Nest Opportunity Fund: A Buy-And-Hold Investment Strategy For Distressed Single Family Homes
From the Aug. 13, 2020 edition of the Mapable USA podcast.
Ron: Well, hello everyone, and welcome to the Mapable USA podcast. This is Ron Costa broadcasting live in the Mapable USA Studios in Las Vegas, Nevada, and folks today, we got a really interesting show. We’re going to be talking about some of the nuances of Opportunity Zones and in order to do that, let’s bring in Vickie Huchmala from the marketplace and the Opportunity Zones Authority. Vickie, how are you today?
Vickie: I’m outstanding today, Ron. Great day in Vegas as always. And we have a very interesting guest today. We’re going to talk about Opportunity Zones and a little bit about financial planning.
Ron: Let’s get this thing going now. Let’s introduce Clint Edgington. Clint is the founder of the Nest Opportunity Fund. Clint, how are you doing over there today?
Clint: Hey, I’m doing great. And I’m here in beautiful Columbus, Ohio, where it’s a beautiful day today. It’s not always beautiful.
Ron: Let’s get into this whole conversation: What you’re doing right now and your background on the Opportunity Zones, and how you kind of got into this whole business.
Clint: Yeah, well, it’s a long, arduous road to where we’re at today, but I would say it probably started mowing yards for my parents. Their small kind of real estate mom-and-pop operation in the early ’90s. Then we fast forward 20 years, and we started an RIA in the shadow of the collapse of the great financial recession in 2008. Clearly, market timing is not our specialty. We’ve been running and operating that for the last 10 or 12 years. And our focus is on business owners. Inherently, with business owners, you have a bunch of tax planning that goes into it, hand in hand with their CPAs. And, as I was describing it to new clients, our job is to kind of throw 10 different tax minimization techniques up against the wall, and the CPA will help pick which two are reasonable.
And so, doing that through time, we’ve done a lot of tax advantaged investing and financial planning on that end. And, in 2017, when the Trump Tax Cuts & Jobs Act came out, when I was kind of burrowing through it and got to sub-chapter Z, my eyes lit up a bit because at the same time, my family and I and my partner in business really had our first kind of real sizable, at least for us, capital gain. And so I just knew the power of that incentive when I started to read through it, although it was murky at the time, and what that would do for us and kind of started getting the wheels turning. So it’s been a long road, and from 2018 until really December of last year, we started setting it up as a private partnership, just for myself, and my business partner and family, and we had an operator in Lexington, Kentucky that we had done work with who also had a capital gain at the same time.
So the stars seemed to align, and we put it together for ourselves. And then our clients started having some cap gains from selling businesses, and also the language started being more open to multi-asset multi investor funds. We just said, “Gosh, we should do this for our clients and other investors as well.” And so we did, and got the pleasure of working with our attorneys and audit partners for about six months before it got kicked off. But, I guess the last year we did a little capital raise the last three weeks of December when the fund had opened. And we’ve been kind of working on a bunch of single families, and some smaller duplexes in the Lexington, Kentucky and Columbus, Ohio markets. And we’ve been working on setting up our processes and procedures and getting some of those done, and it’s been a lot of fun.
Vickie: So what’s the name of your fund?
Clint: Our fund is called the Nest Opportunity Fund
Vickie: And it operates in Kentucky?
Vickie: Is that where you do most of your investing?
Clint: Yeah, the majority of our investments are in Lexington, Kentucky, which has some great Opportunity zones that are really in the kind of urban core area. Lexington is a smaller town, but it’s got pretty stable employment, and it’s been growing relatively stably over the last 10 to 15 years. Think of the employment there – it’s pretty much the University of Kentucky and then both the city and county government. So we like Lexington a lot. We’ve got a great operator down there, and we also do a little bit in Columbus, and we’re working on expanding that out a little bit.
Vickie: So the Nest Fund is not strictly your family’s investment. Your clients through Beacon Hill can also invest in the Nest Fund, is that correct?
Clint: Yep, clients as well as outside investors who have an interest in it. Although it started as just – well, we had to call it a “fund” because it’s an Opportunity Fund – it was really just a private partnership. So all of us threw in some money. We had started with a half a million bucks, and that’s really been the seed capital. And so we were the first LP’s, and we still are in the Fund as an LP.
