Michael Episcope is a principal of Origin, co-chairs the Investment Committee, and oversees investor relations, marketing, and company operations. Michael brings 25 years of investment and risk management experience to the company and believes that calculated risk-taking in inefficient markets is the key to building wealth. He has closed over $2.3 billion of transactions and has raised or invested principal funds of over 56 million and averaging a gross IRR of 30%.

He’s been featured on Forbes ValueWalk and HuffPost. He was a Commodities Trader on one of the exchanges. Now, he’s focused on helping others transform the way they invest in commercial real estate.

 

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Educating Individuals About Real Estate Investing with Michael Episcope

 

Brett:

Our guest is one of the Principals of Origin Investments. He is a co-chair of the Investment Committee and oversees Investor Relations, Marketing, and Company Operations. He brings 25 years of investment and risk management experience to the company and believes that calculated risk-taking in inefficient markets is the key to building wealth. He has an amazing story of being on the Chicago I believe, based hedge fund and trading on the floor of exchanges. And then he brings that expertise and focuses to the commercial real estate world. Please welcome to the show with me, Michael Episcope. Hey, Michael, how are you doing?

Michael:

Great, Brett. Thanks for having me on again. That last conversation once so quickly, I’m glad we could do this again.

Brett:

Absolutely. So, let’s just dive right in. Instead of going to the backstory and the focus info, you can go find that episode. We’re gonna dive right into the main topic, which is opportunity zone ground-up developments. So Michael, what’s the biggest best-kept secret when it comes to different capital gains tax using opportunity zones?

Michael:

Well, I’ll just back up a second. I’m sure there are some people who aren’t familiar with opportunity zones at all. This was a program that was built out of the 2017 tax cuts and JOBS Act. It’s really a way to defer, reduce and eliminate capital gains taxes when you are investing in real estate through an opportunity zone fund. The first benefit is the reduction if you invest in 2021, this year, and you have a million dollars in capital gains, you only have to pay capital gains on $900,000 of that and actually disappear after 12-31 of this year, and it goes down to zero. So the reduction is actually going to be short-lived here, it has been going on for the last three years and sort of stepping down from 15% to 10% until it gets to zero. And then the deferral is actually a nice benefit. Because if you have a capital gains obligation this year, you’ve realized capital gains, you have to pay taxes, if you invest in an opportunity zone fund, you actually don’t have to recognize those gains until the tax year 2026 payable in 2027. So it’s actually like an interest-free loan from the government for six years or so. And then the big kicker to it is that if you are in the opportunity zone fund for 10 years in one day, no matter how much you make, if you invest a million dollars, and it grows to $2 million, $5 million, $10 million, $100 million, whatever it might be, you pay zero taxes when you get out. So it’s one of the best programs for real estate. And you know, for an already efficient asset class. From a tax perspective, it makes it that much better. And you know, when we run the math, and we look at this and look at the after-tax returns of an opportunity zone investment, versus using after-tax dollars, the benefit is about 60% to 70% greater in an opportunity zone. So if you like real estate, and you’re willing to take the ground of development risk, there’s really nothing better than you can invest in at this time, than in opportunity’s own fund.

Brett:

Absolutely love those benefits. So again, the first one is deferring, you can defer your capital gains tax from a previous investment until 2026. And the end of this year, you said it’s the benefit goes down. Would you just clarify that again, one more time to make sure I understood that?

Michael:

