A decade of no exit, and what I'd give up to shorten it

Your 26 month average against a ten year commitment is the whole post, and I don't think it's a tax question at all. It's whether your operating style survives having capital immobilized. I've watched myself in the analysis stage for eight months and one thing I've learned about me is that I need optionality to stay calm. If that's true for you, a ten year lock will make you a worse operator elsewhere because you'll feel poor while owning something.

The interim distribution funds make me nervous for a construction reason. A ground-up project distributing cash in years two through four is either done and leased faster than anything I've built, or it's paying you out of the raise. Ask which. If the answer involves the phrase "from reserves" you're getting your own money back and calling it yield.

@harrow that's the cleanest test in the thread. I look mostly at small rural markets and low price points and the decks that promise early cash are the ones that scare me most.

On the lock, I'd rather own two small houses I can list on a Tuesday. But I recognize that's a preference and not an argument.

Question rather than an opinion. If you did need out at year six, what actually happens? Does the sponsor buy you back, do you find a buyer for the interest, or are you just stuck?

@pike from the docs I've read the usual answer is stuck. Transfers need consent, there's no market, and any repurchase is at the sponsor's discretion at a price they set. That's the part people skim.

On the operations side of a ten year hold, ask who's managing the asset in year eight. Sponsors staff up for construction and lease-up and then the asset sits with whoever is cheapest. I've taken over stabilized properties in year five that had been on autopilot for three years and the deferred maintenance was ugly. A ten year hold means you're relying on someone else's management discipline for the six years after the interesting part is over.

@trellis that's the first thing in this thread that made the ten years feel long to me in a concrete way. Six years of someone else being bored with my building.

@keystone the clause set I'd read before deciding anything about the lock. First, transfer restrictions and whether estate transfers are carved out, because ten years is long enough that this matters. Second, whether the fund has the right to extend its term, and how many times, because a ten year fund with two one-year extensions is a twelve year fund. Third, capital call language after the initial close.

I've seen a fund document where the sponsor could extend twice at their sole discretion and the LP consent threshold to force a sale was 75%. In practice that means the sponsor decides when you get out. That's the real hold period, and it isn't the number on the cover.

@fathom the extension language is what I'd never have thought to look for. Does the term start at first close or final close? Because that could be another year and a half.

@beacon usually final close for the fund term, and the ten year clock for the tax treatment runs on your own investment date, which is a different date again. Confirm both with your CPA because they can diverge.

@keystone I'd frame the lock as a required return premium rather than a yes or no. Illiquidity has a price. If I can get a comparable pre-tax risk-adjusted return in something I can exit in five years, then the QOF has to clear the liquid alternative by enough to pay me for the extra five years of being stuck. My own number is a few hundred basis points on the pre-tax IRR before I even look at the tax layer. If a sponsor's projected pre-tax IRR is the same as what I can get in a liquid-ish structure and they're pitching the tax as the difference, the deal is priced for the buyer who only counts after-tax dollars, and I'd rather not be that buyer.

@sextant a spread requirement over the liquid alternative is exactly what I've been missing. I've been comparing QOFs to each other, which tells you nothing about whether you should be in any of them.

Rough sizing on the third option, since @keystone asked what interim distributions cost. If a project's stabilized cash flow is being paid out instead of retained or used to pay down debt, you're giving up compounding inside the vehicle, which is exactly the thing the ten year benefit is designed to reward. Money you take out along the way gets taxed on its own terms as it comes.

So the distributing structure gives you liquidity and shrinks the untaxed appreciation you were holding ten years for. That may still be the right trade if the liquidity has real value to you. It isn't free, and the decks present it as free.

Five years into my own business the thing I've learned about long commitments is that my life changed twice in ways I didn't forecast. Both times I needed cash faster than expected. I'd size to the amount that can disappear without changing any decision I make, and for me that number is smaller than my ego wants it to be.

Watch the debt maturity against the ten year hold. A construction loan converting to a seven year permanent loan means a refinance around year eight, in a rate environment nobody can call now, in a tract whose designation history is part of the story. If that refi is tight the sponsor may need to sell before your ten years are up, and then the hold period you were paid for ends on the lender's schedule. Ask for the debt term sheet and the assumed refinance terms in writing.

@tender that's the failure mode I hadn't pictured. The sponsor forced into a year eight sale by a maturity, and everyone's tax plan breaks at once.

@tender's point is the one I'd chase down in documents. Look for whether the fund can borrow at the fund level to bridge an asset-level maturity, and whether that borrowing needs LP consent. A fund with the ability to bridge has a chance of protecting the hold period. A fund with no fund-level facility and a hard asset maturity in year eight is telling you its real hold is eight years, whatever the tax planning assumed.

@keystone on your actual question, I'd take the sizing answer over the abstinence answer, with a condition. Commit an amount you can forget, and only into a structure where you've read the extension, transfer, and capital call language and can state the worst case hold in a sentence. If you can't state it, you don't know what you bought.

I've done four of these across two sponsors and the lock has bothered me exactly once, when a sponsor went slow on reporting for three quarters and I had no way to apply pressure and no way to leave. That's the cost of illiquidity in practice. It isn't wanting your money, it's having no lever when the person holding it stops communicating.

So I diligence the communication cadence now as hard as the pro forma. Ask for the last four quarterly reports from an existing fund, unredacted, and ask two current LPs whether reports arrive on time. A sponsor who won't connect you to LPs has answered the question.