A proposal to bifurcate California’s property tax rolls will be on the ballot in 2020’s General Election – here’s what it means for commercial property owners.
While it is way too early to predict its probability of passage, this realistic threat to undermine the protections of Proposition 13 for commercial property should be enough to roil markets. Voit’s research group released this preliminary summary on the topic last week:
What will the California Schools and Local Communities Funding Act mean to all Californians? If passed, it will be the first significant change to the property tax assessment process since Proposition 13 passed back in 1978. That law fixes the base tax levy for any type of real property to 1% of the value at the most recent time of sale. That base levy is subject to a maximum of increase of 2% per year and is net of existing or future municipal assessments. Prop 13 stopped the annual property reassessment of property that was sending property tax levels to unmanageable levels. Tax hawks have heralded the law since its inception, while opponents have maligned it as threat to education and local governments, the primary beneficiaries of property tax revenue. Numerous attempts to change the law have failed in the California State Senate and Assembly. This is the first successful attempt to circumvent Sacramento lawmakers on the issue.
The proposal leaves the Prop 13 rules in place for all residential property and agricultural land, but specifically targets properties designated for commercial use. Industrial, retail and office properties are specifically named in the proposed law, but we assume that it will also include hotel properties and other uses that fall under the commercial umbrella. These properties would be reassessed to current market value no less frequently than every three years, but can be reassessed every year for the purpose of adjusting the base levy to 1% of current market value.
The proposal calls for an exception for property owners whose businesses occupy the majority of the space in properties below a current market value of $2 million. At today’s prices, that equates to industrial buildings under roughly 8,000 square feet of space. The vast majority of buildings in Orange and Los Angeles Counties are much larger than that. As an additional offset, the proposal exempts the first $500,000 of tangible personal property from taxation. Neither of these provisions will come anywhere close to fully mitigating the financial impact of the proposal overall.
So, who will this new law hurt most in the short run? For starters, long term property owners and the vast majority of tenants occupying commercial property. An owner who bought his or her industrial building as recently as 2012 could see their property tax double because property values have risen dramatically since that time. Since most tenants are on leases that either require them to pay all real property taxes or any increases in taxes over the initial year of their leases, it is the local business owners who will be stuck with the bill. Essentially, the law is a potential game changer for any commercial property owner or occupier, now or in the future. It could also have a devastating effect on property values, as real property taxes are considered an operating expense and are thus figured into the amount of income capitalized to determine property value. As an example, every dollar in additional property tax paid at today’s capitalization rate of approximately 5%, will reduce the property’s value by $20 ($1 divided by .05 equals $20).
Our team is looking further into this issue and we will keep you posted as the market weighs in on the potential impact.