February 1, 2020
“We see lots of potential,” said Phillips, surveying the once-abandoned 300-acre waterfront Navy Yard for investments. “There are already 400 companies here now, and I think that could double or triple in the next two to three years — and it is one of the largest and most prolific opportunity zones in the US.”
Phillips said the program could help narrow economic inequality.
“There is a big gap between the wealthy and the poor in America, which is why the opportunity zone program was created,” he added. “There’s a lot of capital gains tied up — and this is a way to incentivize people to sell their assets and put the gains to work in communities, and help revive our country.”
Pearl Fund is selected as one of the top 10 OZ funds in the U.S.
The Pearl Fund, a New York City-based qualified opportunity zone (OZ) and venture capital fund, was recognized on the inaugural Forbes OZ 20 list as one of the top 10 OZ funds In the country.
The Pearl Fund was selected from a large pool of applicants for its focus on investments in technology, internet infrastructure, cellular coverage, and green tech startups in OZ communities, as well as for its role as a catalyst for the launch of other business-focused funds across the country.
"...Brian Phillips, on the other hand, can't wait for the starting gun. A serial entrepreneur, he's looking to raise $25 million to put into opportunity zones and plans to launch an investment vehicle, the Pearl Fund, this month."
"His game plan is to set up shop in the Navy Yard to be close to scores of startups that could be interested in investors like him. "When people hear about opportunity zones, they say, 'You can do this?'"
"'It seems too good to be true,' said Phillips, whose enthusiasm is winning attention. After speaking at a January expo, he was invited to appear at a March 14 White House event to tout opportunity zones."
Investor Connect Podcast: How to Invest in Startups
Brian explains the ins and outs of Opportunity Zone investing, how to do it, and why it can be so advantageous for the investor.
He also explains why meeting the Opportunity Zone requirement can give startups a leg up when it comes to securing funding.
While OZ investing is currently dominated by real estate, The Pearl Fund is part of a small but growing trend of funds focusing on startups.
"The next big venture-capital gold rush may be in Opportunity Zones."
"Venture capital might be more attractive for investors than real estate."
"While real estate can be the safer call, venture capital returns have more potential. Thompson Reuters Venture Capital Index has returned 31% over the last five years, compared to 7.9% by Vanguard's Real Estate index fund."
Why Investors Are Taking Big Bets on the Land of OZ:
Brian Phillips is managing partner at The Pearl Fund, the first Opportunity Zone fund in the country that is also a venture capital fund. He believes there are "huge incentives to release capital into OZs," which is why he says "we are moving high growth businesses into these zones."
"My perspective is that you can build and grow solid businesses with good returns. Companies with the right amount of capital can see returns of 10 to 50 times the initial investment."
So Far, Real Estate Dominates a Tax Break Meant for Businesses
"Venture capitalists and public equity firms still have a good pitch for investors. Phillips is looking for startups growing so fast they could increase his original investment 10 times over, or more."
“The relative tax benefits are actually better for investing in operating businesses, particularly those with heavy capital assets,” said Jonathan Tower, managing partner at Arctaris, an impact investment fund manager based in Boston."
Webinar: What You Need to Know About Opportunity Zones and Operating Businesses
"Brian Phillips, Managing Partner at The Pearl Fund, shared his experience as the first venture capital fund to have launched an QOF, including the challenges presented by the initial lack of regulatory guidance. With increased certainty, he spoke about the high potential of venture capital investing in operating businesses located in Opportunity Zones, calling the potential upside of the policy 'unprecedented' and citing beneficial social outcomes through job growth and increased local spending."
The Pathway for American Businesses to Access Opportunity Zones Equity Capital by Brian Phillips & Paul Saint Pierre
The OZ capital marketplace features the following potential benefits for businesses:
Expands the dialogue between investors, businesses, and their respective advisers to evaluate and strategize on the wide range of private business investment opportunities- including start-ups, early-stage venture capital, growth stage capital for proven businesses, and capital deployed in connection with strategic buyouts;
Crain's NY Business:
"We now have the confidence to fund a business and know they won’t be in violation of the opportunity zone rules,” said Brian Phillips, an investor who plans to raise $25 million to back startups in the designated areas, including the Brooklyn Navy Yard. “It’s accelerating the start of our fund.”
