competitive returns by eliminating the proverbial “second cook in the kitchen”.

While QOFs can own their qualified opportunity zone properties directly, the “partnership interest” is the key asset held within the first-generation funds (i.e., necessitating a 70% test at the holding entity level). The development strategies we have seen thus far involve real estatecentric assets focusing upon developments of land in cities or urban areas, and redevelopments of improved real estate in such areas. Multi-faceted developments situated within historically significant metropolitan areas, multi-family projects, condos, office space, retail space, and hospitality are all strategies that are being used within the retail syndicated QOFs we have reviewed, with other classes of real estate, such as industrial/warehousing and storage naturally also being potential strategies for future funds.

While real estate has dominated the first-generation QOFs offered in the retail channel, private equity related investments in new businesses or in existing businesses could present possible opportunities, provided new equipment is deployed or real estate is substantially improved within the opportunity zone census tract of interest. Opportunities involving oil lease development and/

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While real estate has dominated the first-generation QOFs offered in the retail channel, private equity related investments in new businesses or in existing businesses could present possible opportunities, provided new equipment is deployed or real estate is substantially improved within the opportunity zone census tract of interest.

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or pipelines may also fit into the realm of potential investments assuming the project has a bona fide growth component to it (e.g., working interests in wells and related leaseholds or establishing pipelines and gathering systems in areas with upstream growth potential).

Program Economics Despite the hype surrounding the QOF’s tax benefits, the threat for an investor to “suffer a death from a thousand cuts” must be taken seriously when reviewing the various fees associated with the first generation of QOFs. While certain of these fees are also charged in programs outside of the QOF arena, almost all of these fees appear to be making their way into the structures of the QOFs we have seen in one form or another.

The offering costs and fees that are paid to sponsors and their affiliates include the following: • Syndication Costs and Offering Costs: 10-12% of gross offering proceeds • Fund/Asset Management Fee: 1-2% of capital raised or fund asset fair values • Acquisition Fee: 1-2% property purchase price or project costs • Development/Construction Management Fee: 4-6% of project costs • Loan Placement Fee: 1-2% of loan amount • Loan Guarantee Fee: 1% of guaranteed loan amount • Property Management: Market rates • Loan Restructuring Fee: 1-2% of loan amount • Disposition Fee: 1-2% of sales price • Other Fees: Interest charged on capital advanced for start-up costs

In view of the offering loads (i.e., 10-12% of gross capital raised), various levels of management carries, and fees charged within the QOFs, cautious underwriting of the underlying asset under offering adjusted conditions is strongly recommended. The underwriting should consider prevailing economic conditions, occupancies, rents and construction costs within the markets the assets are located, as well as whether future events may work to the disadvantage of the asset held. The underwriting should also consider the fact that market cap rates could turn for the worse over time. Independent valuation experts should also be consulted to assess whether the sponsor’s pro formas are achievable under conservative market conditions. We note that while our independently underwritten investor level returns have ranged from 9% to 15% IRR on some projects with identified assets (with an additional 300 bps of IRR possible based upon the potential tax advantages), returns can vary greatly from program to program depending upon the fees and levels of promote involved.

While we have yet to see an energy related QOF, we have heard from a number of sponsors that

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plans are underway to present such opportunities in the future. Where leasehold related energy assets are involved, engineering experts should be retained to provide independent reserve analysis and to assess whether enough reserves can be established to help support a capital gain on the capital invested in leasehold, facilities and drilling.

Other Special Risks Additionally, there are a number of other considerations we have observed within the first generation of QOFs that present special investment risks. While we believe there is much potential for retail QOFs to deliver value, there are areas where improvements need to be considered.

First, and while most QOFs we reviewed had identified projects in which to deploy capital, none of the reviewed QOFs had established a minimum offering requirement. On a better note, and in a couple of cases, a couple of sponsors did provide a backup plan by making short term loans to the QOFs to help them fund their capital constitutions at the property entity level pending equity funding during the offerings. In the other cases, however, no contingency related plans were articulated within the offering materials explaining the sponsor’s plan if the QOF were to raise a substantially lower amount of capital than the maximum offering.

The risk of raising a much lower level of capital is that the sponsor, its affiliates, or its development partners may be required to either procure more project debt than anticipated or to offer more favorable equity investment terms to other parties. Alternatively, the project may need to be scaled

While we have yet to see an energy related QOF, we have heard from a number of sponsors that plans are underway to present such opportunities in the future.

down or abandoned. All of these could have an adverse impact on the ability of the QOF to achieve an economic return. As such, it might arguably be preferable to work with sponsors with track records of raising significant investor capital for real estate, energy, or private equity projects.

