96 OPPORTUNITY ZONE MAGAZINE | ISSUE 2 • VOLUME 2
underlying real estate asset is probably at stabilization of such asset . However , a sale at such time would not avail the investors of the Opportunity Zone benefits .
Most sponsors intend to refinance the underlying real estate asset and make distributions of the excess cash proceeds prior to the date that the investors will be required to pay income tax on the eligible gain that was deferred with respect to the Opportunity Zone incentive . Based upon the distribution waterfall described above , in order for the sponsor to receive any portion of the excess refinancing proceeds , this amount needs to exceed the amount of the investor ’ s 8 % preferred return plus the investor ’ s original capital . It appears to be a challenge for the sponsor to receive any cash from the distribution of excess proceeds from such a refinancing based upon the waterfall set forth above .
CRYSTALIZING THE PROMOTED INTEREST
One alternative for the sponsor is to negotiate with the investor the ability to make an election to “ crystalize the promote .” By crystalizing the promoted interest , the distribution waterfall is changed from a layered hurdle approach to a straight up percentage interest between the investors and the sponsor . This will have the impact of freezing the value of the real estate asset for distribution purposes based upon what the investors and the sponsor would receive upon a hypothetical sale of the assets and a distribution of the excess cash at the time of the election .
An election to crystallize the promote is often made at the time of a certain milestone , such as stabilization . Having an election at the time of such milestone is usually beneficial for the sponsor because it establishes a value for the crystallization when the hypothetical liquidation proceeds should result in an advantageous percentage as it relates to the sponsor as compared to the investors because of the shortened period for the accrual of the investor ’ s preferred return . This should also protect the sponsor from downward fluctuations in the value of the real estate over the 10 Year Holding Period .
EXAMPLE – NO PREFERENCE ON CAPITAL
Assume that a number of QOFs formed by high net worth individuals contribute an aggregate amount of $ 10 million to a QOZB . The QOZB obtains a $ 10 million loan and then acquires and develops a parcel of real estate for $ 20 million . The distribution waterfall is the same waterfall as described above but without a distribution to the QOF investors for a preference on their capital in clause ( 1 ).
In the fourth year , after the developed property has reached stabilization , the property is worth $ 30 million . If the property were to be sold at such time , the sponsor would obtain $ 2 million of hypothetical liquidation proceeds , or 10 % of the total $ 20 million of hypothetical liquidation proceeds ( after
OPPORTUNITYZONE . COM