BUSINESSES ARE MISSING A LUCRATIVE PART OF OPPORTUNITY ZONES, EXPERTS SAY
Most investors have focused on the real estate investment side of the federal opportunity zone program, but many are missing out on a part of the program that could generate far greater returns, experts said.
The returns on investing in a high potential company that sets up as a qualified opportunity zone business, or QOZB, and starts or relocates in one of the designated 8,700 opportunity zones could be 10 times more profitable than flipping commercial real estate, The Pearl Fund founder and Managing Partner Brian Phillips said.
"For real estate, you may get two times your money back, triple, maybe quadruple, but we don't even think about investing in a [QOZB] if we don't at least get a 10 times return on it. It's huge potential but it's also higher risk," said Phillips, who launched New York-based The Pearl Fund in May.
Proponents says if it is successful, a QOZB will grow, create a lot of jobs and support the smaller businesses in an opportunity zone community. "That can yield much more significant return than you can in real estate investing and there is a much greater impact on the community," he said. "It's nice to have that double impact."
Advantages and disadvantages to being a first mover in Opportunity Zone business investing.
Why business investing may be the best use case for Opportunity Zone investment, both in terms of investment return and economic impact.
Brian’s response to the August 31 New York Times article that was critical of the Opportunity Zone incentive.
The importance of diversification and balancing an investment portfolio between both business and real estate.
The coming Opportunity Zone business investment movement, or “second wave” of Opportunity Zone investing.
Best practices for structuring, capital raising, and timing Opportunity Zone multi-asset business funds.
The challenges that the Opportunity Zone tax incentive pose for venture capital investing.
Opportunity zones (OZs) are a hot news topic right now: Part of the new tax law, they’re intended to draw $6.1 trillion in unrealized capital gains into furthering economic development in 8,700 designated low-income areas around the country via investment in real estate and business.
But they’re also drawing controversy, specifically the critique that they will benefit the rich through an unprecedented tax break, while investment goes to real estate development that would have happened anyway, and that furthers gentrification while doing little to benefit the communities residing in the zones. Skeptics ask how the OZ regulation can actually lead to measurable economic development and social impact.
There is a reason we can experience both the promise of OZs along with skepticism about their impact. This is because the OZ life cycle consists of three distinct "waves."
Wave One: The Land Rush
When the first tranche of OZ regulations was released last October, it focused primarily on real estate, and the result was that real estate funds that have existed for decades needed to make very few changes in order to make the jump into real estate investment in opportunity zones. Large real estate projects are also a quick way to soak up large amounts of capital gains looking for tax shelter. An estimated $20 billion flowed into OZ real estate (OZRE) in the first six months after the regulations were released, and land values in opportunity zones went up an average of 20%, fueling speculation and concern that money was going to development projects that were already underway. These first investments cherry-picked many of the projects with the most promising returns. Because of the way opportunity zones were originally designated, some of the initial investments were in zones that didn’t need to be designated as OZs in order to attract investment.
However, wave one is perhaps least representative of the legislative intent behind OZ. (Lawmakers made this clear in the letter they sent to the Treasury following the release of first tranche regulations). And the cherry-picking rush with which it kicked off is not sustainable. Soon, all the low-hanging fruit will be taken and OZRE will slow. Finding and developing additional projects that can generate returns will be much more challenging: It will take three or more years to rehab or build properties, then there is the issue of finding tenants to occupy these spaces at rates that justify the initial investment plus rehab. OZ regulations specify that the basis of the real estate (minus the land value) must be doubled in order to qualify for the tax break, which puts tremendous pressure on rent rates.
Wave Two: The Business Boom
OZ businesses (OZB) are the sweet spot of the OZ program, both for investors and for communities and social impact. OZB investing (i.e., OZ venture capital) has the potential to generate much better investor returns than OZRE. As with venture investing in general, the target returns for OZB investing should be at least 10 times the investment; the Holy Grail is to fund the next Apple or Google in an OZ. By comparison, average real estate investments target returns of two to three times the investment. Additionally, the requirement to double the base value of an OZRE investment means in all practicality that two to five years of the 10-year OZ window will be consumed with investment prior to seeing cash flow. By contrast, OZ businesses generally will be operational (ideally, doubling in value every year) even while investment is flowing in to speed their growth.