Although most of the QOFs we have reviewed to date have identified projects, some have been organized as “blind pool” funds. In addition to the standard risks of investing in a blind pool fund (i.e., lack of underwriting of assets, no investor control over acquisition decisions, etc.), there is a risk that these funds may not be able to source enough acceptable investments in a timely fashion in order to comply with the 30-month capital deployment requirements of the QOF regulations.

Second, one should consider whether the sponsor is playing the role of a developer/asset manager as opposed to the one of capital raiser and promoter. While this observation is one that is not always fatal to success, the consequence of bringing in a JV partner can pose considerations of an economic nature that include multiple levels of carried interests imposed at the fund level and at the property entity level.

Where outside development guidance is needed, the sponsor may be inclined to allow for a recalibration of the outside development partner’s interest, allowing the development partner’s carried interest otherwise kicking in after a QOF preferred return to be converted at project stabilization into a fixed interest that does not subordinate to the QOF’s preferred return (i.e., based

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upon the project’s fair value and the percent of the distributions the development manager would get in a hypothetical sale of the project). While these circumstances are ones that are understandable and sometimes needed to engage an appropriate level of expertise, the deals whereby the sponsor can source and manage its own projects could present better opportunities for competitive returns.

Third, and in cases where specific projects had been identified within the reviewed QOFs, we observed varying levels of targeted project leverage, which broadly range from 50-75% of the project costs. In a couple of cases, the sponsor’s loan terms originated from loan commitments, whereas in most of the others, the terms originated from the sponsor’s internal objectives and expectations and in which case loan commitments had not been secured.

Not surprising to us, the sponsor’s financial projections in many cases assumed that the construction financing and permanent loans would be financed with interest-only payments. We remind, however, of the risks involved in failing to amortize debt, which may involve investment losses if cap rates were to increase from today through an investment hold period of ten years or

In cases where specific projects had been identified within the reviewed QOFs, we observed varying levels of targeted project leverage, which broadly range from 50-75% of the project costs.

more (we of course concede that I/O construction/mini-perm debt through development and value stabilization is appropriate).

Fourth, and on a better note, a majority of the QOFs reviewed made a commitment within the organizational documents of the fund to provide investors with annual audits and quarterly financials.

In a couple of instances, however, the sponsor’s commitment to investor transparency was either limited or non-existent, with the sponsor not required by fund agreement to provide any level of financial statements to investor partners. On this point, we remind you that a common theme within prior fund investment fraud cases involves the absence of sound investor-related financial transparency practices.

Fifth, and unlike the prevailing practice we often see in non-traded investment programs, none of the QOFs we reviewed provided the investor group with an “at-will” manager removal right. In most cases, either a majority or super majority of the investors were given a for cause manager removal right, for circumstances relating to fraud and misconduct, and in some cases, for a breach of the QOF’s organizational agreements and sponsor/manager bankruptcy. Although we normally encourage at will manager removal rights, at a minimum we would encourage the QOF sector to (i) subject a for cause manager removal to a voting threshold lower than a super-majority; and (ii) to include a breach of the fund agreement and sponsor/manager insolvency, bankruptcy, or receivership as for cause removal conditions.

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Conclusion Consistent with the pending status of the next round of QOF income tax regulations, the structures and features of QOFs marketed within the retail investment channel appear to be very much a work in progress, and in many cases, in search of an identity. As perhaps several billions in potential investor capital come up for grabs in 2019 and 2020, we encourage the unfound identity of the QOF sector to be established sooner than later.

As the opportunity for the financial services sector to deliver tremendous service and value to the investor community develops before us, we also encourage broker dealers and investment advisors alike to be diligent in their evaluations of QOFs and to look beyond the hype of the tax benefits in an effort to competently evaluate the economic return potential of the assets and the retained rights for the investors that decide to place their confidence and dollars in the QOF sector.

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Second Round of Regulations Add Some Clarity Around Qualified Opportunity Fund Investments

By Russell Putnam, FactRight

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FactRight specializes in third party due diligence and risk management consulting for the alternative investment community. Our forensic accounting, risk mitigation, and investment professionals are experts in investigating and explaining investment sponsors and their offerings.

In April, the IRS and Department of Treasury released a second round of proposed regulations on investments in qualified opportunity zone funds (QOFs).

The proposed regulations clarify requirements that were not addressed in the initial proposed regulations released in October 2018. The IRS and Treasury are seeking comments and will hold a public hearing regarding the proposed regulations in June. Even though the regulations are merely proposed at this point, they reflect Treasury’s current approaches to many items that Section 1400Z-2 leaves open to interpretation and represent the best indication of where the final requirements will be fixed.

