Commercial Investment Real Estate September/October 2019 | Page 17

Immigration Services, an agency of the Department of Home- land Security, established this employment-based visa program to encourage foreign investment in 1990, though it grew in popular- ity after the 2007 financial crisis. Foreign investors could gain permanent residency through investments, between $500,000 and $1 million, in a new commercial enterprise that created at least 10 full-time jobs. In the early days of EB-5, the dimensions of the program were undefined, but it has become a vital driver of the American econ- omy. Throughout the course of any program, consumer opinion will ebb and flow. Regulations will change, and funds need to expect and be ready to manage that. No fund environment will ever remain static. You need to have the data and paper trail to be prepared to answer questions from not only the government, but from inves- tors. Ask yourself: “What happens if the IRS does this or that?” Make sure you have an answer. EB-5 also taught us a lot about security. In opportunity zone funds, the capital investment is driven by the investors’ taxable event, and capital is moved into the fund before the specific need and use of that capital are predicated. Large pools of capital will exist in the subscription phase before distribution into a qualify- ing opportunity zone project. The EB-5 marketplace was similar, where we saw multiple instances of fraud and abuse where those resting funds were inap- propriately allocated for purposes other than the EB-5 develop- ment. The need for third-party oversight and investor trans- parency of this capital became increased measures of security. Industry best practices were developed to prevent malfeasance and ensure investors’ capital was properly protected and appro- priately utilized. Best Practices from Your Fund Administrator Hiring a third-party fund administrator to help manage your investments is not required, and some companies feel that they don’t need extra oversight. But if history tells us anything, third- party oversight should be sought, and dismissing it completely may be a misstep. Take the Bernie Madoff scandal, where regulators missed his $50 billion Ponzi scheme that defrauded thousands of investors. With third-party administrators, investors would have been less likely to be fooled by his scheme by requiring the fund to be more transparent. Investors should want fund managers to have reputable out- side administrators to help ensure their investments are safe and that all regulations are being met. Fund managers should want third-party administrators so they look good to investors and to protect their own company. It can be extremely challenging to work with opportunity zone fund tax and securities laws, regulations, and tracking and report- ing requirements. Scaling up to meet sudden investor demand can also pose problems, especially if the accounting is performed with software too basic for such sophisticated fund accounting. CIREMAGAZINE.COM Opportunity zone funds must be equipped with tools that allow them to adjust, and best practices need to be established in security, compliance, and transparency. Security In other financial industries, the use of independent, third- party controls and record keeping is standard practice, so it should be no different with opportunity zone funds. If you don’t have a third-party administrator, investors will likely hesitate for fear of poor record keeping. They will also want to be certain their information is not subject to a cyberattack, so assuring them that their data is secure will be key to gaining trust — and their investment. Opportunity zone fund structures are inherently different than traditional private equity funds, where investors make cap- ital commitments that are realized when there is a capital call necessitated by a pending fund investment. Opportunity zone funds feature single asset funds where the operator/developer is both the fund and the project. Once the money moves from subscription to deployment, it’s imperative to provide visibility and assurance that capital is being allocated consistently with the project’s business plans and in compliance with opportunity zone regulations. Compliance In the world of compliance, it is better to overprepare than to underprepare. Track compliance at the fund and investor level and, once again, prepare for rules and regulations to change. Opportunity funds must also comply with additional tax and reporting requirements, such as the “substantial improvement” and 90 percent investment in qualified opportunity zone prop- erty tests. This can add complexities and make evolving regula- tions more difficult to manage. If history is any indicator, the IRS is certainly able to shift from friendly to aggressive. Funds must plan for a potentially exhaustive level of scrutiny by the IRS at the fund level and at the investor level. Oversight is a dangerous and potentially costly risk for a fund to take with investor capital. Transparency Fund managers should be transparent from day one. The complexity and number of stakeholders make transparency a challenge — but it is best practice to make sure all material information is accessible to all relevant stakeholders. Unsurpris- ingly, investors want to know where their money is and how it is being used. If you want to invest in opportunity zones, make sure you do it right. You need to know your paper trail is continually up to date. Michael Halloran is founder and CEO of Silicon Valley fintech company NES Financial. Contact him at [email protected]. September | October 2019 15