Proposition 15 - Look into it, Please!

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 First, a bit of context and a brief history lesson. 

“Proposition 13 (officially named the People's Initiative to Limit Property Taxation) is an amendment of the Constitution of California enacted during 1978, by means of the initiative process. The initiative was approved by California voters on June 6, 1978. It was upheld as constitutional by the United States Supreme Court in the case of Nordlinger v. Hahn, 505 U.S. 1 (1992). Proposition 13 is embodied in Article XIII A of the Constitution of the State of California.” Source: Wikipedia.

 Two hallmarks of the amendment are - 1. values of ALL real estate, residential, commercial, or otherwise are fixed at their 1976 levels. Assessed values may increase annually by the rate of inflation not to exceed 2%. Exceptions are for a property which is sold or newly constructed. These are then assessed at their “new” values. 2. Maximum amount of any ad valorem tax on real property cannot exceed 1%. 

This “third rail” of California law has been in place since some of us wore shag haircuts and big-belled Levis. Thank goodness those had shorter shelf lives than the legislation!

Flash forward to now - 2020, the year of the pandemic.

A ballot initiative - Proposition 15 will appear on November 3. You can read the full text of the initiative here. California Proposition 15, Tax on Commercial and Industrial Properties for Education and Local Government Funding Initiative (2020) - Ballotpedia

 From the website above - Simply, “a yes vote on Proposition 15 supports this constitutional amendment to require commercial and industrial properties, except those zoned as commercial agriculture, to be taxed based on their market value, rather than their purchase price.”

Ok. I’m with you so far - you may be thinking. I don’t own commercial real estate, schools need our help, so what’s the big deal? Please read on.

Owners of commercial real estate either occupy the buildings they own or rely upon a tenant to pay them monthly. Commercial real estate exists in three main categories - office, retail, and industrial. Office buildings - ranging from high rise towers to two story garden varieties - house your physician, dentist, CPA, wealth advisor, tax attorney, insurance broker, residential real estate agent, homeowner’s association, news organization, non-profit outfit, and many others. Retail - neighborhood shopping, regional malls, power centers, strips, freestanding, big box, automotive - provide purchasing destinations for goods such as your cat’s food, groceries, apparel, and school supplies - or services such as your favorite bar, restaurant, theatre, or gym. Finally, industrial - generally manufacturing, service, or logistics providers - who domicile in concrete boxes. Some notables are aerospace tooling, plastic molding, warehouse distributors, and trucking outfits.

Commercial real estate is EVERYWHERE! Whether you own it or not - your life - employment, consumption, entertainment - is impacted by someone who does.

If Proposition 15 passes - in this author’s opinion - five things are certain to occur.

First, property taxes on commercial real estate will increase. Second, the increased property taxes may be used to fund local communities and schools. Third, owners of commercial real estate will pass along the increased property taxes to those companies that occupy the commercial real estate - read. Tenants. Fourth, tenants - faced with increased costs - will raise the prices of their goods and services to offset the increase. Fifth, you - as the consumer of said goods and services - will pay more.

Please, educate yourself on Proposition 15 and exercise your civic duty and vote.

 Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.

Are 1031 Exchanges at RISK?

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As we have now surpassed Labor Day in the election year of the pandemic 2020 - expect political rhetoric to reach a fever pitch. Sorry. Pun intended. As our nation slowly recovers from business lockdowns, distance learning, storms along the gulf coast, wildfires in California, and upheaval in our streets - and governments respond monetarily to stem the bleeding - expect the next question to be - “how on earth can we possibly pay for all of this?”

 California has proposed a 16.8% marginal tax through AB-1253. Targeted are those who earn more than $5,000,000 annually. Who cares, you may ask. They should pay their fair share. What’s another 3.5% of their income to help the greater good? Consider this, please. Many small business owners could tip this scale and face the extra burden. How long will they remain in California when Nevada, Texas, and Washington have ZERO state income tax? If we export a significant amount of our tax base - who’ll be left to foot the tab?

