If you regularly read my blogs you know that I generally avoid being political. Not with this blog. I am adamantly opposed to California’s Proposition 15. In my opinion, the state’s desire to increase revenue on the backs of the business community will be very damaging which will far outweigh any benefit that the communities and schools might receive from this tax increase.
My thoughts are based upon reading numerous articles about the proposition, visiting the websites for those for and against and actually reading the exact wording of the proposition (yes that is what I did for “fun” over Labor Day weekend).
Many of you receiving this blog are already likely against this proposition. My hope is that you will share this info with others not in our industry to help inform their vote. Polling is currently showing a very tight race and those supporting Proposition 15 are flooding the air waves to convince the public that this proposition will be good for them.
Here are 12 reasons, I oppose the measure:
1.Increases Property Taxes for Small & Large Business Owners that Own & Rent: Just about every commercial lease whether is in a shopping center, office building or industrial park, has provisions that stipulate increases in property taxes to be passed through to their tenants. Even if they do not have such a provision, the concept is built into the lease rate. These businesses have already been harmed by the current recession, increases in the minimum wage, and ever-increasing burdens by new laws and regulations. The advertisements in favor of Proposition 15 will try to make voters think that these property taxes are paid by just a few very large property owners which simply isn’t the case.
2. Increased Blight and Store Closures: Some might argue that the large property owner should absorb the increase. Whether the property owner passes along the increase or absorbs it, the net result is a higher total occupancy cost which results in either tenants vacating and/or property values decreasing (due to lower overall net income). In either scenario, many properties, especially those in lower income areas with more buildings that have been held for over a generation, will become economically less viable if property taxes double or triple. For example, there are many grocery and pharmacy stores throughout California that are operating long-term leases with low rent. A substantial increase in property taxes is likely going to cause many of these stores to become unprofitable and may result in their closure.
3. No Guaranty the Public will See Any Benefit to their Schools or Communities: If Proposition 15 passes:
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- Approximately 35% of every new tax dollar will go to schools;
- Approximately 55% will go to local communities;
- And the remaining 10% will be spent by each county on administering the new requirement to reassess all commercial properties every 3 years and to cover the State for the shortfall in revenue that will result from less income tax collected due to higher property tax deductions.
Please note what goes to the local communities and the schools after the State and County takes their share is fixed at 60% and 40% respectively. But it is very possible that the State could grab a lot more of the funds if they determine that their harm is much greater. The schools and local governments will be waiting impatiently to see what actually trickles down to them.
Furthermore, there is no guaranty that all these funds won’t go toward higher salaries and pensions for California government employees who are already almost the highest paid in the nation.
4. Decreased Property Values: It is true that California’s property tax system that keeps property taxes at 1% results in higher overall property values compared to other regions of the country with higher property taxes. Increased property taxes will result in decreased property values which will further disincentivize community investment. Investors look to invest in areas of rising property values not decreasing values.
5. Increased Uncertainty to Business Owners and Investors: Business hates uncertainty. One of the best aspects of Proposition 13 is the certainty it creates. Knowing that a major business expense will only go up 2% per year provides clarity to make decisions. The choice to buy real estate and the ability to control occupancy costs is one reason many business owners purchase real estate. In particular, investors will be hesitant to invest in lower rent areas (which are generally lower income areas) if they believe that property taxes will outpace the rate of inflation and therefore result in lower rental income and/or value over time.
6. Title of the Proposition is Misleading: The measure is called “The California Schools and Local Communities Funding Act of 2020” which is a half-truth. The Attorney General is supposed to be the referee of naming ballots in an effort to make them more politically neutral. In my opinion, the Attorney General has chosen not to do his job. There is nothing in this name that indicates that the source of the revenue is coming from a constitutional amendment that modifies Proposition 13. If the state is going to make such a major change to the tax system, I think it is important to be honest and transparent.
7. Trading Private Investment for Public Investment: Effectively what Proposition 15 does is take money from the private sector (property owners and businesses) and redeploys it in the public sector. I believe the private sector, especially the over 1,000,000 business and commercial property owners in California will do a better job of allocating these resources to increase the overall tax base resulting in overall higher taxes for California’s government.
8. Increased Consumer Costs: Consumers will pay in one of two ways. Either business owners will need to increase prices to maintain similar profitability OR businesses will close and therefore reduce competition which generally results in higher consumer prices. Either way, the consumer loses.
Now the More Technical Reasons
9. “Fair Market Value” Isn’t Necessarily the “Real Value”: Many properties are encumbered by long term leases that have below market rents. For example:
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- A grocery store might be paying only $10,000/month in rent for a location it leased 20 years ago that would now rent for $30,000/month.
- In the private sector, this property might be valued at $2.4M resulting in property taxes of about $24,000/year.
- But the assessor’s office could elect to value this property based upon the $30,000/month rent even though contractually the tenant might have a lease for the next 20 years at close to the $10,000/month.
- This could result in a valuation of $7.2M and property taxes of $72,000/year. An extra $48,000/year in business expense could be the difference between staying open or closing.
10. Commercial and Industrial Land Owners Disproportionately Affected: In the “findings” section of the proposition text it states: “a reformed system that assesses all properties based upon their fair market value would create a powerful new incentive to build new housing.” The theory is that if residential land keeps increasing in value and therefore if the property taxes increase, the holding costs will increase, and thereby encourage a land owner to sell. But the proposition specifically excludes residential land. What it will do is cause the property taxes on commercial and industrial land to potentially skyrocket making the actual value of the land substantially less. Those of us in the industry know that just because a fast food tenant pays $1,500,000 for a one acre parcel does not make all the other one acre parcels across the street worth the same. Land owners and people with older buildings should be very concerned about this proposition.
11. Further Guaranteed Employment for the Accounting Industry (the “$3,000,000 Exemption”): In an effort to try and make it look like the proposition is looking out for “the little guy”, there is an exception for “any commercial or industrial real property with a fair market value of $3,000,000 or less. But this $3,000,000 shall not apply if the direct or indirect beneficial owners of such real property own a direct or indirect beneficial interest in other commercial and/or industrial property located in the State if such real property in the aggregate has a fair market value in excess of $3,000,000.” Keep in mind:
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- Real estate is frequently owned with partners;
- So all of a sudden, the bringing in of a partner for a minority interest could trigger higher taxes;
- OR what if someone wasn’t a partner, but because of inheritance becomes one, then what?
The logistics of proving that a property should be excluded from the increases are so cumbersome that it is likely that one would be safer not to fight it in the event of a dispute to avoid accidentally perjuring themselves which would be a crime.
12. Residential Could Be Next: I hate slippery slope arguments. I find that they are usually unfounded. BUT as I read the findings and the proposition itself, I tried to plug in the words, “a residence exceeding $500,000” to see if it worked. For the most part it does. At first I did not think residential properties could ever be on the chopping block. I thought this is the political 3rd rail of California politics. But when you realize how many people in California are renters and then how many others live in homes below a certain value, you can easily see how the next proposition could pick a home value that strategically would garner enough support. Residential really could be next.
I hope this blog was helpful to you. An important part of our team’s role at Progressive Real Estate Partners is to keep our clients informed and especially about issues as important as this one that directly affects the commercial real estate industry. Your comments and your business are always welcome. If you want to reach me, please contact me at 909-816-4884 or brad@progressiverep.com.