California 2020 Ballot Initiatives Pose Risk of Major Changes to Commercial Real Estate

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In Short

The Situation: With the changes proposed to taxation of commercial real estate and residential rent control on the 2020 ballot, the real estate landscape may be changing in California.

The Result: Propositions 15 and 21, if adopted, could have lasting effects on commercial real estate owners.

Looking Ahead: Owners of commercial real estate assets and their lenders should pay close attention to the results of the 2020 election to assess their impact on real property taxation and rent control provisions in California.

Of the 12 propositions that will be on California's ballot in November 2020, two of those propositions directly affect commercial real estate. Specifically, propositions 15 and 21, which are summarized in pertinent part below, take aim at relatively long‑standing real property taxation and rent control provisions and, if adopted, could have lasting effects on commercial real estate owners.

Proposition 15

Proposition 15, also known as the California Schools and Local Communities Funding Act of 2020, is designed to create a "split roll" for purposes of California real estate taxation, and would in essence undo the effects on commercial real estate of Proposition 13, which was approved by California voters in 1978. The incremental revenues expected to be generated from this proposition, and the constitutional amendment that would result, are in large part earmarked for California schools and are expected to be in excess of $11 billion per year. Pursuant to the most recent statewide survey, published by the Public Policy Institute of California in April 2020, 53% of California's likely voters would support a "split roll" property tax to fund public schools.

In accordance with Proposition 13, California real estate is currently taxed based on its assessed value, which is deemed to be the assessed value of such property identified on the applicable 1975-1976 assessment rolls, subject to an annual increase equal to the lesser of the inflation rate or 2%; however, subject to certain exclusions, if a property is transferred, it is then reassessed at its then-current market value for tax purposes. With respect to the foregoing, Proposition 13 does not distinguish between real estate asset classes. Proposition 15 would change that.

Proposition 15 would establish a "split roll," distinguishing, for purposes of taxation, commercial real estate asset classes (with limited exceptions) from all residential real estate asset classes (including single family and multifamily). While the assessment provisions of Proposition 13 would continue to apply to the residential real estate asset classes, Proposition 15 would require reassessment of commercial real estate beginning with the 2022-2023 fiscal year lien date (with (i) a phase-in period to allow for county assessors to assess all real estate within the county and (ii) an extended phase-in period (2025-2026 fiscal-year lien date) for real estate at least 50% occupied by small businesses, which is a term of art more specifically defined in the text of Proposition 15) and require subsequent reassessments not less frequently than every three years. The maximum rate of taxation, however, would remain one percent of the assessed value, as required by the California constitution.

Proposition 21

Proposition 21, also known as the Rent Affordability Act, would implement a significant amendment to the existing rent control provisions currently codified in the California Civil Code and commonly known as the Costa‑Hawkins Rental Housing Act ("Costa-Hawkins"). While Costa‑Hawkins does not preclude local jurisdictions from adopting rent control ordinances, it does prescribe certain elements of those ordinances. Adoption of the Rent Affordability Act would, among other things, result in many more residential units becoming subject to local rent control ordinances and significantly limit landlords' right to establish the starting rent under a new tenancy.

Costa‑Hawkins provides that a local rent control ordinance may not preclude the owner of a residential unit from (i) establishing the initial rental rate of a unit (i.e., starting rent for a new tenancy) or (ii) if the applicable rental unit was issued a certificate of occupancy after February 1, 1995, establishing any subsequent rental rate for such unit (i.e., there can be no limitations on rent increases during the term of a tenancy for such units). Further, Costa‑Hawkins precludes local jurisdictions from subjecting a residential unit to any restrictions on establishing initial or subsequent rental rates for a residential unit if such unit was exempted from such a restriction by any local ordinance in effect on February 1, 1995. The result of the foregoing is that a handful of jurisdictions (including San Francisco and Los Angeles) exclude residential units that received certificates of occupancy as long ago as the late 1970s from their rent control ordinances due to exclusions in their rent control ordinances that existed on February 1, 1995.

Specifically, if adopted, Proposition 21 would:

  • replace the provision of Costa‑Hawkins that currently exempts a residential unit from local restrictions limiting a residential unit owner's right to establish the initial and subsequent rental rates of a unit, if that unit first received a certificate of occupancy after February 1, 1995, with a provision that would allow such exclusion only for a unit that first received a certificate of occupancy within 15 years of the date on which the owner proposes to establish the initial or subsequent rental rate of such unit (resulting in all existing and newly constructed residential units eventually becoming subject to local rent control ordinances due to the rolling nature of the referenced exclusion);
  • mandate that if a local jurisdiction adopts a rent control ordinance, then notwithstanding any more restrictive provision of that ordinance, an owner of a residential unit would be permitted to establish the initial rental rate for a new tenancy of such residential unit, but only if such initial rental rate, together with any increases in such rental rate during the subsequent three years, is not more than 15% greater than the rental rate in effect during the prior tenancy; and
  • eliminate the provision of Costa‑Hawkins that currently has the effect of "grandfathering in" exclusionary provisions of local rent control ordinances that existed on February 1, 1995.

Two Key Takeaways

  1. If Proposition 15 is adopted, the protections of Proposition 13 will no longer apply to most commercial real estate asset classes.
  2. If Proposition 21 is adopted: (i) all residential units will eventually become subject to rent control ordinances if adopted by the applicable local jurisdiction and (ii) limits on starting rent for new residential tenancies will be imposed.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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