As an owner of industrial / commercial property, it is important for you to know about a looming threat to increase your property taxes.
Necessary signatures have been obtained for a proposition to be placed on the California 2020 General Election ballot that would split the property tax rolls and remove Proposition 13 protection for commercial properties.
Since 1978, the base levy for all real properties has been set at 1% of the acquisition price of the property, plus existing and future municipal assessments. The base levy cannot be increased by more than 2% each year.
The California Schools and Local Funding Act, would leave the residential property and agricultural land under Prop 13 protection but would allow for the annual reassessment of commercial property to full cash value for tax purposes. This would effectively eliminate the 2% annual cap on the base tax levy and expose taxpayers to large annual property tax increases.
The amount you pay for property tax is determined by what you paid for the property. If you acquired your commercial property in the 1990’s when prices were low, chances are that your taxes are a fraction of what they would be if the property were acquired in the last year or two, when prices hit all-time highs. In fact, a typical 10,000-square-foot industrial building acquired in 1995 for $650,000 is probably worth $2,250,000 or more today
Under the proposed law, that property could be immediately reassessed to its current value and the base levy would be increased to 1% of $2,250,000.
Property would be reassessed every three years at a minimum, which means taxing authorities could simply not reassess for up to three years when market values are falling. The proposed law contains no mechanism for a property tax appeal process that is part of current law.
The proposed law exempts property owners who own less than $2 million worth of commercial property and whose businesses occupy the majority of space in a property they own. The text of the proposed law makes no reference to small third-party investors who own commercial property under the $2 million dollar threshold. This may be disingenuous given the fact that almost 90% of commercial properties already have a value in excess of $2 million.
So how will this impact the commercial real estate market? To be sure, almost every owner and occupier of a commercial property will be paying more. Long term owners, the group that enjoys the protection of Proposition 13 the most, will get slammed, as the proposed law would allow taxing authorities to immediately reassess commercial property to its current market value.
That could double, triple or even quadruple the tax bill for these property owners in a single tax year.
Tenants on net leases, requiring them to pay all real property taxes, and tenants on gross leases, that pass-through tax increases to them over a base year, will all take a hit. Commercial property values would likely fall immediately, especially for owner/users who pay their own property taxes as an operating expense, which reduces Net Operating Income, the amount capitalized to determine a property’s value. In those cases, every $1 in additional property tax will decrease the value of that property by $20 at a current market cap of 5%.
I have read the law and it is clear to me that the authors lack knowledge in terms of how the commercial property market works. Their intention was to stick it to wealthy property owners who they feel are taking advantage of a loophole by following a law that has been around for 41 years. The unintended consequences could be disastrous to the industry, but it may pass anyway because the law is expected to generate upwards of $11 billion per year in additional revenue to schools and local governments. That means every school district, and local government will be using its lobbying muscle to get the proposition passed. The opposition will come from commercial property owners and property services industries, which lacks the cohesiveness to mount substantial opposition. The vast majority of voters don’t own commercial property and are likely to vote in favor of raising additional revenue that won’t cost them a dime. STAY TUNED. . .