Yeah, and I’ll clarify one of the risks too because the deferral means that you don’t have to pay your capital gains this year. So you’ve got a million dollars in capital gains on your tax statement, and you’re gonna have to pay that if you invest that into a qualified opportunity’s own fund that gets kicked out. Now, the risk is that capital gains rates go up during that 2026, 2027 period, if they double the flipside of that is that the forgiveness at 10 years in a day more than equalizes the added tax that you’ll pay in 2026 or ‘27. If those taxes go out, so when you run the math, if taxes if you believe tax They’re going up, there’s actually a greater reason to invest in this fund. And so just taking on that example 100 million dollars this year, you would only recognize $900,000 of capital gains in 2026. So even if cap gate cap, capital gains rates go up slightly, or a lot, some of that is offset by the fact that you won’t be recognizing a million dollars, you’ll only be recognizing $900,000 at that time period. But it’s definitely some calculus that every investor should do. And understanding that during that time period, you’re going to have a huge liability. And one of the ways that we are trying to solve for that within our fund is as we build these ground-up development projects, in about year three or four, once we’ve created value, then we refinance the project and generally send back anywhere between 20 to 30, even 40%, of investors equity to pay those tax obligations, and I should just tell you, like my partner and I are heavily invested in this fund, we have about $10 million between the two of us. So people always ask us questions about this, in reality, we have these large tax obligations that we have to take care of. So it’s in our best interest from both a manager’s perspective and an individual perspective, to refinance these properties, get the money back as quickly as possible because we’re both on an IRR clock, and we have a huge tax liability ourselves to pay.

Brett:

Excellent. That’s a good summary. And then at the end of the year, he mentioned that, so I imagine it’s 2022. Now, we have a window to get into these deals, if I’m hearing you right, what happens in 2022, to clarify that one more time?

Michael:

So in 2022, not the program is still there, it’s still available, the only benefit that disappears, is the tax deduction if you will, or so the elimination is there, the deferral is there, but the reduction is not there. So in 2022, if you realize capital gains, and you’re going to invest those into a qualified opportunity’s own fund, if you have a million dollars, you’re going to be recognizing a million dollars in capital gains in 2026. So it’s that reduction that goes away, but the program will be here through 2026.

Brett:

So that’s great. So you have the defer, you have the reduction. And then probably the sweetest thing I’ve ever heard of is the elimination. So pay zero capital gains tax earned by the QOZ Fund, if held for more than 10 years in a day. So let’s just say at a million dollars, and it was a million-dollar gain. I’m in California with a pay, let’s say, 400,000 of tax, I roll it into your fund, Michael, and you’re building some projects we’re talking about here in a second, but 10 years from now, that million is turned in, let’s say turns into five. So if I’m hearing you right, or if I’m reading this, are you saying that’s all tax-free that one to five, all that growth?

Michael:

Yes, 100%. And that’s the nice thing about it is that’s the huge kicker is it’s a huge benefit for investors. And then along the way, Brett, we actually get the benefit of depreciation. So any cash flow that’s produced by the properties will be shielded by depreciation, so you actually get the traditional tax benefits of real estate, and you get the QOZ kickers on top of that. So and I do want to be clear, just to temper expectations in our funding, we’re targeting about a two and a half net multiple to investors over that 10 year period. So million dollars is likely to generate around two and a half million dollars from both appreciation and cash flow during that time period. But with most of it practically being a tax-free return. So you’d have to compare the IRR over 10 year period, there’s about 12 or 13%. When you take in the timing of cash flows, and again, looking at it on an after-tax basis. It’s hard to compare to you know, this program is really a gift to real estate investors. I do want to say like one of the things you know, the QOZ, just even the term has become much more popular over the last couple of years. And I think there were a lot of cynics in 2017, ‘18, and ‘19. And one of the requirements of this program is that managers like us have to go into qualified opportunity zone areas which generally follow census tracts that are lower-income if you will or moderate to lower-income. So the thing is, though, when this census tracts when the qualified opportunity zones, there are about 8,700 of them throughout the United States. These are all built on the 2010 census and what got us comfortable with the qualified opportunity zone, investing are two things. Number one, all of our investors are taxable, we deal with high net worth, ultra-high net worth family offices. And so we’re really catering to the group who could who can benefit from this the most. And on top of that, when we were doing the research in the market, what we were finding were the areas that were already investing in infant three were qualified opportunity zone areas, and these are areas that are not blighted, they’re not distressed. These are what are called transitioning areas and a lot of our projects, when you look at our project in Phoenix, and you look at our project in Chicago, we’re actually on the edge of the qualified opportunity zone itself. And I’ll just make this clear that we don’t look at these projects any differently today than we did three, four, or five years ago in any of our funds. Because the benefit happens on the back end, the qualified opportunity zone tax benefits don’t help us, as sponsors, we don’t have a different model for this, we are still looking at the same return on cost metrics, the same margins, the same everything because we have to make sure that we do our job, deliver a great project to the market that builds value and produces a return for investors so that they can get the benefits on the back end.

