Markets love certainty. Big jumps or big dips may be great opportunities for day traders to make money, but they’re risky for those in commercial real estate development. This was the case with property taxes in California before 1978 as localities randomly, and in some instances arbitrarily, increased property tax assessments and rates. Because of this, some property owners found themselves being priced out of their properties as their taxes soared beyond their ability to pay.
However, since 1978, residential and commercial real estate owners have been able to predict with certainty their annual real estate taxes. The reason for this certainty is that voters passed a constitutional amendment, known as Proposition 13, which provided new protections for both residential and commercial properties and shifted property tax management to the state.
Proposition 13 provides residential and commercial property owners with two important protections. First, residential and commercial property assessments may increase no more than 2 percent annually unless a reassessment is triggered. Properties are only reassessed to current market value under one of three specific circumstances: 1) upon its sale, 2) when more than 50 percent of its ownership transfers, or 3) when construction of a new project or renovation is completed. The second protection capped the annual property tax rate at 1 percent for all real estate.
The level and predictability of property taxes are important considerations in driving commercial development. “Under current law, businesses can be certain what their future property taxes will be,” explained Rex Hime, President and CEO of the California Business Properties Association and coalition co-leader to preserve Proposition 13.
Proponents of higher property taxes recognize they don’t have the political support to overturn all the protections of Proposition 13. Instead, they’re trying to weaken it through a proposed “split roll” initiative that will be on the 2020 ballot. The split roll proposal would leave the taxation on residential properties unchanged, but would lift Proposition 13 protections on commercial properties with the exception of residential (apartment) investment and agricultural properties.
If adopted, the ballot measure would result in all commercial real estate, apart from the exceptions, being reassessed to its market value in 2020. After that, the reassessments would occur at least every 3 years. This would be a huge tax increase, up to $11 billion annually on commercial real estate.
That’s a problem, because property taxes matter. The cost of doing business matters. By targeting commercial real estate, proponents would end up going after small- and family-owned businesses, which comprise a significant portion of the tenants in commercial properties. Also, any NAIOP member who invests in commercial real estate or receives professional services from a California business would be impacted.
Removing the Proposition 13 protection on commercial real estate would also harm the state’s competitiveness in attracting and retaining business. Businesses could react to split roll by moving out of state. A 2012 report from Pepperdine University’s Davenport Institute report predicted: “The cost to the California economy of this property tax increase would total $71.8 billion dollars of lost output and 396,345 lost jobs over the first five years of a split roll property tax regime. These losses would be even greater in succeeding years.”
California voters will go to the polls on November 3, 2020. However, the threat of split roll is already having an impact as commercial tenants decide on whether to renew leases, downsize/expand their business, or depart the state entirely. So, if you live in California or invest there, the campaign is already underway.
NAIOP of California is actively raising money and has joined the Californians to Stop Higher Property Taxes in order to defeat the measure. It is organizing a statewide campaign to educate voters on the damaging effect that split roll would have across California. The campaign is expected to cost $100 million.
“Californians are some of the most heavily tax-burdened in the country,” Hime said. “A split roll property tax increase isn’t needed and will just make it more difficult to do business in California.”
State and local initiatives are increasingly turning to commercial real estate as a revenue source. That is the case in California. The split roll initiative targets one industry, and one industry only: commercial real estate. Our campaign aims to keep the fairness and protections of Proposition 13 in place for both residential and commercial property owners.
James V. Camp is President of NAIOP of California.