Vickie: Oh, OK. So you created it using all the criteria with the IRS and treasury to actually create an Opportunity Zone Fund, or it’s just an investment fund that you’re investing in Lexington and Columbus?
Clint: Yeah. So we created it just with three partners at the time, as an Opportunity Zone Fund that we invested our capital gains into. That was January of 2019. And at that time, the language, we didn’t really get final regulations until December of 2019. And the language then was a little dicey on multiple outside investors with multiple assets. So we didn’t even think about raising outside capital. But then the language started to kind of solidify really July of last year – those issues went away. And so we pivoted to, well, hey, why do we need to just do this only with ourselves? We could have outside investors in. And so the outside investors will invest on the same exact terms as we put our investment in. So they are limited partners, just as are we limited partners.
Clint: In addition, we act as the GP. So we’ll manage it and operate the fund as well. It’s a little bit unique, just because we started making our own soup and then some other people liked the soup. So we opened up to other people to have some soup.
Vickie: Well, initially, even though the program was outstanding and the concept of the program was great, initially, it was just like a little bit unknown. Nobody really knew what it was or where it was. There wasn’t any real definition to it, but as time has passed now, and the regulations have become a little bit clearer, more people are understanding the impact and the investment in Opportunity Zones. That was insightful of you.
Clint: Yeah, I think it was less than insight. It was just caution. I’ve generally not seen the IRS move to make something as beneficial as it originally sounds when they’re finally done with final regs. And I think they really did with this QOZ language. I mean, generally, you see the IRS throw up some gotchas and issues before where there is ambiguity of language, and really, so far, where I’ve seen as in most large areas where the language was ambiguous, they usually made it consistent with the spirit of the law, and they really didn’t throw up a bunch of issues. I mean there are some issues, but I didn’t know that at the time, and I wouldn’t want to get outside investors kind of tangled up in a web that I helped weave.
Vickie: And the government tends to do that where they create a program that’s fabulous, but they give no direction and no specific rules and regulations of how it’s going to work. And they kind of just let it evolve and see what happens. And then, after the fact, put in the rules, so a lot of time gets wasted because nobody really understands it. But Opportunity Zones are a fabulous program. The program itself is great because its prime focus is to elevate the quality of life of people who live in a distressed area that need help. And this is an excellent way for public-private partnerships to help everybody. It’s kind of win-win for everyone.
Clint: Yeah. And we’ve really worked to kind of take the spirit of the law and to operate within that. So our areas obviously are distressed. Some of them are up and coming, but generally they are distressed. And what we’re trying to do is also share the benefits of an improvement of a neighborhood with the current people who live there. So we’ve actually partnered up with the city of Lexington to give our tenants a program basically where, for each year that they rent a property and that they are the tenants and pay on time, that it will kind of give them a reduction in the purchase price of the house if they would choose to purchase the property. And in doing so, Lexington has giving us a decent chunk of grant money and also some low interest loans that are recourse only to the Fund, which is helpful for a couple of reasons. But we’ve really kind of taken that. We’ve really tried to work with the spirit of the law with that and structuring it, even when we don’t get that grant money we’re still trying to work within that.
Vickie: And the stronger the relationship the fund has with the municipality, where the zone is located, the easier it is to get things accomplished. When they’re offering incentives that are beneficial to the Fund and to its investors, then it can only benefit the residents that are located in the zone. And so we’ve found that a strong connection, a relationship, with the municipality goes a very long way in whatever they can provide.
Clint: Absolutely, and I think that’s an area that perhaps someone that’s not in the real estate game doesn’t think of as much, but even as simple as: We bought a package of properties, about 15 properties, at the outset of this last year sometime. And all of these properties were vacant. They were all vacant, single-family homes, all had code violations, and you could drive by and tell that there was going to be some code violation.
So, at first, there is that relationship building. We’re these new guys, we’re buying these properties, and it took a while for the inspectors and for the people in the code compliance departments to take our calls and to let us talk to them. “Hey, we just bought this property. Yes, I know there are some issues. Here is a timeline that can work with me, work with me on this. What are the issues that you see need to be taken care of right now? Obviously, we need to get the yard mowed and clean-up done. But I can’t get the roof replaced tomorrow; not going to happen.”
