On November 3rd Californians will decide whether to partially remove property tax protections, granted under Proposition 13 in 1978, for most non-residential properties. The initiative they will vote on, the California Tax on Commercial and Industrial Properties for Education and Local Government Funding Initiative (2020), would amend the state constitution to require commercial and industrial properties be taxed at their market value.
Currently all property in California is protected by Proposition 13 (1978), which limits property taxes to 1% of the purchase price plus up to 2% of inflation per year. By removing such protections for commercial properties, some estimate the initiative will generate another $13 billion of property taxes in California. While not arguing the merits of the initiative’s objective, should the initiative pass I do think it will negatively impact California businesses in ways familiar to corporate real estate but perhaps not the general public.
The obvious impact of increasing property taxes on non-residential property is on the non-residential property owners themselves. Some of the largest commercial employers in California also have large property holdings in California. For companies who own their real estate, an increase in property tax is shown on income statement as an increase in operating costs. Which means when property taxes are increased, all sorts of indicators of company health are negatively impacted like EBITA, profitability ratios, price-earnings ratios, etc. That may be acceptable if you are a tech company whose investors may focus more on the cash flow statement, but not OK if you are an established aerospace company heavily penalized for any indication of being unprofitable.
Perhaps less known are the impacts on companies leasing space when property taxes are increased. The vast majority of leases stipulate that any increases in property taxes are “passed-through” to the tenant leasing the space. This means the tenant, not the landlord, is responsible for the increased tax. For the impacts to corporations who lease space, the negative impact of property tax increases on their income statement is the same as the ownership example above.
While proponents of this initiative have argued the initiative will target wealthy investors and large corporations, small and medium sized businesses will likely get impacted the most. Small and medium sized businesses in office buildings, multi-tenant industrial parks, and shopping centers likely do not have any protections from property tax increases in their leases. Their landlords will pass along the cost of the additional property tax to them.
Do you know who is much more likely to have protection against tax increases in their leases? Typically large corporations, who had substantial negotiating leverage with the landlord when they entered into their lease, and wealthy investors savvy enough to include them in leases when they purchased a business and leased back from the Seller.