A study showed that investment in rapidly scaling small to medium enterprise is the most effective way to drive economic development. Before launching a VC fund specifically for OZs, I spent a decade mentoring and advising entrepreneurs in countries such as Kenya, Nigeria, Brazil and India. I saw firsthand the proven benefit to investing in diverse and women entrepreneurs, a finding that should also be applied to OZ community development in the U.S. The bottom line is that fast-growing companies create jobs. More jobs mean more people who need better housing near their workplaces, and who also need more local services such as day care, dry cleaning, auto repair and places to eat and shop. This is the cycle of wealth creation and community revitalization that legislators intended to spur with OZ.
So why is OZB wave two? Simply because it is getting a slower start than OZRE. A business-friendly update to OZ regulations was released on April 17, six months after the regulations that opened the gates for wave one OZRE investment, and 15 months after the law was passed. Complying with OZ regulations is more complex for OZB than for OZRE, so there are fewer experienced OZB fund managers than OZRE, and the initial setup costs are high. Despite the slower start, OZB investment and development is expected to scale quickly due to the higher potential for both returns and impact.
Wave Three: The End Zone
This is where we can see the full potential of OZ investment and impact realized. In this wave, with the right foresight, the potential shortcomings and challenges of both OZRE and OZB will each solve the other’s problems, and in so doing create something greater. In my view, this will likely occur three to five years into the OZ program.
At that point, OZRE will have slowed and been possibly overbuilt. OZRE construction projects will be coming ready for occupancy. OZRE will need tenants who can pay rents/leases that justify the increase in basis. The best source of such tenants ideally will be successful, fast-growing companies and the supporting service infrastructure that has scaled up, fueled by OZB fund investment in wave two. Meanwhile, OZB will be growing rapidly, outgrowing their current spaces. But to remain a qualified OZB, they are required to keep 70% of their tangible assets and 50% of their workforce in an OZ.
Ultimately, anything that creates an impact comes in waves. The good news is that these waves do not have to be sequential in time, but with the right kinds of smart investment can build on each other simultaneously, lifting the tide.
Are Opportunity Zones (OZ) Nothing But a Tax Break for the Rich?
Yesterday, the New York Times published an article on Opportunity Zones by Jesse Drucker and Eric Lipton: How a Tax Break to Help Poor Communities Became a Bonanza for the Rich. We think the authors correctly point out several real estate developments underway under the auspices of OZ which do not meet the ambitions or aspirations of the OZ program in terms of delivering needed social and economic development to low-income census tracts. The factors described driving the rise of such projects are all spot-on, including investor opportunism, the inclusion of zones that are not currently or strictly low-income, and zoning that encompassed already planned or pet projects. However, we agree with John Lettieri: this “early wave” is not what we should use to judge OZ overall.
In fact, we believe there will be “Three Waves of OZ”: Wave 1, The Land Rush, is the current focus on real estate (OZRE). It is worth noting, this wave is itself in early days, which is why we see the most opportunistic projects happening first. Wave 2, The Business Boom, is venture capital investment in OZ businesses (OZB) and is the sweet spot of the program in terms of community/social impact as well as broader scale investor returns. Cherry-picked projects aside, venture capital has the potential to deliver higher ROI than real estate development over time. Wave 3, The End Zone, is when OZB and OZRE together deliver on the full promise and ambition of OZ. At that point, OZRE will have slowed and be possibly even be overbuilt, OZRE construction projects will be coming ready for occupancy, and they will need tenants who can pay rents/leases that justify the increase in basis required by OZ regulations. The best source of such tenants ideally will be successful, fast-growing companies and the supporting infrastructure (places for employees to live, eat, and shop) that will have been fueled by OZB investment (wave 2).
Fortunately, waves 1 and 2 do not need to be sequential, and wave 2 has already begun. The only reason OZB is wave 2 is because it has had a slower start than real estate investment. When OZ was passed in January 2018, it was essentially seamless for the big money real estate firms and funds to begin OZ development projects. It was also fairly straightforward for Treasury to issue regulations around OZ real estate, in October 2018. Real estate investment in OZ thus could move forward with the momentum of “business as usual” and in large-scale projects.
