California real estate taxes: The potential impact is tremendous

With election season upon us many are watching to see what happens in California with Proposition 15, also known as split-roll. The measure increases funding for schools, community colleges and local government by changing the property tax assessments structure originally set by Proposition 13 in 1978. Residential, agricultural and smaller commercial or industrial property owners would be exempt but all owners of commercial and industrial property with a combined value over $3 million would potentially find themselves with huge property tax bills should Proposition 15 pass in November. The state of California believes that there will be a net increase in annual property tax revenues totaling between $7.5 and $12 billion per year. The potential impact to business and to occupiers, is tremendous.

A little background

Proposition 13 passed in 1978 and assessed ALL commercial and residential properties at the 1976 purchase price with annual increases capped at 2% per year. It prevents reassessment of a new base year property tax value except in the case of (1) A change in ownership or (2) completion of new construction, at which time it reassess value to the that current year but still caps the increases of assessed value at 2% per year moving forward. This means that if a property has not been sold, or nothing new has been built on it, the assessed value is 1976 market rates + 2% capped increase per year.

Examples

Here is an example to provide clarity on financial impact:

• Under Proposition 13 TransAmerica Pyramid in SF had an assessed value of roughly $252,000,000 in 2018 and a tax burden of around $2,930,603
• In 2019 the value increased only 2% to around $257,000,000 with a tax burden roughly $3,085,464.
• This is an increase of $154,861 from 2018 to 2019. If you are a tenant in the building leasing 10,000 SF, the increase in your tax burden from 2018 to 2019 is $3,097. Not unbearable….
• TransAmerica Pyramid actually sold during the pandemic (at a significantly discounted rate) for $909.70/SF x 501,458 SF = a new assessed value of $456,176,343. For ease and clarity we are going to assume 2020 as a full tax year rather than partial for this property.
• So the value jumps from around $257,000,000 (2019) to $456,176,343 (2020); tax burden increases from $3,085,464 (2019) to $5,383,444 (2020) an increase of $2,297,837 in one year!
• The same tenant with 10,000 SF of space in TransAmerica Pyramid will see their tax burden increase a by $45,958 from 2019 to 2020.

Another example from one of our team’s client Ontario, California with a 103K SF warehouse lease:

• Real Estate Taxes 2018 equaled $98,962
• Real Estate Taxes 2019 equaled $99,813
• Property was sold October 2019 and new tax burden for the 2020 tax year is projected to be $180,423 (an 81% change from 2019), all of which falls on client because they occupy the building in entirety.

How Proposition 15 ties in

It gets even more complicated with Proposition 15, if passed, it will bring all commercial and industrial properties up to date on market value. It’s on the November ballot in California, and it could pass.

Proposition 15, also known as split-roll, will not affect residential real estate. Residential real estate will remain untouched and will not be reassessed unless it changes owners or a new structure is built on the property.

However, all commercial and industrial real estate properties will be reassessed under Proposition 15 and be based on its current market value (thus the term split-roll). Meaning if a building has not changed ownership in the past several years, those properties will see market value skyrocket like in the above examples, should Proposition 15 pass. This obviously won’t happen immediately and reassessment will be phased in between 2022 – 2025, but companies with larger holdings and bigger footprints are scheduled to be reassessed first.

The kicker is that unless a cap on OPEX or the so-called “Proposition 13 Protection” was negotiated at lease inception, tenants have no recourse. Many landlords won’t consider either because it makes it more difficult to find a buyer, should they want to sell. So if we have clients in California who did not negotiate either of these into their lease, you might make them aware of what could happen to their property taxes should the building in which they are leasing space sells, or if Proposition 15 passes in November. Moving forward, when negotiating leases in California you should keep this in mind, both educating the client and negotiating caps on OPEX if possible.

Any client with a lease in California is at risk should the property they occupy be sold during their tenancy, or if Prop 15 passes, and a tax analysis should be completed to see if their business is susceptible to a potentially significant increase in property taxes.