When all is eventually said and done, 2020 may very well go down as one of the most calamitous years for the commercial real estate industry in California history.

Already mired in substantial economic duress due to the global COVID-19 pandemic and the stay-home order that has followed, California’s commercial real estate industry and the small businesses already suffering from stunted economic productivity are about to face yet another problematic challenge right around the bend.

The California Schools and Local Community Funding Act of 2020 (now known as Proposition 15), an upcoming initiative on the November ballot, seeks to eliminate tax protections for commercial and industrial real estate properties that have been in place since 1978 when the landmark Proposition 13 was passed. If passed, Prop 15 will remove most commercial properties from the present acquisition value-based assessment system for determining property taxes and placing them, instead, on an assessment system based on current fair market value at least every three years.

Over the course of the next few days, we will break down the issue in a series of pieces that we hope will inform both real estate property owners and many of the nearly four million California small businesses the real estate industry supports about the jarring effects of this monumental initiative in order to better prepare them for the upcoming November vote and, perhaps more importantly, provide a head start to make the necessary preparations if it does indeed pass.

First, A Bit of History

The People’s Initiative to Limit Property Taxation – aka Proposition 13 – was a response to a growing problem with California’s property tax assessments in the 1960s and 1970s. With California’s population skyrocketing during that time, an increase in housing demand coupled with ensuing inflation caused reassessments to increase property taxes on residential property so much that Californians, particularly those with fixed incomes, struggled to pay them.

With a bevy of regressive state and local tax distributions and the steady expansion of California’s government, it’s not surprising that Prop 13 passed with a 63% approval and has stood the test of time.

As a result, all California real estate since has been taxed under an acquisition value system in which the 1% county tax rate is applied to the property’s assessed value at the time a property is acquired. This is typically the purchase price based on the property’s fair market value at that time. That then in turn establishes the base year value with the annual increases then capped at the maximum 2% per year until and unless the property has an ownership change at which point a reassessment restarts the clock.

Granted, there are exceptions where, for example, reassessments could occur if there is new construction on an existing property or if property value dips below its assessed value but generally speaking, Prop 13 has ensured that property taxes remained manageable for Californians over the past four decades.

The significance of Prop 13 and its importance to the commercial real estate industry is multifold. On one hand, it better allows for property owners (as well as the small businesses that lease from them) to budget accurately as the fixed costs allow for predictable and easy computations of trajectory tax hits as the base year value remained consistent. Furthermore, under Prop 13, tax revenues for commercial property owners rarely if ever go down unless there is an appeal or if a property sells for less than it originally did. In that event and as is often the case, the property will more than likely be rehabbed in order to increase its value and that in turn creates jobs, accumulates building permit fees and eventually new sale tax revenue.

Summarily put, Prop 13, considered the third rail of California politics, has standardized consistent practices in our industry that has helped propel successful business throughout the state for over four decades.

Tomorrow, we’ll jump into what the Schools First initiative seeks to do in more detail.