The various meanings of “substantially all” The term “substantially all” is included in Section 1400Z-2 five times; however, the previously released regulations clarified what that meant in only one instance, detailing that in order to be a QOZ business, substantially all of the business’s tangible property (at least 70%) must be QOZ property. (In other words, at least 70% of a subsidiary partnership’s tangible assets must be QOZ property in order for the QOF’s investment in that subsidiary to count towards the 90% test.)

This round of proposed regulations provides that the “substantially all” requirement regarding “use” of QOZ business property will be satisfied if at least 70% of the use of such property is located in a QOZ, whereas “substantially all” in the context of “holding periods” requires a 90% threshold. As such, QOZ business property is defined as tangible property that, among other things, during substantially all of the QOF’s holding period (at least 90%), substantially all of the property was used in a QOZ (at least 70%). Additionally, this clarifies that, in order to be considered a QOZ partnership interest or QOZ stock, the partnership or corporation would need to qualify as a QOZ business for substantially all of the QOF’s holding period in such interests (at least 90% of the holding period).

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It’s possible that real property could straddle two census tracts, one that is a QOZ and one that is not.

These requirements are particularly important because we expect many QOF’s to be structured as a fund that invests 90% of its assets in QOZ partnership interests that are considered QOZ businesses that own QOZ business property. Clear as mud.

“Original use” begins when the party starts to “use” depreciation/amortization deductions In order to be considered QOZ property, among other things, the original use of the property must either (i) commence with the QOF or (ii) the QOF must substantially improve the property.

We already know that substantial improvement requires that additions to the property’s basis over a 30 month period exceed the original basis in the property at the time of acquisition. But what does original use actually require?

The proposed regulations state the “original use” of tangible property begins when a party places the property in service in the QOZ for purposes of depreciation or amortization. This means that if the property is depreciated or amortized by another taxpayer, other than the QOF or the QOZ business, the property would not meet the original use requirement. In other words, the QOF or QOZ business would need to substantially improve the property in order for it to qualify as QOZ property. However, the requirement would be satisfied if the tangible property has not been amortized or depreciated by another taxpayer, and substantial improvement would not be necessary.

Additionally, the proposed regulations provide that if a building has been vacant for at least five years prior to the QOF or QOZ business purchasing the property, the building will satisfy the original use requirement. This means that, in theory, a QOF could purchase a vacant building and have it qualified as QOZ property without actually substantially improving it.

Property that walks the line It’s possible that real property could straddle two census tracts, one that is a QOZ and one that

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The proposed regulations provide three safe harbors for determining whether sufficient income is derived from a trade or business in a QOZ for purposes of the 50% test.

is not. The proposed regulations state that a property located partially within a QOZ and partially outside, will be treated as being located in a QOZ if the unadjusted cost of the real property inside the QOZ is greater than the unadjusted cost of the real property outside the QOZ.

Where to locate the active conduct that produces the income In order for a trade or business to be considered a QOZ business, at least 50% of its total gross income must be derived from the active conduct of the business within the QOZ. This may not be a significant concern for real property investments located within QOZs, but what about programs that invest in operating businesses located in QOZs that derive portions of their income from other census tracts?

The proposed regulations provide three safe harbors for determining whether sufficient income is derived from a trade or business in a QOZ for purposes of the 50% test. A business is only required to satisfy one of the following safe harbors: • 50% of the services performed by the business’s employees are performed within the QOZ based on the number of hours completed, • 50% of the services performed for such business by its employees are performed within the QOZ based on the amounts paid for those services, or • Tangible property of the business located in the QOZ and management (or operational) functions performed for the business in the QOZ are necessary to generate 50% of the gross income.

• Treasury is specifically seeking comments on this safe harbor and also clarified that leasing of real property used in an active trade or business is treated as the active conduct of such trade or business.

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Inclusion events are transactions that would reduce or terminate the QOF investor’s investment for federal income tax purposes or constitute a “cashing out” of the QOF investor’s qualifying investment.

Enlarging the working capital safe harbor As Treasury has previously clarified, QOZ business may characterize working capital as QOZ business property for up to 31 months, provided they meet certain requirements, including that there be a written plan that earmarks working capital as held for the acquisition, construction, or substantial improvement of tangible property in a QOZ. The proposed regulations changed this requirement by also including working capital for the “development of a trade or business in a QOZ,” as well as the acquisition, construction, or substantial improvement of tangible property.

Reasonable periods for reinvestment The Internal Revenue Code provides that a QOF has a reasonable period of time to reinvest the return of capital from investments in QOZ stock or partnership interests and reinvested the proceeds from such sale.

The recent proposed regulations provide that sale proceeds will be treated as QOZ property for purposes of the 90% test as long as the QOF reinvests the proceeds into other QOZ property within 12 months of the sale. This could potentially give investment programs some added flexibility in pursuing liquidity for its assets, instead of having to hold each of the individual assets for the 10-year hold period that is necessary to maximize the tax benefits associated with a QOF investment.

