Opportunity Zones Promise Great Rewards, but to reap the rewards, investors should beware of land use and zoning associated with opportunity zones.

Opportunity Zones are intended to spur private investment in low-income areas that have been designated by California as Opportunity Zones. See here for a map of opportunity Zones by GovOps.  While much has been written on the tax benefits of Opportunity Zones, this article addresses some common land use hurdles that arise in California.   

 

As the recent Forbes article noted, “[t]he [Opportunity Zone Fund] rules favor ground-up real estate development due to the requirement that invested capital gains must ‘substantially improve’ the property or business, which means the entire initial investment must be matched in improvements to the property. While this can be achieved in a myriad of ways, the most straightforward way to meet this requirement is to purchase land within an Opportunity Zone and build something on the raw land.” [1]

Moreover, good underwriting will be paramount.  This may be especially true in California where developers face stringent land use controls and compliance with the California Environmental Quality Act (CEQA) when substantially improving these Opportunity Zone properties as required by the OZF rules.   

 

When looking to invest in a California Opportunity Zone property, here are some common land use and zoning limitations to consider. 

1. Does the City or County’s Zoning allow for the improvement or development intended for the Opportunity Zone? 

The current zoning and general plan requirements of the property should be analyzed prior to acquisition. Any planned general plan or community plan updates by the City or County should be evaluated given the ten-year time span required to hold the opportunity fund zone investment to reach forgiveness for additional capital gains. A change to the general plan could impact what type of projects will be allowed on the property moving forward.  If a Major Use Permit or other use permit is required for the intended use, CEQA will likely be implicated which can result in additional hurdles and delays if not approached properly.

2. Is the current use of the Property non-conforming with current zoning?  

If the current use on the property is no longer allowed under the City or County’s current zoning, their may be a vested right, also referred to as a grandfathered right to continue operating the use the property.[2]  

Caution should be used in acquiring these vested right properties with Opportunity Zone Funds since many jurisdictions have rules that will phase out the vested right over time or even terminate the right to operate immediately if the use is expanded, altered, or relocated. Since the Act required “Substantial Improvement” the vested right may be terminated when the property is substantially improved.   

3. CEQA may be required when substantially improving Opportunity Zone Property.

There are many different ways in which review will be required pursuant to the California Environmental Quality Act (CEQA).  Some to be on the look out when acquiring Opportunity Zone properties include: 

  • When acquiring property from a city, county, school district, or public utility, the mere purchase or lease of property may trigger CEQA.[3]  One possible solution is to enter into an option agreement to protect your interests while conducting environmental review pursuant to CEQA and/or ensuring the project is exempt from CEQA. See my prior post for more on this topic.  

  •  The Opportunity Zone Requires that the property be “substantially improved.” There are several different ways that CEQA could be triggered here.  For example, if a use permit is required, CEQA will generally be triggered. Moreover, if the development requires any discretionary action by the City, for example a parking variance, CEQA will also be triggered.  However, even though the Opportunity Zone Fund requires that the property be substantially improved, the project may still fit within one of CEQA’s categorical exemptions like Existing Facilities (CEQA Guidelines § 15301), Replacement or Reconstruction (§ 15302) or even New Construction (§ 15302). 

  • If an Environmental Impact Report may be required, consider negotiating the terms of the deal to allow for the environmental review prior to close of escrow. Also, the more you can shape the project early on to avoid CEQA impacts, the less likely that an EIR will be required.  

By Stephanie Smith
Stephanie is a Land Use and CEQA Attorney with Grid Legal
https://www.gridlegal.com

[1] Drew Dolan, March 1, 2019, Forbes, Forbes Real Estate Council. See also Internal Revenue Code § 1400Z-2(d)(2)(D)(ii), Rev. Rul. 2018-29.

[2] Attard v. Board of Supervisors of Contra Costa County (2017) 14 Cal.App.5th 1066, 1076. The right vests only after and to the extent that the use is lawfully established under the prior law, and then may continue after the zoning law changes. See, e.g., Id. at 1076; City of Ukiah v County of Mendocino (1987) 196 CA3d 47, 56.  

[3]Bridges v. Mt. San Jacinto Community College Dist., 14 Cal. App. 5th 104 (2017)