 Proposition 15 - on the California ballot in November - proposes to split the property tax roll and tax commercial properties differently than residential parcels. I’ve written ad nauseam about where the ultimate bill will be paid. Yep! By you as the consumer of goods and services. You see - if the cost of commercial real estate rents rise through an increase in property taxes - businesses who occupy the industrial buildings, office space, and retail storefronts will be forced to pass that expense along to their customers - you.

 A target for a significant tax grab could also be the way in which capital gains taxes are deferred through 1031 exchanges. I’ve not seen any storms massing on the eastern horizon - but it’s always calmest - so the saying goes.

 Congress could propose an elimination of this “loophole” and generate billions in tax revenue. It currently works like thus. If you sell a piece of income property - you are allowed to defer your long term capital gains taxes. Simply, you enter a contract to sell, create a qualified intermediary before you close, close, net sale proceeds go into an accommodator account, you identify upleg purchases within 45 days from close, and buy the upleg(s) at the earlier of 180 days from close or the filing date of next year’s tax returns. Easy! Literally thousands of these are done each year. Deferred are Federal long term capital gains of 15-20%, depreciation recapture of 25%, California state taxes on Capital Gains of $13.3%, and 3.8% for the Affordable Care Act. A whopping amount! Assumed is - if we tax those sales today vs allowing a deferral - think of the revenue we’d generate!

 Good in theory - but here’s the rub.

 When I visit with owners of commercial real estate about the likelihood of selling their property - I’m asked this question. If I sell, what will I do with the proceeds? After all - I don’t want to pay close to half my gain in taxes! We then have an in-depth conversation about tax deferred exchanges. So if Congress were to change the rules or disallow 1031 exchanges altogether - sellers would be left with very little motivation to sell. 

Some might say - this argument is quite self serving. After all, this guy is paid to sell commercial real estate. True enough. However, please don’t forget the multitude of industries who benefit from the sale and purchase of commercial real estate. Title companies, escrow holders, transactional lawyers, CPAs, qualified intermediaries, lenders, property inspectors, environmental engineers, contractors all drink from the trough of a commercial real estate transaction. Behind the scenes are real people - with families - whose livelihoods depend on property sales.

 Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.

Proposition 15 - Split Roll - Who Pays?

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For the next few weeks, I will endeavor to sound like a broken record. Or is it Groundhog Day? Or as Yogi Bera once opined - “it’s Deja Vu all over again.” Not that I’m partisan - my goal as a commercial real estate practitioner is to inform my readers about the ins and outs of splitting the tax roll. Today - with full permission - I’ve borrowed a review of certain AIR CRE lease documents from Usman Mohammed from Consensus Legal P.C. If you have questions, you can contact 

Usman directly:

Direct: (213) 814-2552

Email: Usman@ConsensusLegal.com

www.ConsensusLegal.com

Many, many small businesses have entered into one of the below AIR CRE leases and are governed by their language.

 A bit about AIR CRE. “AIR CRE is an innovative, member-owned platform that provides commercial real estate professionals with the critical tools they need to be successful. AIR CRE has curated the best resources that the industry has to offer, and packaged them together as a single integrated network. Members have unparalleled access to a system of market research, listings services, contracts and legal resources, networking, and education.”

 So, simply - if a Tenant enters into an AIR CRE lease today, would the Tenant be required to pay the increase in property taxes resulting from the potential passage of Prop. 15?

 Short Answer: Yes, except under the rarely-used AIR CRE month to month lease (entitled “Standard Industrial/Commercial Multi-Tenant Month To Month Lease – Gross”).  

 How does each individual AIR CRE Lease allocate responsibility for increased Real Property Taxes resulting from Prop. 15?  The following is a breakdown.

Industrial/Commercial Leases

Single-Tenant Lease – Gross: Tenant pays increases in Real Property Taxes over the fiscal tax year during which the Commencement Date Occurs. (Paragraph 10.2.)

Single-Tenant Lease – Net: Tenant is responsible for Real Property Taxes. (Paragraph 10.2.)

