Investors Beware: The Threat of Proposition 15 is Real

As investors like you, we have grown concerned over the increasing likelihood that Proposition 15, the so-called Split-Roll Initiative, will pass on November 3rd. For several reasons, we believe this attempt to unravel the 42-year-old protections of Proposition 13 is ill-conceived and will hurt the entire California economy. It will substantially increase property taxes on commercial property going forward, place a further burden on the tenants who occupy our properties. The proposition will likely reduce the value of our investments as would-be Users and Investors would insist on adding an additional risk premium into their budget and underwriting.

Currently, base property tax levies are set at approximately 1% of the purchase price at the time of acquisition and are then subject to a 2% increase thereafter until the property is re-sold. This makes certain the amount of property taxes that will be due each year during the hold period. Further reducing the risk associated with the investment. If Proposition 15 passes, your investment property will be subject to reassessment to full market value every three years.

So, if you have a low tax base tax levy because of when you bought your property, that advantage you hold over owners with a higher basis will be lost overnight. Plus, any potential buyer for your project will estimate a higher base property tax during underwriting as a precaution, effectively lowering net operating income (NOI), a key component of the value equation. A modest rise in the market cap rate, say an increase to 5.5% from 5%, will reduce a property’s value by 10% on the same NOI. If NOI decreases at the same time, the falloff in value would accelerate.

Your tenants will also be exposed to higher operating costs they pay along with their monthly rent. Any tenant on a full service office lease not in his or her base year when a property gets reassessed will have to bear the full cost of any base levy increase. Anyone on a net lease, common to industrial and retail properties, will have to pay the entire increase in property taxes in addition to all other operating expenses. That potential burden will put downward pressure on base lease rates to compensate for higher projected operating expenses.

Who is behind the measure? How much will taxes go up and where will the money go? The main proponents of Proposition 15 are public sector unions and leaders of city governments, who stand to gain the most from an increase in revenue. They hope to raise up to $12 billion in new property tax revenue and send 60% of what’s left after administrative and other costs to local governments and split the remaining 40% to K-12 school districts and community colleges.

According to our calculations, even if they raise the full $12 billion each year, schools will see just a nominal increase in per-student allocation. Estimates for administrative costs for property reassessments run up to $1 billion per year. The next money out goes to the Franchise Tax Board as reimbursement for the reduction in income tax revenue occasioned by the deductibility of higher property taxes. Only then would governments and schools see any money, and whatever they get can be spent on whatever they choose without restriction other than to make public exactly where the money went after the fact.

There are other important aspects to the law, which further complicate the issue, but the foregoing outlines the primary dangers of Proposition 15. Simply put, it will raise costs to commercial property owners and their tenants who, as prudent entrepreneurs, will pass along those higher costs by raising prices on their goods and services. That means higher prices for everyone across the board. The risk of owning and occupying real estate will go up. That means lower property values and less space occupied going forward. Make your vote count on November 3rd.