Ron: And Clint, once you buy these properties, you fix them up obviously and you bring them to code, and then you put renters in there. Do you flip them, or what’s the strategy on that?
Clint: Yes, we are buy and hold. Our view is: We’ve got a 10-year horizon on this, so we just need to hit singles and consistently hit these singles. And so far we have been, so we buy heavily distressed single family properties. We’re buying them basically in the wholesale market. Sometimes we can take down a larger package if we know that there’s a block coming up. Sometimes they are onesies, twosies, and then we will be doing heavy rehab down to the studs or more. So there’ll be an initial ramp of the first two months dealing with some code issues. Then some planning issues … a few of our properties will have kind of more extensive planning issues.
And then we start the heavy rehab works, and obviously, in the single family market where we’re going to be buying and holding, frankly, we overinvest in certain items. We could come in year one on when we’re renting the property and have a higher yield by kind of reducing some of our build quality. But what we’re really looking into is what’s going to be the best house for us to sell in 10 years. So we are buy and hold. We will sell properties. Through times they don’t kind of fit the footprint. Like, if we bought them as part of a package, and 1 out of 10 of them just doesn’t belong, we will sell them, but we have not yet. And we do imagine there will be some sales to tenants, through time, but not significant. And right now our real focus is just on the purchasing and the efficient construction of these properties.
Ron: Yeah. And are you working with the local real estate agents there to acquire properties? Are you going to foreclosures or mixture of everything or how are you getting your inventory?
Clint: Yeah, it’s going to be all of the above. So a large block of the properties we purchase from a public company that just didn’t fit within them and they wanted to get rid of them, because it just always looked like losses for them. And it just doesn’t make sense for a public company to own small single family properties. If you have to kind of audit every single toilet flange – well, you’re going to be at a competitive disadvantage.
So we purchased about 15 of our properties through that. And then the remaining 15 or so properties, we’ve purchased mainly through wholesalers. We’ve purchased foreclosures in the past. However, that market has been shut down, effectively, for six months. And in the previous year, there just wasn’t a lot of inventory in foreclosure. Now, I think there’s a reasonable chance that’s going to change, and we might get more active there. We’re certainly like keeping tabs on that, but right now the flood gates certainly haven’t opened yet there.
Ron: Yeah, and you mentioned before how you have a couple of duplexes in there. Do you get anything higher than that? You don’t do any like 12 units multifamily or anything like that, do you?
Clint: We haven’t yet. We are looking at a 4-unit now. We just passed on an 8-unit, but in the smaller space. We are open to it, and it’s something we have some experience in, but frankly, right now, with multifamily of any size, our view is what we’re trying to do is ensure the highest probability of capital gains for my clients in the future. And so if I can buy, I’m seeing that we can buy value, add multifamily right now, and by the time we’re done with the construction, we’re coming in at a cap rate of 5% to 7%. And all it takes is for cap rates to move up 20%. And then, all of a sudden, our future capital gain is gone. Yeah, we are open to it. I don’t know what your market looks like. We just don’t see that the pricing works for it right now.
Ron: Right, right. Gotcha. What I think is really interesting about this is like your clients, I guess, from Beacon Hill, they can generate capital gains a whole bunch of different ways, including selling businesses or non-real estate ways of capital gains exposure, and you take that and invest it into your fund, which is investing in real estate. So you can almost sell your business, you have your capital gains, and now you can invest that money into a real estate venture, through the Nest Fund, which is really kind of cool. I think for a lot of these guys, and it looks as if you guys have a good target market out there, and you’re hitting the right spots, it seems.
Clint: Yeah. I think it does work. So for the majority of Beacon Hill’s investors and outside investors who have come in not through Beacon Hill, a lot of them have sold their business and they maybe are in their 50s or 60s. They really liked this tax opportunity, and they really want something more conservative than reinvesting it into another business. And they’re really looking for something more conservative, to dial down their risk in their life. So, like, a dirt deal in the hospitality sector perhaps is not something they’re looking for. So this is a little more stable. I mean, we’re not going to have a 20% rate of return annualized for 10 years. That’s just not going to happen in this space. But we’re relatively confident that we’re going to have some reasonably good returns. With any real estate, there’s risk.
