This November, commercial property owners in California could be budgeting for a substantial increase in their 2022 real estate taxes.
The potential increase is due to the California Tax on Commercial and Industrial Properties for Education and Local Government Funding Initiative, which has qualified to appear on the ballot in California as an initiated constitutional amendment on November 3, 2020. The initiative would amend the state constitution to require commercial and industrial properties, except those zoned as commercial agriculture, to be taxed based on their market value. In California, the proposal to assess taxes on commercial and industrial properties at market value, while continuing to assess taxes on residential properties based on purchase price, is known as split roll.
The current initiative (#19-0008) represents a revised version of the original (#17-0055), which was filed back in December 2017. The initiative was delayed until 2020 in order to decrease the costs to qualify and to increase voter awareness. In August 2019, the revised initiative was filed and included the following notable changes for commercial property owners:
These changes reflect an attempt to gain public support by casting a wider net on what properties will be eligible for reassessment, thus increasing the total tax revenue for state education distribution. Opposition to the initiative states that a split roll will greatly damage job and business growth in California, which will still be recovering from the Covid-19 Pandemic. However, the $13.5 million that has been raised in support of the initiative dwarfs the $2.6 million that has been raised in its opposition.
Support for the initiative includes the California Democratic Party, which represents a significant advantage in the predominantly blue state of California. Additionally, the California Teachers Association and California Federation of Teachers are major backers, and 100 percent of the tax revenue will be distributed to the public-school systems. This will likely draw major public support as all school districts may need significant additional funding to rebound from the prolonged school closures brought on by Covid-19. Current polling via the PPIC Statewide Survey indicates a slight lean in support of a split roll. This has caused real estate professionals across all sectors to begin preparing for the potential impacts.
First, assessor offices across the state will need to go through the process of implementation, which means reassessing all commercial property to reflect market value. According to William “Bill” Jimenez, former Chief Deputy Assessor in the County of San Diego, this process will be time consuming; so much so that the San Diego County Assessor office will need to double its workforce. Therefore, the hiring and training process for new staff will be a major component of the implementation. The current initiative includes a three-year phase-in process due to the workload of implementing a split roll. However, Jimenez was unable to comment on whether or not the three year phase in period would be adequate to complete the process.
When asked about the macro-economic impacts, Jimenez indicated that certain counties would be more affected than others. According to him, the base year assessments in San Diego County are much higher than other counties, mitigating significant increases in assessed values. Conversely, Bay Area counties typically have much lower base years, which will result in larger increases in assessed values and unhappy property owners. Despite the potential increase in tax liability, Bill indicated that he doesn’t believe that this will
result in a substantial loss of local businesses in the Bay Area as most owners in the region have a geographical need to be there. However, he also mentioned that smaller, secondary territories may be in trouble of losing businesses to states with more favorable tax laws if property owners are saddled with unmanageable tax bills.
Without question, property owners affected by the split roll will look to appeal their market value assessments. This has property tax appeal agents such as Ken Sullivan, President of RPC Property Tax Advisors, gearing up for the expected increase in clientele. In preparation, Ken stated that he has been, “polling both field and supervisory assessment officials from multiple counties, both large and small, throughout California for their input.” Based on these officials’ feedback, Sullivan agrees that the implementation of the initiative will be quite an undertaking.
Sullivan believes that the largescale implementation will be highly impactful to the appeal process. First, the change to regular reassessments will dramatically increase the number of appeals filed annually. This spike in appeals will occur simultaneously with each county’s bulk hiring and training process. The combination of an increase in appeals and the time-consuming mass on boarding process will cause appeals to pile up in assessor’s offices across the state. As a result, Sullivan believes that counties may have to extend the assessment appeal filing period and revise the Revenue & Taxation code1604(c) statute, which states that, “an assessment appeals board’s hearing and decision on a hearing officer’s recommendation must be completed within two years.” Due to this anticipated log jam of appeals and probability of an extended appeal timeline, counties will likely lean on appeal agents, such as Sullivan, to settle appeals out-of-court in order to handle the high volume in a timelier manner.
The increase in real estate tax liability created by a split roll will also have a major impact on real estate leasing and sales activity across the state. Overall, small businesses subject to triple net lease agreements and smaller owner operators will be the most impacted parties. Small businesses that lease space on a net basis without real estate tax expense caps will be subject to significant increases in real estate tax reimbursement. As a result, base rents will likely flatten or decrease as landlords will be forced to charge more for real estate tax reimbursement as a net expense.
A key change detailed in the revised initiative states that owner-operators will no longer be exempt from Prop 13a protection. As such, owner-operators will take a hard look at selling their facilities and relocating to neighboring states with more business-friendly real estate tax laws. A significant increase in owner user buildings being listed for sale over the next three to five years should be expected. Therefore, it is likely that Investors will seek out value-add opportunities due to many owner-user facilities being under-renovated, allowing for an early exit via a renovate, lease-up, and sell strategy.
The Covid-19 Pandemic has also highlighted some specialized property types where investors may find significant redevelopment value in older owner-user facilities. For example, dated distribution warehouse space may be converted to cold storage, or traditional office may be redeveloped into medical or life science/ lab uses. Overall, buyers will welcome an increase in available product in California, a state where major markets are built-out and transaction velocity is high.
It is difficult to project the impact that the Covid-19 Pandemic will have on the probability of this initiative passing come November. However, market participants across all sectors of the industry are already preparing for the potential impacts of a split roll. Major opportunities for buyers, sellers, and service providers will be presented with a “yes” vote, and Kidder Mathews will remain informed and ready to provide our clients with the most current and well-researched information available.
Source: Ken Sullivan, RPC Property Tax Advisors, LLC
|KEVIN M. THENE, MAI
Managing Director, Valuation Advisory Services
LIC N° AG003085
|TAYLOR J. KENDZORA
Vice President, Valuation Advisory Services
LIC N° 03007202