Potential relief from the 90% test In order to qualify as a QOF, a fund will need to hold at least 90% of its assets in QOZ property, which is tested on a semi-annual basis. The 90% test will be determined by averaging the QOF property held by the fund on the last day of the fund’s first-six month period of the taxable year

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and the last day of the taxable year. But what happens if a QOF raises a significant amount of investors capital right before the end of the first six month period? The proposed regulations state that a QOF does not need to factor in any investments that have been received within the preceding 6 months when calculating its first 90% test.

How leased property can help satisfy the 90% test Leased tangible property may be treated as QOZ business property for purposes of satisfying the 90% test, provided that it is acquired after December 31, 2017, and substantially all of the use of the leased property must be in a QOZ (at least 70%) during substantially all of the period in which the QOZ business leases the property (at least 90%). These requirements exist for any type of tangible property. However, the proposed regulations do not impose an original use or substantial improvement requirement with respect to leased property.

The proposed regulations also provide certain limitations on leases with related parties and the methodologies for valuing leased tangible property for purposes of satisfying the 90% test.

Inclusion events Treasury also provided clarification on numerous inclusion events, upon which investors would need to recognize portions of the deferred gains. All of these inclusion events are beyond the scope of this post; however, generally speaking, these events are transactions that would reduce or terminate the QOF investor’s investment for federal income tax purposes or constitute a “cashing out” of the QOF investor’s qualifying investment.

What questions remain?

Treasury stated in its commentary to the regulations that it is working on, and seeking comments on, additional proposals regarding the following items, which may be published in the future: • Administrative matters related to QOFs (anticipated in next few months) • Whether anti-abuse rules are needed • Applying an asset-by-asset or an aggregate standard in determining whether QOZ business property has been substantially improved • Consideration of inventory in determining whether a QOZ business has met the 70% test • Treatment and valuation of leased property • Whether additional rules are needed to determine whether a trade or business is actively conducted

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5 Questions: A Spotlight on Student Housing

By Brian Nelson, NB Private Capital

NB Private Capital is a student housing investment company located in Orange County, Calif. The firm’s predecessor, Nelson Brothers Professional Real Estate (NB), was originally founded in 2007 providing brick-and-mortar investment opportunities that potentially offer a balance of stable performance, monthly income, tax efficiency, appreciation and diversification—all from one investment.

Under the leadership of Brian Nelson, Founder and President, the company currently has a growing portfolio of 22 properties in 11 states with over $650 million under management and a staff of 15 experienced employees, several who were previously with NB. The firm’s investments are primarily geared to income-seeking investors who enjoy the simplicity of 1031 exchanges in a DST structure.

It is a real estate category uncorrelated to economic and seasonal gyrations, and the returns have been Grade A. Student housing has been a hot niche property type for real estate investors, including for Brian Nelson, founder and president of NB Private Capital, a student housing investment company located in Orange County, California.

Nelson has spent a lot of time considering what student housing investors and developers need to take into account when committing to this specialized category.

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You have argued that student housing is different than other real estate investments.

How so?

What are some of the special considerations developers must take into account with student housing?

The consistency of demand. The predictability that students

New development is inevitable. The focus should be

will attend college year-in, year-out, decade after decade. For

to build something special, that offers a sustainable

non-commuter campuses, inherently, many of these individuals

competitive advantage or differentiation with something

will need a place to live. Preferably close to campus.

students value over the long term. Something difficult

M a n y c o m m e r c i a l r e a l e s t a t e properties, especially

to replace.

office and retail, are heavily driven by local economic factors.

the United States in the past 40 years, you see there is

College-age kids are notoriously hard on furniture and the built environment overall.

Does that imply maintenance at student housing facilities is unusually expensive?

almost no correlation to economic cycles, real estate cycles,

Yes, this could be the case. Knowing that in advance

Student housing is typically anchored by the steadiness of university enrollment and consequent demand for housing. In looking at college enrollment throughout

presidential elections or any other macro-economic factor.

With most universities well over a century old and inherently a finite amount of land near campus, it is an investment environment where occupancy and performance can be more predictable. In today’s uncertain economy, that’s hard to find.

According to your analysis, student housing is the property type with the best cash flow potential. Explain, please.

helps. Furniture nowadays can be inexpensive though.

Even for nice, chic designs. However, given the strong demand for student housing, there are several tools an owner can leverage to mitigate the impact. For example, often parents must co-sign a lease that requires they guarantee liability for damages.