Brett:

Excellent. That sounds fantastic. So what is the downside of the Opportunity’s Zone Fund or who may not be a good fit for it?

Michael:

There aren’t downsides. I mean, this to us is business as usual, we’re in the same neighborhoods we’re investing in, I suppose if you’re an investor, and you’re not comfortable with ground-up construction risk that might steer you away from this. But I would add that when you think about a 10 year hold period, what we’re doing in our fund, we’ll have about eight to 10 assets, when when we’re done at the end of this year, raising money and deploying it, and about three to four years of your whole period two years is in construction, then you got a year to year and a half and lease-up and stabilization. And after that, then you’re really holding a Class A property for the duration. So, 70%, 80%, 90% of your whole period is going to be in a portfolio of Class A stabilized properties. So you know, this program allows you to be in much longer than 10 years in a day. For somebody, like myself, I’ll be in it for 15, 20 years, 30 years even. And so I’m really investing for the next generation when I look at this, but certainly, some people want to be out in 10 years and a day. And Brett, I’m sorry, I forgot your follow-up question there. I know you had two questions.

Brett:

I think you answered it there. If you’re not comfortable with ground-up development or that longer-term hold period. Take a little while to develop it, lease it up, get the cash flow going, could take a couple of years to get that all down. So you just got to realize you gotta be patient, you got to plant the seeds and water and let it grow. The next question would be the depreciation recapture. So you mentioned, once your cash flow and you’re depreciating, perhaps you did some cost segregation on that, at the end of that 10-year, is that also eliminated? Or is it recaptured?

Michael:

No eliminate, there’s no recapture tax, there’s nothing. So they did a really good job of creating the benefits here that I’m giving you all of the benefits to real estate both during the whole period and that depreciation now, certainly if people get out early, and there’s a circumstance that changes, then they will get hit with that recapture tax on that side. But if you’re in again for that more than 10 years in a day, then you’re not going to you know, it’s basically a tax-free investment. 

Brett:

Now, there are certain states that aren’t, let’s say cooperating or saying they’re not going to allow it? I think California is one of them. I think there are a few others. I know most of the deals that you’re doing, Houston, Texas, Charlotte, North Carolina, Colorado Springs, Chicago, or Illinois, and Phoenix, Arizona. What are those states? What does that mean? Like when they say they don’t allow it? If I live in California, I have capital gains tax, does that mean I can’t participate? Or is it just the properties and cells can’t be located in California? No, that’s also just for the cap. That’s just for the state right state, no federal.

Michael:

So what that means is that the federal program or the program operates at the federal level. So if you are in California, then and you have this million-dollar capital gain, you will have to recognize that on your California state taxes this year, you don’t get the benefit. There are actually some states and I don’t have these offhand, that are going along with the program and they’re actually allowing the deferral, the reduction, the elimination after 10 years, but some states just aren’t you know, they’ve decided not to participate in the program. And I think the ones they’re actually seeing a much larger portion of the development dollars go there. So jobs really the revitalization of neighborhoods. I don’t have the numbers in California or the states exactly. But the states that we’re operating in, and some of them are, don’t have an income tax. So when you think about Florida and Tennessee and places like that the program itself, if you’re living in those states or operating those states, it’s fantastic. You don’t even have to worry about it. So there’s nothing for them to do to play along. But California, it’s unfortunate, you’re still gonna pay your fair share of taxes, they’re gonna get you.

