Proposition 13 property tax protections for commercial properties may be repealed as soon as this year
[UPDATE: APRIL 3, 2020: The campaign Schools and Communities First reported filing 1.7 million signatures in support of its revised #19-0008 ballot initiative. Consequently, the Split Roll Initiative will appear on the November 2020 ballot in the form of #19-0008 as discussed below.]
The California Schools and Local Communities Funding Act of 2018 has qualified to appear on the ballot in California as an initiated constitutional amendment on November 3, 2020. The initiative is backed by Schools and Communities First, an organization primarily funded by Chan Zuckerberg Advocacy, the San Francisco Foundation, and the California Teachers Association. The initiative would result in an increase of real property taxes for commercial and industrial properties by partially repealing Proposition 13. This would require local governments to “split” their tax rolls between those taxed based on current value under the new law, and those still taxed on the purchase value under Proposition 13.
California passed Proposition 13 in 1978, which limits increases in real property taxes to 2% per year. Under Proposition 13, properties taxes are only reassessed to market values upon a change of ownership or following new construction. Residential – including single family homes and apartments – and agricultural real property would be exempt from the Split Roll Initiative (as defined below), and remain a beneficiary of Proposition 13 protections.
The Legislative Analyst’s Office estimates the measure would generate between $7.5 billion and $12 billion annually for schools and local governments. The Split Roll Initiative has a broad base of support amongst the leaders of the democratic party, including Joe Biden and Bernie Sanders.
Two Forms of the Split Roll Initiative
The initiative (collectively, the “Split Roll Initiate”) currently exists in two forms: Ballot Initiative #17-0055 (California Schools and Local Communities Funding Act of 2018) and Ballot Initiative #19-0008 (California Tax on Commercial and Industrial Properties for Education and Local Government Funding Initiative (2020)).
- Ballot Initiative #17-0055 was submitted to the California Attorney General’s office in January 16, 2018, and qualified for the November ballot on October 15, 2018
- Ballot Initiative #19-0008 was submitted on September 12, 2019, and must qualify for the November ballot by April 14, 2020. Ballot Initiative #19-0008 needs
997,139 signatures to qualify for the November ballot. As of December 6, 2019, the revised initiative had surpassed the 25% threshold of signatures (248,385).
Ballot Initiative #19-0008 amends and revises Ballot Initiative #17-0055. While both forms of the Split Roll Initiative will result in a repeal of Proposition 13 with respect to commercial and industrial properties, the manner in which they achieve this result differs significantly:
| Policy | #17-0055 | #19-0008 |
| Initial Re-assessment Date | January 1, 2020 |
|
| Reassessment Frequency | Every Three Years | Same as #17-0055 |
| Exempted Commercial and Industrial Properties | Commercial and industrial properties worth less than $2 million based on current assessed value are exempt. | Commercial and industrial properties worth less than $3 million based on current assessed value are exempt. For purposes of this exemption, the fair market value of a property must be combined with the fair market value of all other commercial properties in the state in which any direct or indirect beneficial owner owns a direct or indirect beneficial ownership interest, and if the aggregate sum of all such properties exceeds $3 million, the exemption no longer applies. |
| Mixed-Use Properties | Only that portion of the property that is used for commercial and industrial purposes should be subject the Split Roll Initiative | Same as #17-0055; but…
…permits legislature to provide for an exclusion from reassessment for the commercial share of mixed-use property if 75% or more of the property by square footage or value is residential |
| Small Business Exemptions | Ends taxes on personal property, such as equipment and furniture, for small businesses.
Exempt up to $500,000 worth of personal property from taxation for larger businesses. |
Same as #17-0055 |
| Small business definition | 50 or fewer full-time equivalent employees |
|
| Owner-operator exemption | Property owners operating their own business on a majority of the property exempt | No exemption for owner-operators |
If Ballot Initiative #19-0008 fails to qualify for the November ballot, then the Split Roll Initiative will appear in the form of Ballot Initiative #17-0055.
Effects on Commercial Real Estate
If either of the Split Roll Initiatives is passed in November, the impact on commercial real estate in California could be extreme. Just the threat of such initiatives has caused commercial real property owners to adjust expectations, and has precipitated a slowdown in the commercial real estate market. When combined with other efforts to cap rental increases on residential properties through rent control, which went into effect on January 1, 2020, the California real estate market could undergo a drastic overhaul in the course of just a year.
Although proponents will surely argue that the Split Roll Initiatives will cause “rich property owners” to pay their fair share, the opposite may in fact be true. Due to the pass-through nature of real estate taxes under triple-net leases and modified gross leases, the effect of the Split Roll Initiatives may ultimately burden tenants more than property owners. Under triple-net and modified gross leases, a tenant, not a landlord, is responsible for the payment of any increase in real property taxes. In fact, savvy landlords have included language in leases that specifically states that tenants are responsible for increases in real estate taxes due to any change to Proposition 13. Consequently, tenants – many of which are small businesses – may be the most impacted by the repeal of Proposition 13. Increased rent costs could ultimately be passed onto consumers through higher prices on food, alcohol, consumer products, and other services that rely heavily on commercial properties.
For landlords that have used “full gross leases”, a different problem could ensue. Such landlords would bear the full burden of any increased taxes, and may be forced to sell their properties if they cannot afford the increased payment. This could result in increased liquidity in the lower end of the commercial market (properties that do not qualify for the $2 or $3 million exemption, but have been owned by families or unsophisticated parties whose primary wealth is tied up in commercial real estate). Additionally, passage of the Split Roll Initiative would likely result in the end of full gross leases in California because landlords would be scared to face the burden of re-assessments every three years.
What to do before November
Any landlord entering into a lease prior to November should sign modified a gross lease or triple net lease – not a full gross lease – in anticipation of the Split Roll Initiative passing. Even if the Split Roll Initiative fails, it’s likely that similar efforts will be made in the near future. Landlords should plan for the passage of Proposition 13 repeal or reform, and incorporate provisions with respect thereto into their leases. Additionally, landlords should conduct a review of all existing leases to determine any potential liability they could face as a result of the passage of the Split Roll Initiative.
Any tenant entering into a lease prior to November should push for a full gross lease, or, alternatively negotiate provisions that allow for the “phasing” of any increased tax liability as the result of Proposition 13 repeal, which could prevent tax “shock” from an increased tax bill on day one. Additionally, tenants could seek short term leases to mitigate any potential acute tax increases that result from the passage of the Split Roll Initiative. Tenants should review their existing leases to determine what – if any – liability they have under their existing leases. If a tenant has a lease that places the liability of Proposition 13 repeal upon them, it may want to approach its landlord to discuss a potential workout in the event of passage of the Split Roll Initiative.
Conclusion
The Split Roll Initiative faces an uphill battle. Prior repeals or modifications to Proposition 13 have faced fierce opposition, and the Split Roll Initiative is unlikely to be any different. If the modification measures made pursuant to Ballot Initiative #19-0008 fail to receive the necessary signatures on April 14, 2020 to appear on the November ballot, the battle is likely to be even more difficult. According to proponents of the Split Roll Initiative, the changes to the Split Roll Initiative were made after consultation with political and labor leaders to “substantively strengthen the measure” and “widen the path to victory.” We will be following the Split Roll Initiative through the April 14, 2020 deadline and the November ballot.
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