Our biggest culprit however is typically carpet. If anything, that is an item that gets replaced far more often with students than traditional multifamily. This can be mitigated by replacing carpet, when practical, with luxury

I would not say best potential. There are riskier

vinyl flooring, which looks like natural hard wood but is

investments that can potentially achieve higher cash

inexpensive and durable.

flow potential, if things work the right way. For student

7.5 percent income per year, that have been consistently

All property sectors seem to run in feast or famine cycles. Is the summer a dead zone for student housing?

100 percent occupied.

Great question. This has been one of the most revolutionary

housing, we would emphasize the risk-adjusted returns.

We can find properties capable of yielding 6 percent to

A second factor is the overall net income, after taxes are considered. A factor often overlooked, is how tax-friendly student housing can be from a depreciation standpoint.

It’s common to have a 6 percent to 7 percent annual income and be able to shelter 100 percent of the income from taxes. CDs or a savings account would likely have to produce an income of 9 percent to 10 percent to produce the same net income.

changes we have seen in the past 20 years. In tighter, more constrained markets, 12-month leases are required almost everywhere. That helps dispel the seasonality of cash flow.

Some markets, especially smaller regional schools have yet to migrate to the 12-month model. Most firms avoid those markets. However, there may be some compelling opportunities where a new owner can create value by moving a property to the 12-month schedule.

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The Power of Triple Non-Traded Protection

By Triton Pacific Securities

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Prospect Capital Management is a registered investment adviser with approximately $6.4 billion of assets under management as of December 31, 2018. Triton Pacific Securities, LLC, founded in 2005 and registered in all 52 states and territories, dealer manager for TP Flexible Income Funds, and publicly registered non-traded business development company.

Stock Price and Value Do you ever wonder why the stock price of a company can vary so wildly, even without any news about the company or its financials? If a company’s market capitalization drops suddenly, absent any new information, is it truly worth less than the previous day?

Case in point, on May 6, 2010 virtually the entire U.S. stock market dropped by nine percent in 10 minutes. Over one trillion dollars in equity evaporated before the market regained six percent by the end of the day. Certainly, the underlying “value” or “worth” of all U.S. listed companies did not fall by nine percent in minutes, simply due to the actions of a rogue futures trader in suburban London. There are times when a company’s stock price moves for reasons unrelated to the value of the company itself. Indeed, technical trading is based on this very principle.

Non-Traded (Private) Companies To avoid the capricious volatility of the stock market, investors may look to companies that are not listed on an exchange. One need not look far. Over 99 percent of all U.S. companies are not listed on a public exchange. However, investing in these private companies is more difficult than finding them.

Historically, most outside capital for private companies has come from private-equity firms and banks. Individual investors had little opportunity to invest in private companies, large or small. In recent years, however, a handful of funds have launched in the retail market, offering private-market access to individuals. Collectively, these funds are known as “middle-market private credit funds,” and they generally invest in credit instruments (and sometimes equity) of healthy, growing companies whose stock does not trade on an exchange. Because private companies do not trade openly, the value of an investment in a private company is tied more closely to the health of the company itself, rather than the stock market.

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To avoid the capricious volatility of the stock market, investors may look to companies that are not listed on an exchange. One need not look far. Over 99 percent of all U.S. companies are not listed on a public exchange. However, investing in these private companies is more difficult than finding them.

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Non-Traded Assets The secondary market for private credit and equity instruments is very thin, and in many instances is nonexistent. In accounting parlance, these securities are known as “Level III” assets, which means they are illiquid and not “marked to market” on a daily basis. Rather, such assets typically are valued quarterly or when an event occurs that may materially affect the value of the underlying company or instrument. As a result, such non-traded assets exhibit greater daily value stability than traded instruments. This is especially true when the underlying company is also non-traded.

Non-Traded Funds Today, some middle-market credit funds are also non-traded. Examples of such investment companies include non-traded BDCs, non-traded closed-end funds and interval funds. Depending on the fund, it may publish quarterly, weekly or even daily values for its fund shares. Yet the shares’ values are based on estimates of the underlying assets described above, rather than an exchange-based market price (e.g., a listed BDC or closed-end fund). As with private companies and their non-traded loans, nontraded funds enjoy some independence from the hourly vagaries of the NYSE or NASDAQ.

Triple Protection No investment is completely insulated from the forces that move the stock market. Certain macroeconomic trends, political risks, interest-rate movements and disasters can impact virtually every company—traded or not. But bloggers, whims, rumors and trading algorithms may have less influence on private investments than on traded securities.

This benefit is known as “non-traded protection,” and in some funds the protection can be double or even triple.

Of course, the major trade-off for

Investing in small and midsized private companies

non-traded protection is liquidity. Not

involves a number of

only are shares in non-traded funds

their size, limited experience,

illiquid, but their ability to redeem or

stability and smaller pool of

tender shares can be affected by the

significant risks related to lesser degree of financial management talent, leading to risk of loss. In addition,

illiquidity of their portfolios. If a partial

evaluating such companies

allocation to an illiquid investment is

difficult due to the lack of

suitable for you, a fund with “triple nontraded protection” could be a smart way to reduce exposure to potential

for investment may be more publicly available information.