Brett:

That keyword being fair. It’s definitely subjective there. So being in California on the front lines of tax you got Biden considering 20% to 40% on federal, which again, just only bodes well more for opportunity zones, because that means there’s going to be more pain if you don’t have that deferral. And we’ll see if that gets passed, that’s still you know, it’s in it’s based upon a number of things. And also if you make a million dollars or more, so things to consider, but all in all most would agree that investing in real estate, if you have some time, you have some big capital gains tax, and an opportunity zone sounds like a fantastic and option here. So okay, so now let’s shift to some of your deals. So talk about the ground-up development happening. Perhaps you can focus on Colorado Springs, Elan Pikes Peak, you want to talk about that one, Michael?

Michael:

Yeah, so Elan Pikes Peak is a is a deal that we’re a joint venture with Grace. For those who maybe don’t know, Grace is the largest multifamily developer in the country, if not the world. Colorado Springs is an area that is one hour south of Denver, and for many years, it really passed over by element and it was passed over because the local government there was anti-development. What’s changed in a sort of the last 10 years is that the whole government structure has changed there. And they’ve gone to what they call a strong form, they have a mayor who is pro-development, they’ve been opening their arms. And so when you look at all of the growth of Denver, and what’s happening in Denver is a lovely city. And it’s incredible. But all of the variables that helped Denver grow, being close to the Front Range, just the lifestyle there, no traffic, affordable living, some of those are changing now in Denver, there’s there hasn’t been a city that’s appreciated more than Denver in the last 5, 6, 7 years. So what you had was an affordable city that has become somewhat unaffordable, what you also have is now a lot of traffic where you used to be able to drive up to the mountains and get there in an hour and a half. And I talked to some people now and they’re like, that’s not three hours. And they would rather choose to drive south go through Colorado Springs and up the back way to get to the mountains. So a lot of that you find this in growth cities you love and you know, the city for what brings you there, but then it has all the big city problems. What’s happening in Colorado Springs, is it has all the qualities that Denver did have 1020 30 years ago, it’s a smaller city, it’s close to the Front Range. It’s a lifestyle city, a tremendous amount of jobs, great conductivity, and an airport, right the hair. And ironically, we flew into Denver, the first time I visited the property, and we were driving by the airport. And I said, How can we didn’t fly in there. And our acquisition officer said I don’t know. He said, there’s a Southwest flight going to Chicago twice a day. So I didn’t even think about it because Colorado Springs never been there before, didn’t realize, you know how big it was and how fast it was growing. So it’s an exciting project. And we are right downtown. And one thing that we’re getting here as a first mover and somebody who’s taking an interest in the downtown, creating a lot of jobs, helping to revitalize the downtown, the city has come forward with a 75% I’ll use TIF for lack of a better word tax increment financing, what it does, on a project like ours is if our taxes are called it $500,000 a year on a project like this, we as the sponsor will only be required to pay around $125,000 or 25% of that obligation. So you can imagine what that does the free cash flow of that investment. So rather than six to 8%, we’re gonna actually be producing close to eight to 10% on a deal like that. And I can go I can talk about Colorado Springs for an hour. We had webinars on this, but we love it a lot. Um, we actually have another deal that we’re going to be breaking ground on there, too. We haven’t closed on it yet. That is called a Leinweber Street and that is about you know, a half-mile away as the crow flies right down the block and another joint venture with a Greystar. So we’re not clear about the first deal in that market. And we’ve talked to the developer who was there, welcomes us with open arms. He was fantastic and he really was the one who helped us get comfortable with it and corroborate demand. And he said, look before I had my doors open, I had 320 people on the waiting list here. So you see these small cities and especially with the virtualization of the world and people can live where they want to live in these lifestyle cities close to the mountain skiing all that and it’s really a fantastic community that we’re excited to be a part of.

 

 

Brett:

Amazing by the way can learn more about Michael Episcope at origininvestments.com. So, opportunity zones, Colorado Springs, chronic development, all of that. Sounds really, really amazing. Michael, is there a second type of location or property in the zone that you want to touch on briefly? 

