The Effect

This is ultimately why we’re here; what is the breadth of the impact on California and its citizens? COVID-19 has already broken many of the proverbial camel’s bones by heaping a megaton of stress on an already inundated back but could Prop 15 be the straw that finishes the job?

What happens if it passes? What are the long term effects?

Assessments

Let’s first look at how this will affect the system that will actually implement the new measure. An estimated 1,000 new, trained assessors will be needed statewide bringing up serious questions with regards to the feasibility of training and hiring given that commercial and industrial appraisals are particularly complex and the state standard for training is a minimum five years. The grace period – if Prop 15 is passed – is only two. To the layman, a demand for new jobs might sound like a great thing. However, the rush could lead to an influx of undertrained commercial appraisers and converted residential appraisers flooding the talent pool.

The buck unfortunately won’t stop there. Like all things that are downstream, the cumulative effect on the appeals work that’s associated with assessments will also be staggering.

Appeals

According to Jeffrey Prang, a Los Angeles County assessor, LA County alone has 3,000 backlogged assessment appeals, some taking several years to resolve. Most if not nearly all of the properties that will be reassessed once the grace period is up will trigger appeals… and as they divert resources from residential appraisals to meet the increased workloads, it’ll then result in an increase in residential appeals, too particularly if those will rely on computer generated models as he and many others are anticipating. In other words, the more load on the system, the more likely for imprecise and contested assessments leading to a tidal wave of appeals. And it isn’t just an issue of workload; this costs money. Prang estimates the present backlog costs the county $20-30 million a year in property tax value from one fiscal year to the next and that’s before the split roll.

This will be most noticeable when operating around the $3 million exemption cut off. If there is a disagreement on whether any given commercial property is valued at, say, $3.1 million or $2.9 million, it makes a huge difference on whether that property gets the exemption or not. And as we pointed out earlier, since the valuation operates on aggregate, a commercial owner with properties in different counties will receive different valuations from different appraisers which could very well be the difference between breaking through the $3 million threshold and not. Which, of course, will lead to an appeal.

For the Kids!

There’s a legitimate concern that the estimated $12 billion of annual tax revenue that’s being framed as going to them won’t make it there to begin with. First of all, the measure’s language indicates that from this pot of money, funds will be set aside for various tasks first, chief among them the funding to counties to pay for all the aforementioned costs of carrying out the measure. It’s estimated that several hundred million dollars annually will be needed for assessment work alone and, even more troubling, the measure would loan money to counties to cover these costs until the tax money is available which won’t be until at best half a decade from now.

So while Los Angeles County or any of the Bay Area counties can dig into deep pockets, what will the likes of Madera, Imperial or Tulare do?

According to Deputy Legislative Analyst Brian Uhler, after accounting for the reduction in business personal property and the funds set aside for costs related to the measure, the state is looking at about 60% of the tax revenue going to cities and counties for these new costs although not all cities and counties are guaranteed to receive the new funds. In some cases, such as in the more rural areas, they may end up losing revenue because of lower taxes on business personal property. It is only then that revenue would end up going to schools and community colleges which will be based primarily on how many pupils they have, again, raising serious questions about what that means for the vast disparity between California counties.

There is unfortunately no two ways about it. The schools are not receiving $12 billion annually; they’d be lucky to get $5 billion and while any amount of money to education is good (so long as it isn’t misused and poorly budgeted, that is), this uncertainty should be alarming.

Priced Out Citizens

Californians are already leaving.

According to the U.S. Censor Bureau, California’s population has dropped 6.1% from 39 million to 37 million between 4/1/2010 and 7/1/2019. In some cases, Californians can stay but choose to leave due to growing restrictions and regulations “cramping their [life]style.” In many more cases, unfortunately, they’re leaving because they have no other choice.

Rising costs of living in the major urban centers of the state are driving Californians to commute upwards of two hours each way daily just in order to afford life in California which is nigh unbearable with gas prices as they are.

Property owners may be the ones billed by the counties but it’ll be their tenants under triple net leases that will see a substantial increase to a significant line item in their annual budgets. And as we demonstrated earlier, increased cost in the production of goods or provision of services results in higher consumer costs for the general public.

The issue with the grand exodus from California is that as costs continue to climb, the people who will likely be leaving are going to come from whatever is left of the middle class. They’re ultimately the ones with both the means to leave and the most pressure to. A precipitous drop in the middle class population of the state will cause a similar drop in small business enterprise both as proprietors and as consumers.

The Commercial Real Estate Industry

As for the commercial real estate industry itself, there’ll undoubtedly be a substantial shift towards favorable investments. Multi-family properties will become enticing investments considering their exemption as well as residential and agricultural land as both of those retain their protections under an acquisition value system, driving investment away from commercial real estate. Additionally, smaller commercial buildings that can be valued under $3 million will become more attractive to prospective investors as the savings will be monumental over the long term. The leasing impact on existing properties valued under $3 million will also be huge as small business tenants will flood that market seeking favorable triple net leases and cheaper rents.

Perhaps more troubling is the inevitable shift toward small business being operated out of the home. Many small businesses that had been operating on the decades old paradigm of leasing office or retail space as a social norm will join the growing movement of home-bound small businesses as prospectors discover that they can take advantage of the split roll exemption for residential properties.

This coincides perfectly with the millennial trend towards home driven small businesses, anyway. Already millennials make up close to 20% of U.S. small businesses and that number is only growing every year. It is predicted that by 2025, 75% of the workforce will be of the millennial generation and that generation is one driven by technology, remote work and flexibility… all features of running a business from home rather than a traditional commercial space. This doesn’t apply to the industrial sector so much, of course, but with such incentive baked into Prop 15 why would any future entrepreneur even bother looking for office or retail space?

Not that it’ll matter in the bigger picture; because if this is any indication, these sorts of legislative quagmires are only the beginning. There’s an old Arab proverb that poignantly frames this summarily. “Camel’s nose into the tent.” Bedouin Arabs have long held that once a camel gets its nose inside of a tent, it becomes impossible to prevent the rest of it from entering.

It might just enter the tent with a broken back, to boot.