Multi-Tenant Lease – Gross: Tenant is responsible for Tenant’s share of any increase above the Base Real Property Taxes (i.e., the Real Property Taxes assessed during the calendar year in which the Lease is executed). (Paragraph 4.2(a)(v).)

Multi-Tenant Lease – Net: Tenant pays Tenant’s share of Real Property Taxes. (Paragraph 4.2(a)(v).)

Multi-Tenant Month To Month Lease – Gross: Paragraph 10 provides: “Landlord shall pay any Real Property Taxes.”  In this AIR CRE Lease, Landlord is responsible for all Real Property Taxes.

Land Lease – Gross: Tenant is responsible for increases in Real Property Taxes over the fiscal tax year during which the Commencement Date occurs. (Paragraph 10.2.)

Office Leases

Multi-Tenant Office Lease – Gross: Tenant pays Tenant’s share of the amount by which all Operating Expenses (including Real Property Taxes) for each Comparison Year exceeds the amount of all Operating Expenses for the Base Year. (Paragraph 4.2(a)(v).)

Multi-Tenant Office Lease – Net: Tenant pays Tenant’s share of all Operating Expenses (including Real Property Taxes). (Paragraph 4.2(a)(v).)

Shopping Center Lease

Multi-Tenant Shopping Center Lease – Net: Tenant is responsible for Tenant’s share of all Common Area Operating Expenses (including Real Property Taxes). (Paragraph 4.2(a)(v).)

You, as a Tenant, would be well advised to review your lease carefully. If the heading contains one of those above - you know the impact. If not, seek counsel. If you’re considering entering into a new lease - you are certainly advised to ask for Proposition 15 protection.

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.

 

Transitions!

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Family owned and operated businesses are the lifeblood of our California economy! I am passionate about helping them create legacy wealth through commercial real estate ownership. One of the coolest things I observe during my daily grind are the many ways Californians make a living. The entrepreneurial spirit is amazing. However, many of our family owned and operated manufacturing and logistics clients are facing a transition in their business which leads to a commercial real estate decision.

 These transitions include:

 Reorganization from Covid upheaval. Sadly, the pandemic has brutally thinned some industries. Others have crushed it. I walked the bulging warehouse with a COO of a family owned and operated business last week. They supply fabric to the likes of Walmart, Joanne’s, and Target. With stay at home orders, more now sew - therefore sales have exploded. Forward looking - their facilities will not handle the uptick in orders. We are exploring ways to minimize their short term pain - a need for more space, now - vs a longer term solution. On the flip side. A client who once supplied lights, video screens, and temporary power to concerts, festivals, and sporting events has no more business. Gone! Just like that. A thriving enterprise evaporated. Our task is more somber as we work through an excess of space and relieving this company of its lease obligations.

 A sale of their operating company or acquiring a competitor. Never since the halcyon days of Gordon Gecko have we seen a spate of mergers and acquisitions like now. Private equity capital - seeking favorable returns - has poured into traditional manufacturing. Plastic injection molding, aerospace tooling, and packaging have found renewed interest from these groups. Common is a “roll up” of these separate operations into a larger entity. Generally, the play is to manage the companies for a few months or years, continue to acquire additional units, shed the unprofitable pieces, and then resell the consolidation. Created - as you can appreciate - is a duplication of facilities - akin to a “yours, mine, and ours” that occurs when a family is blended. Cultures must be morphed, excess real estate shed, and a balance struck.

 Relocation out-of-state. California has made life quite difficult for anyone starting or managing a business. A noose of strangling regulation - licensing, enviro compliance, conditional use permitting, zoning - hangs over new and existing companies. Layer in a few wacky - sorry - new laws such as AB-5 (which unravels the way in which independent contractors are classified), the pending Proposition 15 (if passed, would tax commercial real estate differently than houses), and the new marginal tax rate - highest in the country - and you consider a moving van to tax and regulation friendly stares such as Texas, Nevada, and Arizona. The outmigration is startling yet understandable. Left behind are industrial buildings which must be leased or sold.

 Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.