Michael:

We are multifamily only. I mean, right now we are in areas like Colorado Springs, we’re in Phoenix, we’re in Chicago, we’re in Charlotte, we’re in Houston, we have a deal tied up in Orlando. So we are a nationwide platform, we cover about 13 cities, we’re actually expanding that right now. And the nice thing about our fund is that investors if they come in today, they’re actually buying into an existing portfolio of investments that are in all stages, some of them in Chicago, and Houston are being delivered and leased up in the market today. Some of them are going vertical, some of them have just closed and they’re in the land. And some of them are our part of the pipeline. So you get instant diversification. But you can also see and touch and feel the assets themselves. And if you live in one of the neighborhoods, and if you ever want to go tour, we’re always happy to set somebody up. And if we have a representative down there, we can have helped you to kind of tour the property and kick the tires a little bit. So it’s great to have sort of that national exposure and see deals all over the place, and certainly, an opportunity zone where the opportunity set is so small, you need a wider lens.

Brett:

Excellent. That being said, Are you ready for the lightning round?

Michael:

Yes.

Brett:

All right. So, knowing what you know now, Michael, if you go back to your 25-year-old self, or let’s say you put it that way, rather than 25, let’s do the first deal you did, the first commercial real estate deal you did?  Knowing what you know now, what’s the one thing you would make sure to tell yourself to do on that one?

Michael:

Well, again, I’m glad you changed it out. I’m glad this doesn’t sound like the same lightning round like last time. You know, I think when we look back, my partner and I, when we started Origin, it was more like a family office, and they’re doing deals. And I know, this isn’t lightning round. You know, I’m telling a story here. But I think that when we looked at the world, we were just looking at good deals, and we weren’t looking at how to scale and we were buying some small units in Chicago, and we weren’t looking at the debt aspects, we weren’t looking at the depreciation aspects of real estate, the ability to refinance non-recourse debt. And so there’s a lot of advantages to real estate on the tax side. And you have to really take advantage of all of them to realize the benefits here, the 1031 benefits, the depreciation benefits. And so early on we were more of a, Hey, that looks like a good deal, we can make this much money, we can buy flip, and you know, buy, fix and sell, we never really considered the tax implications of that strategy. And as we go forward, everything is about the taxes, and looking at it, make sure that we’re maximizing that because the only thing that matters is what you get to keep after paying the government. And so our strategy more today has evolved and more of a buy, fix and hold strategy because that’s the way you make a lot of wealth, you buy great assets, you fix them up, you take care of the downside, and you let the upside take care of itself. And when we look back a lot of the assets that we sold in the last 3, 4, 5, 8, 10 years sometimes they come back around, and you see them in marketing, where they get where the person who bought them from us has now resold them, and you just shake your head and you’re like, wow real estate is it’s time tested asset class, and it’ll continue to go up, especially as replacement costs and inflation wages continue to increase. So it’s fantastic to preserve and protect and grow wealth.

Brett:

Love it. Questions potential clients or investors should be asking you, they don’t ask you, but should?

Michael:

That’s a good question. I’ve written on this in the past, and I would tell anybody to look at our blog, and you can email or I’m sorry, I actually searched under questions, due diligence questions to ask. And it’s kind of cool because I think I put the top 10 or 15 due diligence questions. I wrote this a long time ago. You know, you should be asking a manager right, all the way down to the middle. gritty. And we get all the time in our Investor Relations Department, people who call up and they’re following the script. And really talking to us and one thing I gave people this tip, I said, look, when you are looking at a firm, right, the best way you can do it, if you say, give me some references, right? You ever like to talk to a reference and said anything negative you can keep on the phone, you can try to read between the lines, but every reference out there is glowing, and this and that. So one of the tips, I said, look, LinkedIn is a great tool, find an old employee reach out to them, say, what can you tell me about Origin? Right, they are going to give you the most honest information. And the question is, look, would you invest with them? Right? And so those are, are some of the tricks of the trade I think I would use interviewing another manager is find the people who they have broken up with and say, look, do you respect them? Are they trustworthy? Do they have all the things that you look for in a manager, but that document has been used over and over and I hear about it all the time that you know, people are going through that checklist. So those are you know, some of the things and the sort of the to do things that I’ve given people the tools to help them succeed in this market.

