Experts cast doubt on San Francisco North Bay 'opportunity zones'

Recently released government advice on investing in tax-incentivized 'opportunity zones' could expand investment possibilities, but questions remain if the North Bay will benefit from the federal program.

Opportunity zones are government-designated, economically disadvantaged census tracts where financiers can invest capital gains like stock payouts through pools called opportunity funds. In return, they receive tax breaks that improve the longer they keep their money in an investment. Opportunity funds are required to hold 90% of their assets in qualified opportunity zone property.

The program aims to revitalize impoverished communities. Investments can be made in building or refurbishing real estate or in local businesses. Under the law which was part of the 2017 Tax Cuts and Jobs Act, investors do not pay tax on 10% of capital gains that they invest in an opportunity fund and hold after five years.

After seven years, the tax break jumps to 15% and investors who keep their money in the pool for a decade avoid taxes completely on any appreciation of their investment.

There are 21 opportunity zones scattered across the North Bay, including nine in Solano County, three in Sonoma County, and two apiece in Napa and Marin counties.

Experts noted the zones were somewhat small however, especially compared to other Bay Area tracts like two in Oakland that begin near the entrance to the Bay Bridge and straddle the Nimitz Freeway running in the direction of San Leandro, including parts of Oakland International Airport.

North Bay zones also include property in areas where real estate is already valuable.

'There aren't that many places in the North Bay that are in the zones,' said Christopher Karachale, a partner at Hanson Bridgett LLP in San Francisco who advises investors and fund operators on how best to benefit from the program.

Karachale noted there is 'almost nothing in Marin,' other than an area near San Rafael and San Quentin State Prison.

He noted there are two large zones in downtown Napa and Santa Rosa, but real estate prices could require significant investment for those looking to build from the ground up or purchase and refurbish property. Sonoma also has zones in Roseland and the Highway 12 corridor in the Valley's Springs neighborhood.

'To make this all work, you've got to buy property in the zone. And who's selling?' Karachale said, adding the property in downtown Sonoma and Napa 'is already pretty valuable property' that is arguably mischaracterized as an opportunity zone.

It might sound odd to hear economically disadvantaged and downtown Napa in the same sentence, but because state governors were given the power to designate the tracts in each state, many of the outlined zones were deeply struggling as well as some were not struggling as much but were places where a small amount of investment could go a long way, according to Julie Treppa, a lawyer and opportunity zone expert at Farella Braun & Martel LLP.

'In many cases, and this is true in California, there was a balance between selecting distressed communities that needed capital and selecting distressed communities in an area that might turn around more quickly,' Treppa said, indicating that all opportunity zones were not created equal.

That could be part of why real estate investor Taylor Lembi of M31 Capital in San Francisco said his firm is looking elsewhere, although they have not ruled out the North Bay completely.

'We have not found a project yet in Marin or the North Bay that would fit out investment thesis,' said Lembi, whose firm recently launched a multimillion-dollar opportunity fund called Morpheus 1 aimed at developing vacant structures into multifamily properties in the Bay Area, said.

He noted his firm had mostly focused on investments in the East Bay, but singled out Mare Island in Solano County as a potential candidate although M31 had not looked at it closely.

Despite the potential difficulty of investing in North Bay real estate, federal regulations released in April shed light on how funds can invest in businesses. The guidance could make businesses investments more attractive than those in property which is already expensive.

Karachale said investors could sink money into a qualified business in one of the zones provided they 'substantially improve the property or make original use of property.' He said one of the key takeaways of the new regulations was that operating businesses, as long as they were not 'sin businesses' like massage parlors, liquor stores, tanning facilities and the like, could benefit from opportunity fund cash.

'That's one of the real key takeaways is that actual operating businesses are good to go,' Karachale said.

However, businesses face strict rules under the new regulations to qualify, according to Treppa, the Farella Braun & Martel LLP lawyer.

'A fund can have an investment in a qualified opportunity zone business but that business has to own 70 percent of its property as qualified opportunity zone property,' Treppa said, referring to business equipment. 'If you bring all your equipment with you, you don't satisfy that test.'

Treppa said the regulations also clarified a rule stating half of the growth of a business needs to come from the opportunity zone it is in to ensure it is benefiting the community, meaning it does not matter where a business's customers are but rather where its services are performed.

Despite the enticing tax benefits for deep-pocketed investors, opportunity zones still represented relatively risky investments, Treppa added.

'You could make this investment and you could lose a lot of money,' she said. 'What if there is no appreciation in your investment? Then you've just made an investment in a distressed community and maybe your money could have been better invested elsewhere.'