Ron: Right. And in the real estate sector, in its own right, you guys chose to kind of focus in on multifamily. Are there any other sectors and Opportunity Zone investing that you guys considered?
Clint: We have been looking at syndications through Beacon Hill for eight years or so, and we have investors and clients in this indication. So we’re familiar with what terms are looking like right now for multifamily, self-storage, industrial, and we kind of stopped doing much of that work in 2017 or 2018. Just that basically, cap rates had gone down to the level that it seemed that people were having to take additional risk in order to get the projected returns that we were looking for in order to do private deals. But we also analyze for our clients. We don’t just present our Fund because we have a conflict there, we’ll present a few other multi-families as well as what we like in this space. So we’ve analyzed multifamily, certainly. And industrial, which if you look at one industrial deal, you’ve seen one industrial deal. Each one is quite unique and frankly hard to analyze, usually. Yeah, we’ve looked at some other stuff.
Ron: And in this COVID world that we live in, at least here in Vegas, we’re seeing industrial to be very popular right now for a lot of investors who are looking to nab warehouses and develop that kind of property. I wonder if it’s the same thing, where you guys are looking as well.
Clint: Yeah, absolutely. Everywhere in the Midwest, every city in the Midwest, uses its proximity to the East coast as the reason why it should be the best distribution in the Midwest. So it’d be like somewhere on the city of Columbus website, it talks about how you can reach 70% of the population within an eight-hour truck drive. And I’m sure it also says the same thing in Lexington. But we are a decent size Amazon distribution center, and there is definitely a change in the industrial makeup right now, just how we’re buying things differently. When I’ll go into the shopping mall to buy things, or ordering on Amazon or wherever, and that changes warehousing and logistics. So yeah, we definitely are saying that area is quite active. Again, for our client base, with change comes great opportunity, but also risk. So ours is a little bit of a simpler, little bit easier, generally less risky type of asset class. But, I’m sure real money will be made in the industrial side.
Vickie: Well, when there’s kind of like a chain reaction situation where here in Vegas, Google is coming in and Amazon is coming in and building huge facilities. And that requires the residential for the employees. And it requires the commercial to support the employees that are going to be working there, giving them a place to live, giving them stores to go to, and entertainment and all of that. So it’s kind of a cause and effect, more so than just residential. Residential is just it and that’s it, and there you go. But with industrial and commercial, that can lead to opportunity in a whole lot of other areas.
Clint: That’s right. Yeah. And if you choose where industrial is growing, well then, you’re likely going to have growth in the demand for single-family housing and for smaller multifamily. That’s kind of our whole take. So in 10 years, will Amazon still be the 800-pound gorilla that it is now? Well, gosh, probably, but I’m not sure. But I do know that likely that distribution function will be existing in the same way, but those people will need places to stay. So I know that people are going to want to live in houses in 10 years.
Vickie: I was just going to say with the virus, the impact of the virus has people seeing what Amazon and Google and all of this, what the impact that they’re having and they are the businesses that are growing technology. And so that creates competition. So even if in 10 years, Amazon isn’t as big as it is today, there’ll be a whole lot of other ones that are smaller but still require the industrial commercial space.
Clint: That’s right. Yeah, absolutely.
Ron: We’re also seeing a bunch of these developers want to come in and repurpose a lot of these buildings. For example, a lot of the retail and the office buildings here… a lot of guys want to convert that into medical space because I guess that’s still going to be OK versus COVID. And I wonder if that might be another asset class that a lot of people might be interested in doing as well, because medical is going to go nowhere, right?
Clint: Yeah, absolutely. One of the Opportunity Zones Funds that we’ve analyzed, ones we discussed with our clients, is actually looking at shopping malls in Vegas, taking them over for Simon Property Group and converting them into multi-family homes. There’s definitely a conversion of retail space likely going to occur.
Ron: Yeah. That’s for sure. A lot of action on that right now. Just a couple of things before we move on to our next topic here. I want to get back to your multifamily and the duplexes and the single-family homes that you’re upgrading. How long does it take you between when you start construction, to bring the thing to code, to when a renter actually rents the unit?