By contrast, regulatory guidance for OZ business investing was not released until April 2019, and it’s complex. In addition, unlike large real estate funds and developers, the big money players on the business side, the large VC and private equity firms, are not moving swiftly into OZ. Over the past decade, venture capital and private equity have moved away from the kind of early-stage, smaller investments that OZ startups require. They will wait to invest larger amounts in later rounds, when winners have emerged. OZ business growth will be seeded by specialized OZB funds focused on creating winners from the ground up.
We believe the good news is that this “OZ Movement” has started. Funds are being created around the country, many by repeat entrepreneurs who are networked into communities and a range of industries. We personally have been helping a number of great OZB funds prepare for a launch. Examples: a mission-driven, minority-founded impact fund in Baltimore, Maryland; a food hall for first time chefs in Houston, Texas; OZ-incubators™ in Manchester, Connecticut and Los Angeles, Berkley, and Oakland, California; a fund to build 5G towers in OZs across the country; a fund to invest in outdoor/recreational companies in Colorado; a consortium of snack foods companies in Danville, Illinois; a clean-tech HVAC plant in Richmond, Virginia; and a group of housing restoration contractors in Atlanta, Georgia. Hundreds more are out there, not open yet but underway. Some of these are wave 2; some are even the earliest signs of wave 3, thoughtfully developing business and real estate together. As more entrepreneurs, investors, fund managers, and communities realize what is possible to accomplish with OZ, these waves will build. Eventually, they will dwarf the early opportunism of wave 1.
Importantly, there are many good players out there, committed to delivering on the promise of OZ to drive attractive tax-free returns for investors and real, sustainable social and economic impact in low-income communities. It’s up to us not to let OZ become nothing but a tax break.
Brian Phillips is a serial entrepreneur and the Managing Partner of The Pearl Fund, a pioneering qualified opportunity zone venture capital fund. He is a well-regarded speaker and thought leader on Opportunity Zones. Follow him @thepearlfund
The Pearl Fund Recognized as a Top 10 Leading Opportunity Zone Fund in Forbes OZ 20 National List January 17, 2020 link: https://bwnews.pr/375Jk1n
There are currently over 500 OZ funds that have launched across the U.S., which have collectively raised over $6.7B. Most are focused on real estate investment in Opportunity Zones. The Pearl Fund was the first OZ venture capital fund in the nation and has been recognized repeatedly as a pioneer in business investing in OZ. In addition to its original fund, the Pearl Fund has also created a network of other OZB funds, each with a unique geographic and industry focus.
The Pearl Fund Adds Colorado and Texas to New Network Designed to Spur Social and Economic Impact in U.S. Opportunity Zones November 19, 2019 link: https://bwnews.pr/37lxoJC
"The Pearl Fund Network of Qualified Opportunity Zone Funds are pioneering OZ funds focused on delivering competitive returns from venture capital investments and a full suite of opportunity zone tax benefits to investors, while driving social and economic impact in opportunity zone communities through investment in entrepreneurship. The Pearl Fund Network of Qualified Opportunity Zone Funds, managed by the Pearl Fund Management Company, LLC, are committed to the highest standards in opportunity zone fund structure, legal and accounting compliance and oversight, and performance and impact metrics and reporting, and are supported by the leading OZB legal, accounting, and tax experts in the nation."
The First Venture Capital Opportunity Zone Fund Opens in the U.S. May 14, 2019 Link: bit.ly/2019PearlFundOpens
"There couldn’t be a more opportune or exciting time to launch our fund than now,” said Brian Phillips, founder and managing partner of The Pearl Fund, who brings more than three decades of experience as a serial entrepreneur and expert on emerging economies. “We will be working closely with our portfolio companies to ensure high returns for our investors who are seeking to diversify their portfolios at such an unprecedented time."
The Pearl Fund Adds Three New Advisors: April 10, 2019 Link: bit.ly/2UNED9t
"The Pearl Fund ( www.thepearl.fund ), the first opportunity zone fund that is also a venture capital fund focused on spurring economic development in opportunity zones throughout New York and Pennsylvania—is pleased to welcome three new advisors. The team of highly-specialized, diversified and accomplished executives brings extensive leadership experience for multinational corporations and startups."
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