Brett:

I like that find the people they’ve broken up with and find out perhaps any skeletons in the closet there before you jump in. Love that. What’s the biggest challenge facing multifamily syndicators or operators as it pertains to raising capital?

Michael:

I would say that if you’re going to market, you have to be marketable. In other words, you have to have something to market. So a lot of people are getting into this, and they want to go out there and raise capital and syndicate and the market has changed quite a bit. I give a lot of credit to individual investors doing their due diligence and the amount of transparency that has been created in the market since 2008, since the JOBS Act, passed back then. But then, it’s a crowded market, and you have to be something to market and market it well and be able to tell the story. And I would say if you’re asking specifically about marketing it’s always important to relay how the real estate and the investment translates to the benefit of the investors themselves. So, a lot of people make the mistake, because they’re in real estate, they use a lot of jargon, they talk about what the deal this and that, and I think what investors want, and we’re in real estate, we really compete against every investment class out there, what investors want when they come to real estate, as they want a tax-advantaged investment that produces passive income and can grow their wealth. Well, if the real estate didn’t accomplish that, they would go find it somewhere else. And so what we try to convey all the time is how we are doing that, how are we protecting their wealth? How are we helping to grow their wealth? What is our track record? What are our competitive advantages that we can convey, and help shortcut that process and really put those competitive advantages that we have upfront and center so that investors can just see them quickly? And marketing is something that is you know, it’s a challenge always and that you know, you want to get in front of people and market your firm in the best way possible. And it’s building trust online. But you know, like, one thing we’ve done is, in our Investor Relations Department, we have more than 1600 individual investors today, there isn’t a single person who has invested with us who has not had a conversation with somebody at Origin, either somebody in our Investor Relations Department, talking about the deal, talking about Origin itself. We think that is such an important point is to have that relationship with people, but also an understanding going in, because if you don’t set expectations, and people think that look, my expectation is that you produce here, you execute here, and we think it’s here, if we execute where we believe then we’ve disappointed them and so having investors come and ask a lot of questions upfront to me is the best thing you know, for starting a relationship or partnership together.

Brett:

Awesome, Michael. For our listeners who want to get in touch. We remind them one last time where they can find you?

Michael:

Go to our website, you can always connect with somebody in our Investor Relations Department there. You can email Investor Relations at origininvestments.com, you can also email me directly, michael@origininvestments.com, my partner and I pride ourselves in having a direct relationship with our Investment Partners.

Brett:

Excellent. We’ve been talking with Michael Episcope and he’s talking about Opportunity Zone Grown-up Developments, ways to defer capital gains tax. This year is the year to do it folks get with Michael check out his stuff if you’re interested. Some class A investment, ground-up developments, mixed-use multifamily. So, Michael, I want to thank you for being on the show. Again for the second time. Fantastic having you. I want to encourage you to keep using the gifts and talents you’ve been given to help people create and preserve wealth with real estate. And with that, I also want to thank our listeners for listening to that episode of the Capital Gains Tax Solutions Podcast. As always, we believe most high net worth individuals and those who help them they struggle with clarifying their capital gains tax deferral options, not having a clear plan is the enemy, and using a proven strategy such as the deferred sales trust or opportunity zones is the best way for you to exit your highly appreciated assets and defer the capital gains tax and grow your wealth. I can be found if you’re wanting to connect with me at capitalgainstaxsolutions.com, learn more about the deferred sales trust and go to capitalgainstaxsolutions.com. Thanks, everybody for listening. Have a great day. Bye.

 

Important Links:

• Michael Episcope
• Origin Investments

 

About Michael Episcope

 

Michael is principal of Origin, co-chairs the Investment Committee, and oversees investor relations, marketing, and company operations. Michael brings 25 years of investment and risk management experience to the company and believes that calculated risk-taking in inefficient markets is the key to building wealth.

He frequently shares his knowledge with individual investors on Origin’s blog, Forbes, ValueWalk, and HuffPost, and his expertise has made him a frequent speaker on real estate investment panels and podcasts.

 

 

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