Clint: That is a really good question. We’ve been doing it for a year and a half, and I will tell you that number is kind of fluid. So, right now we’ve got about 30 different properties, of which 5 are completely rehabbed. We’ve got about 5 in what we call final rehab. So all of our mechanicals are done, a good chunk of the money is been put into it, but the finishing stuff takes a lot of time. 4 in initial rehab and then 14 that we’re in kind of planning and in inventory. And of those 14, it is kind of planning an inventory, meaning just kind of sitting there and working through code violations, those types of things. 5 of those were purchased in the last quarter. So yeah, we think it’s going to be between 7 and 9 months. And right now, we’re trending more towards 9 to 10 months. However, there was a ramp-up period where we started last year from a standing start. Fortunately, it was just our capital at the time that was kind of sitting there. We’ve got more crews operating, so we’re dialing back more to the seven months. That said, there are always anomalies.
So for example, there’s a certain house footprint that occurs a lot in Lexington that is small. It’s got high ceilings, kind of large, highly vaulted roofs with a high slope, like, 6/12, or maybe it’s even 8/12 slope of the roof, that are effectively two-bedroom houses. And we’re working with engineers right now to kind of loft some of them up a little bit and basically try to figure out if we can fit four bedrooms in there and if it will look cool and open, or if it will look like a cave. The nice thing with scale is we can kind of take risks like that. But if that footprint works out, it would be magnificent for us, because we can purchase a lot of these and basically convert a two-bedroom to a four-bedroom without much additional costs. But that’s taking a heck of a long time. So we bought these, we’ve got 3 right now that have that footprint. And those were 2 of the 3 that were purchased last spring. And so we’re really going on 12 months, and we really haven’t started real construction yet. But on average, we’re looking at between seven to nine months to do it. And obviously, with these properties, efficiency is key. They’re relatively small, so we could go in and do it faster. We could go with a large HVC company that employs 300 people and have them go pop out all of ours, but that’s just not the most efficient use of our clients’ capital.
Ron: Right. And you want to do it right. You want to do it right the first time.
Vickie: Yeah, exactly.
Clint: Oh yeah, absolutely.
Ron: OK. That sounds pretty good. And Clint, you have a good pulse on the whole industry in general. Obviously, what are some of the “under the radar” topics about Opportunity Zones that we should be aware of that many people probably don’t know of right now?
Clint: Well, I have a good pulse on the OZ space pertaining to real estate-based funds. I don’t pretend to have much when it comes to venture or private equity in this space, but in real estate, I think one under-discussed topic and one under-discussed benefit is the ability to take depreciation at the K-1 level or the limited partner level, throughout time, which real estate generally will give you throughout time, which doesn’t have a negative cash flow, but gives you a tax benefit. But then, at the end, when you go to sell, you don’t have that depreciation recapture. So, a lot of times, you’ll get that benefit through time. But at the end, you have to pay depreciation recapture at 25% or 28%. It takes away a good chunk of that benefit. But in this case, you get the depreciation tax benefit, but no recapture.
But that being said, for most investors who come into an OZ Fund, they’re bringing a capital gain and, inherently, that gain has no tax basis. And our passive-active loss rules say, “Hey, listen, if you don’t have a tax basis, you can’t take a loss upfront, and upfront is when the majority of your depreciation really is valuable.” So there are different ways to structure it. So the way we have chosen, we were able to work with the city of Lexington, and part of their package to us is that they gave us a low interest loan: 2%, 15-year loan. And that is only recourse to the fund. So effectively, if it were recourse to me, if I put a personal on it, which is obviously the way they generally do it, then it would be recourse to me, but there would be no at-risk capital to our limited partners.
And so, because we structured it that way, and I’ve seen other OZ Funds do this as well, that the limited partners have what’s considered capital at risk, and they can then take those losses. There’s other ways to do it, but that is a huge benefit, and I think it’s a huge benefit that people really talk about. And if it’s not structured properly, you might not be getting it.
Vickie: And that’s something that municipalities can help with in: providing financial incentives. So you can stack the funds with different monies aside from just capital gains monies.
Clint: Yeah. Although, likely your ownership is going to be structured differently. With your cap gain and your non-cap gain money, you might actually have different units, which might not give you that benefit, but it’s just something people should discuss with their CPA and probably have the discussion with the fund about it. And if the fund doesn’t know what you’re talking about, that gives you an indication on how clean their structure is and how much they thought through their structure.