Securities Offered Through Triton Pacific Securities, LLC | Dealer Manager | Member FINRA/SIPC.

stock-market volatility.

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ADISA

News

Events

2019 ADISA Spring Conference Recap ADISA Prediction Survey Results Advocacy News 2019 ADISA AI Research & Due Diligence Forum Preview

A Recap of Our San Antonio Meeting ADISA’s 2019 Spring Conference, held April 1-3 in San Antonio,

advisors in the IBD/RIA channel. Approximately $2.489 billion

drew more than 500 attendees and included approximately 23

in equity was raised in the Section 1031 market, a 27.8 percent

educational sessions that covered qualified opportunity funds,

increase from 2017. In the first quarter of 2019, multifamily

Section 1031 exchanges, private equity, energy, legislative and

dominated with 51.41 percent of 1031 sales by asset type,

regulatory updates, real estate investment trusts and more. In

while office and retail represented 20.07 percent and 17.53

addition to the closed-door Broker-Dealer Advisory Council

percent, respectively. The first quarter of the year closed with

Roundtable, two new roundtables were introduced for RIAs

$612 million equity raised and 19 fully subscribed programs.

and product sponsors.

At the industry update session, attendees learned that the

Alabama Securities Commission and former NASAA president,

market size for energy in 2018 totaled $3.3 billion with 103

along with Frank Borger-Gilligan, president-elect of NASAA and

Reg. D private-placement offerings. Eight sponsors raised

Assistant Commissioner of the Tennessee Securities Division,

approximately $400 million in capital in 2018. The market also

for a legislative and regulatory update. Moderated by HillStaffer

showed a preference for interval funds, non-traded REITs, and

president Thomas Rosenfield, our discussions focused on

non-traded BDCs, which were primarily driven by investments

state regulatory actions in financial services, in particular the

in daily NAV REITs, which represented 43 percent of sales.

fiduciary rule, Regulation Best Interest, vulnerable populations,

Interval funds followed closely with 35 percent of sales.

and alternative securities.

Additionally, totals for 2018 showed that independent

On the last day of the conference, keynote speaker, Dr. Kerry

broker-dealers and RIAs are still the largest source of alternative

Johnson, author of Behavioral Finance and Sales: “Reach Your

investment sales, and that there are more than twice as many

Client’s Mind,” took the stage.

Publications & Standards Committee to Update Guide to Alternative Investments

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ADISA was pleased to welcome Joe Borg, Director of the

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ADISA’s Publications & Standards Committee, chaired by Sherri Cooke of AI Insight, will update and revise the popular Guide to Alternative Investments, and the new edition will be released prior to ADISA’s Annual Conference & Trade Show in October. To view the current edition, go to adisa.org/publications.

Results from ADISA’s First Prediction Survey Are In—BD and RIA Firm Revenue Expected to Show a Solid Increase in 2019 ADISA conducted its first market prediction survey at its 2019 Spring Conference with the participation of approximately 70 due diligence officers from broker-dealer and registered investment advisor (RIA) firms. The results are compelling: • All but 6% of broker-dealer and RIA firms predict a solid increase in firm revenue during 2019, with more an 30% of respondents expecting an increase in revenue of more than 20%.

• Approximately 40% of respondents predict more than a 10% increase in tax-advantaged fund sales.

• Opportunity zone fund sales are expected to grow in 2019.

Approximately 20% of respondents predict an increase of less than 10% and another 20% predict growth of more than 10%.

• Private equity and private debt sales are projected to increase approximately 10%.

• More than 90% of the survey’s respondents predict alternative investment to increase in 2019.

• Closed-end and interval funds are expected to have a moderate increase in sales of approximately 9%.

Sales projections by product type include:

• Oil & gas, lifecycle non-traded REITs, NAV non-traded REITs, infrastructure, hedge funds and asset lending/leasing

• About half of respondents predict that REIT preferred stock offerings will have an increase in sales during 2019.

programs are all expected to remain relatively flat.

Real Estate - Reg D Real Estate - 1031 Exchange Private Equity - Reg D Closed-end / Interval Funds Non-traded REITs (NAV) Non-traded REITs (Lifecycle) Private Debt - Reg D Opportunity Zone Programs Non-traded BDCs Regulation A or A+

Popularity of Product Types Among BDs and RIAs

Oil & Gas - IDC Focused Oil & Gas - Income Focused Hedge Funds

Popularity is represented by the number of programs in each category currently held by respondents’ firms.

