One does not simply stumble into commercial investment. Well, not until Prop 13 descended on Los Angeles, anyway. Pick any collection of commercial properties at random, and you’ll find at least one building that hasn’t hit the market in decades. You’d be tempted to think this was some sort of appreciation strategy floated by a savvy investor. But what we see more often in real estate investment firms when consulting with these unwitting owners is that they fear a sale would trigger a tax bill they wouldn’t be prepared to pay. This is what’s left in Prop 13’s wake: a trail of small-time commercial landlords who mistakenly became long-term investors.
How Prop 13 Turned Owners Into Investors (Whether They Liked It or Not)
Proposition 13 isn’t exactly breaking news. After passing in 1978, Prop 13 capped property tax at 1% of its assessed value while limiting annual assessment increases to 2%, regardless of how much the market value surged. However, there’s a very important caveat to note about Prop 13. A property is only reassessed at the current market value when it changes hands.
Therefore, a family that purchased an Echo Park retail property for $200K in 1983 could very well still be paying tax on an assessment similar to its original assessed value, even if the building itself is worth millions by today’s standard. However, if that family chose to sell, or even to get creative with some ownership restructuring, the clock would reset, and that tax bill would grow exponentially in a moment.
That’s why it’s not unusual for commercial buildings to remain under the same ownership for decades, even half of a century. But a lot of these owners are reluctant investors who have never spoken with any real estate investment firms. They just got in the door when prices were low and are now marooned with their commercial properties, frozen by a looming tax bill that springs like a trap the moment they try to sell. To be clear, many of these owners never dreamed of being long-term investors. This isn’t some masterful approach to appreciation. Rather, they feel stuck and frustrated.
The Added Complexities of Proposition 19
Things became further complicated for mom-and-pop landlords when Proposition 19 passed in 2020. Prop 19 places limits on parent-to-child and even grandparent-to-grandchild property tax reassessment exclusions for transference of personal residences. But it also completely eliminates those same exclusions for commercial and non-residential properties.
Prior to Prop 19’s passage, a family could transfer up to $1 million of assessed value in commercial property to their children without triggering a reassessment. In the wake of Prop 19, commercial and industrial properties are reassessed immediately upon transference to children, regardless of whether this is through an inheritance, gift, or sale. And unprepared landlords who aren’t consulting with real estate investment firms may be too daunted by the combined one-two-punch of Prop 13 and Prop 19 to take any constructive action.
The Guidance of Real Estate Investment Firms Can Help
Obviously, this can create a perplexing dynamic for those who just stumbled into the life of an investor. Rent rolls don’t exactly proclaim a building’s low tax basis. However, this is precisely what dictates whether an owner can afford to sell a building, not to mention what a new buyer’s costs will look like once the escrow actually closes. Without the guidance of seasoned real estate investment firms, small owners often do themselves a disservice, holding onto an investment longer than sensible strictly out of fear of a looming tax.
This response in itself can throw a wrench into the gears of a commercial market. For one, fewer listings are hitting the market. Pricing doesn’t accurately reflect the current market. But it also generates more off-market opportunities for those buyers savvy enough to develop authentic relationships within a community.
The best real estate investment firms recognize the method behind the madness. These brokerages tailor their real estate investment services around the knowledge that mom-and-pop landlords may have wandered into their decades-long investments, glued to it by the combined tenacity of Prop 13 and Prop 19. But these real estate investment companies also understand how to negotiate fair deals, even under Prop 13’s and Prop 19’s restrictions.
This post is for general informational purposes and isn’t tax or legal advice. Property owners should consult a qualified CPA or attorney about their specific situation.
