Dealflow | April 9, 2019

M31 Capital’s Opportunity Fund targets workforce housing in the San Francisco Bay Area

Jessica Pothering
ImpactAlpha Editor

Jessica Pothering

ImpactAlpha, April 9What’s difference do Opportunity Zone tax breaks make for a commercial real estate fund?

San Francisco-based real estate company M31 Capital has launched a $25 million Opportunity Fund to buy up vacant and underutilized apartment and mixed-use properties in the San Francisco Bay Area and restore them as entry-level workforce housing.

M31 Capital’s first Opportunity Fund, called Morpheus Qualified Opportunity Zone Fund 1, will invest in the Bay Area’s roughly 80 Opportunity Zones, designated for real estate and investment tax breaks under the 2017 Tax Cuts and Jobs Act.

M31 doesn’t represent Morpheus 1 as an impact fund, in that it has not targeted measurable impact outcomes, nor baked impact into the investment thesis. But the fund offers an example of how the lure of tax breaks may make Opportunity Funds different from traditional real estate funds. The tax-cut bill that included the Opportunity Zone legislation requires investments to be held for 10 years to qualify for the full tax advantages.

“One great thing about Opportunity Zones is that the money has to stay there,” M31 Capital’s Taylor Lembi told ImpactAlpha. “It’s different than when you fix something up and sell it [immediately]. The money stays in the communities that need it.”

Lembi believes that that is meaningful in underserved communities, because the investors become part of the community for at least a decade.

The fund is also an example of the limited reach of emerging impact frameworks for Opportunity Zone investors. Lembi said he is aware of the frameworks, M31 Capital is employing them for Morpheus 1 at present. Rather, he says the company’s focus is getting up to 150 unused and under-utilized rental units back on the market.

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M31 Capital has been involved in $3 billion in real estate transactions, through acquisitions, redevelopments, management and financing since launching in 2016. Its strategy is to buy blighted properties, fix them up, and reintroduce middle-income rentals units in a metro area that is in woefully short supply of housing.

The firm targets workforce housing built in the 1920s and 1930s—small units that can be restored as studio and one-bedroom apartments for young professionals earning an average salary for the area. Lembi declined to specify an income range for its target tenants, but said it tracks with median incomes, which in the Bay Area can range from $63,000 to $122,000.

The firm already had focused on many of the Bay Area communities that have been designated Opportunity Zones under the tax legislation. Thus, the company says that all of the Morpheus 1 investments will be “economically sound,” even without the tax incentives that come with operating a designated Opportunity Fund.

In other words, Opportunity Zones affect the Morpheus fund’s capital commitment requirements and potential benefits to investors, but not the investment thesis.

M31 is seeding the fund with its own capital and has “soft commitments” of about $12 million from existing investors.

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