Conservation Easements Green Energy Oil & Gas - 1031 Exchange

The size of firms for the approximately 70 due diligence officers that participated in the survey ranged from less than 50 affiliated advisors to more than 1,000 affiliated advisors.

Infrastructure Programs Asset Lending / Leasing Programs Other - Unspecified Other Tax Credit Programs Security Token / Coin Production EB5 Programs 0

50

100

150

200

250

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Advocacy News

ADISA Visits Capitol Hill ADISA’s 2019 president, Greg Mausz (Preferred Apartment

educational outreach efforts such as support for business

Communities) and ADISA’s executive director, John Harrison,

school curricula are also underway, according to Mausz.

recently met in Washington with the leadership of NASAA

In addition to the NASAA meetings, Mausz and Harrison

(North American Securities Administrators Association) and

visited several congressional offices to brief tax and financial

various congressional offices to advance the mission of the

congressional staffers on the need for support for Like-kind

retail alternatives investment industry.

Exchanges (LKEs, a.k.a., 1031 exchanges). “With each new

The NASAA meetings focused on the need to provide

Congress, there is a need to educate anew on the benefits

further education on the wide array of alternative investment

of Like-kind Exchanges,” said ADISA’s Harrison. Indeed, the

products whose use is growing in interest to investors across

congressional staffers visited were appreciative of the easy-

the country. In the meetings were NASAA’s presidents—

to-read LKE booklets left behind by the ADISA delegation.

immediate

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past,

present,

and

upcoming—Joe

Borg

All in all, the ADISA president and executive visited six

(Alabama), Mike Pieciak (Vermont), and Frank Borger-Gilligan

offices, five on the House side: Dank Kildee (D-MI), Drew

(Tennessee) and NASAA’s executive director, Joey Brady.

Ferguson (R-GA), Stephanie Murphy (D-FL), Brad Schneider

NASAA as the association for the 50 states plus Mexico

(D-IL), and Gwen Moore (D-WI); and one on the Senate, Tim

and Canada supports the work of state securities regulators

Scott (R-SC). Present at the meetings were the senior staffers

“through advocacy, education, subject matter expertise,

responsible for tax and financial affairs, including those

communication, and coordination.”

from Senator Scott’s office, the co-creator of the Qualified

“ADISA is launching and updating some of our key outreach

Opportunity Zone legislation. ADISA’s government relations

educational material to help in our efforts to educate state

team member, Anne DarConte, a veteran of congressional

regulators,” noted ADISA president, Greg Mausz. Top on the

affairs assisted. She noted, “the targeted approach to

list, according to Mausz, is an update of ADISA’s popular Guide

offering bona fide research and knowledge to congressional

to Alternatives booklet by Lightbulb Press. Mausz mentioned

staffers—instead of blindly pleading for one’s own cause—

that ADISA’s publication and standards committee chair,

helps ADISA’s reputation on the Hill, and actually prospers the

Sherri Cooke (AI Insight), is at the helm of this project. Further

financial services industry even more.”

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ADISA’s 2019 president, Greg Mausz (left), and ADISA’s executive director, John Harrison (right), met in Washington with the leadership of NASAA (North American Securities Administrators Association) and various congressional offices to advance the mission of the retail alternatives investment industry.

ADISA Supports “The Investment in America Act” to Create New Jobs

ADISA Requests Public Hearing Regarding New Jersey State Fiduciary Rule

ADISA joined major housing and real estate

ADISA Executive Director John Harrison submitted a letter to the New

organizations by co-signing a letter to members

Jersey Bureau of Securities, Division of Consumer Affairs, formally

of Congress in support of the bipartisan Invest in

requesting that a public hearing be scheduled regarding the state’s

America Act (H.R. 2210), sponsored by Rep. John

proposed fiduciary rule (PRN 2019-044). ADISA believes that there is

Larson (D-CT). The Invest in America Act will likely

sufficient public interest in the proposed rule and that the full impact

create 150,000-280,000 new construction-related

of the regulation has not been determined as reflected in its language.

jobs by spurring investment in U.S. real estate and

ADISA also began grassroots outreach efforts, including

infrastructure. This legislation will repeal the arcane

correspondence to regulators and Governor Phil Murphy, ahead of

and punitive Foreign Investment in Real Property

New Jersey’s June 14 deadline asking state constituents to weigh in

Tax Act (FIRPTA) of 1980.

on the fiduciary rule proposal.

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2019 AI RESEARCH &

DUE DILIGENCE FORUM JULY 18-19

THE MAYFLOWER WASHINGTON D.C.

Experience all that our nation’s capital has to offer!

The Mayflower is one of Washington D.C.’s top hotels located near premier attractions including the National Mall, White House, the Smithsonian museums, and entertainment events. Visitors can easily access favorite city spots from The Mayflower’s central location, just steps from Metro and bike share stations.