Ron: Well, Clint, what Vickie always says: Make friends with your municipalities. She always says that. And I think this is a good example of success of the reason why you want to do that.
Clint: Well, the city of Lexington was great to work with. At first, obviously, they would say, “Well, why wouldn’t you want to sign it if you’re so confident in it?” Once, when we talked to them for a long time, really fortunately, one of the gentlemen was an ex-CPA. And so we could walk through those basis rules because they would want to know why, why, why would you not want to sign. When we kind of walked them through this, they understood. And then the next thing is, “Say, listen, we’re going to give you a very low loan to value. So we’re going to give you that safety. We’re going to back it up with our actual fund, not just a subsidiary level guarantee, and our actual fund has a lot of dry powder.” I can tell you larger cities, I don’t think that would have happened.
Vickie: Well, here in Vegas, the Vegas Valley is made up of basically five different municipalities, and some of them are more bought into the Opportunity Zone program. And so they offer multiple incentives to people who are investing in the Opportunity Zones. For example, North Las Vegas offers an expedited permitting experience so that you can bring your plan in, and it can go through planning and zoning and getting the permit in 24 hours and they can modify. The city of Las Vegas is modifying their codes and their zoning and planning rules to make it easier to do what you want to do so they can adjust all of that stuff then. And these little things save a lot of money and give you the incentive to invest in that location. So the more a city buys into it, the easier it is to complete the project. And for municipalities that don’t understand that, you have to explain it to them in a way that it changes their mind so they can see the benefit to everybody. That the more incentive you get, the more investment you’re going to create.
Clint: Absolutely. And just visibility onto what they would approve of and what they wouldn’t. That means a lot. If I’m not sure if they’re going to improve a change, then I probably just don’t make the purchase and make the investment.
Vickie: Exactly. So the more upfront, the more likely you’re to invest there or to go find some other place to invest because it doesn’t behoove them to do anything for you to enter the investment. So Ron is right. That’s why I always say, make friends with the municipality and see what you can get, even if you have to convince them to give it to you.
Ron: Yeah, exactly. Clint, I’ve got to tell you, I’m really impressed on how you’re doing this and how you will be doing moving forward. We know a couple of groups here in town that are trying to do very similar to what you’re doing and they’re running into a lot of problems. And I don’t know. I mean, talking to you today, it looks like you guys are doing it pretty nicely and smoothly. So congratulations on that. And if I wanted to also let people who are on the call right now, listening to this podcast, if they want to get more information on the Nest Opportunity Zone Fund, how would they do that?
Clint: Sure. They can just look at our website, www.NestOpportunityFund.com, or they can feel free to dial me direct at (614) 905-6233.
Ron: And if they want to contact Beacon Hill, how would they do that?
Clint: Sure. (614) 469-4685 is our general office line, or again they can just call me direct.
Ron: Excellent, excellent. Vickie I think we did a good job about putting these guys on the QOZ marketplace. There’s a listing for the Nest Opportunity Zone on that website as well. We’ll link this all in the show notes, by the way. But I think this has been a pretty interesting podcast. Don’t you, Vick?
Vickie: Absolutely. Interesting and very informative. And it shows people that maybe are a little apprehensive that yes, you can do it. Look, you can do it. Just take that risk, go for it and make it happen. Just like Clint has done. And if you need help figuring it out, call Clint, he’ll help you.
Clint: Well, I appreciate that. Ron, Vickie, it’s been a pleasure to talk to you guys. And I’ve had a lot of fun today.
Ron: Same here, thanks for taking time out to do the show. Clint, I really appreciate it and everybody out there. So again, thanks to you, Vickie, for co-hosting. Oh, I miss you. Thank you everyone out there for listening. You’re listening to the Mapable USA podcast at mapableusa.com, where we put you on the map. Go to our homepage, scroll down, you’ll see all our syndication sources. Pick the one you liked best and never miss another episode. If you want to be a guest today on the show like Clint was, fill out that form. We’ll see what we can do about getting you on. If you like what you hear, send us an email at email@example.com, or just put a comment on the page that you’re listening to this on right now. So thank you everyone for listening. Thanks for all your help, your support.
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