ADISA past board member Peter Magnuson, Ladenburg Thalmann, will be this year’s chair of the AI Research & Due Diligence Forum. And with the conference being held in our nation’s capital, it is the educational event of the year to learn techniques of due diligence from experts in the alternative investments space.

• Network with more than 200 industry professionals • Learn about today’s issues and business opportunities • Discover advanced due diligence techniques, processes, tools and resources to remain compliant and safe Last year’s AI Research & Due Diligence Forum held in New York City saw record-breaking attendance of more than 250 financial professionals!

Hotel, part of The Autograph Collection, it is a capital classic, a landmark hotel that

Who Will Attend?

brings timeless elegance, integrity and

• Retail Broker-Dealers

contemporary style to its role as a vibrant

• Registered Investment Advisors (RIAs)

social hub—a Washington, D.C. original

• Family Offices • Due Diligence Professionals • Compliance Officers • Sponsors • Affiliates

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The forum will be held at the Mayflower

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since 1925. It is known as the “Hotel of President” and the city’s “Second Best Address”

SCHEDULE TO DATE AS OF 6/21/2019

THURSDAY, JULY 18 7:45-8:30 am Breakfast & Exhibition 8:30-8:45 am Welcome & Introductions Peter Magnuson, Ladenburg Thalmann, 2019 AI Research & Due Diligence Forum Chair

2:10-3:20 pm Getting Due Diligence Done: Perspectives on the How-To Multiple perspectives on best methods of due diligence: BrokerDealers, RIAs and Third-Parties Moderator: John Grady, DLA Piper Presenters: Andrew Barnum, Cetera Financial Group; Catherine Bowman, The Bowman Law Firm; Jean Merriman, The Strategic Financial Alliance; Brad Updike, Mick | Law 3:25-3:55 pm Break & Exhibition

8:50-10:10 am Opening Keynote Speaker Andrew Busch Andrew Busch, noted market analyst for government and Wall Street, and popular political/economic author does a deep dive on current research and conditions to help managers connect their work to the bigger picture of the global economy, politics and technology.

4:00-4:55 pm Real Estate Meets Behavioral Finance: What Industry Professionals Need to Know Latest trends on behavioral research which affects seller and buyer behavior on real estate purchasing and management.

10:15-10:45 am Break & Exhibition

5:00-6:30 pm Welcome Reception & Exhibition

10:45-11:45 am Opportunity Zone Report Congressional speaker will report on progress, likely path and pitfalls, and general success of Opportunity Zones, with updates from the Capitol Hill perspective.

11:50 am-12:40 pm Alternative Investments Sector Report Views and data from around the Alternative Investments world: 1031s, Energy, REITs, BDCs, Private Placements, Private Equity, ADISA Research Presenters: Sherri Cooke, AI Insight; Mike Andrews, DST Systems; Taylor Garrett, Mountain Dell Consulting; Matthew Iak, U.S. Energy Development Corporation; Brian Buehler, Triton Pacific Securities 12:40-2:10 pm Lunch & Exhibition

Presenter: Michael Seiler, PhD, College of William & Mary

FRIDAY, JULY 19 7:30-8:30 am Breakfast & Exhibition 8:00-8:45 am BD/RIA Program on PPM/ Advertising Issues (open to all) 9:00-9:50 am Legislative & Regulatory Updates The latest from the government and regulators likely to affect our industry.

Panelists: Jim Wrona, Vice President & Associate General Counsel, FINRA; Mike Pieciak, Current NASAA President; and others 9:55-10:45 am Ethics Discussion: Affiliated Transactions

10:45-11:10 am Break & Exhibition 11:15 am-12:05 pm Guest Speaker 12:05-12:15 pm Closing Remarks

REGISTRATION RATES Retail Broker-Dealers, RIAs and Family Offices Complimentary registration and two hotel room nights (limit two per company)

Sponsors Member: $799 (with event exhibit/sponsorship); $2,199 (without event exhibit/sponsorship) Non-member: $2,999 (with or without event exhibit/ sponsorship)

Affiliates Member: $698 (with event exhibit/sponsorship); $1,398 (without event exhibit/sponsorship) Non-member: $2,998 (with or without event exhibit/

sponsorship)

Exhibit opportunities are also available. More information can be found here, or contact ADISA’s Associate Executive Director Tony Grego, 317.663.4173.

Participants: Paula Miterko, Miterko & Associates; Peter Magnuson, Ladenburg Thalmann; and others

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10401 North Meridian Street Suite 202 Indianapolis, IN 46290

2019

ANNUAL CONFERENCE & TRADE SHOW OCTOBER 14-16 THE COSMOPOLITAN LAS VEGAS

adisa.org

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