Question of the week: What propositions are on the California ballot that impact real estate?
Answer: There are three propositions on the statewide ballot for California that have a direct impact on real estate. Here is a very brief summation of each and my position as to “yes” or “no” on each:
Proposition 15: Dennis says “NO.”
The California Schools and Local Communities Funding Act of 2020
This is proposition will fundamentally change the protections to property owners as established by Proposition 13 in 1978 by creating a “split-roll” whereby commercial property is assessed in a different manner than residential property. Under current law property taxes are established when a property is sold, with the purchase price being the tax basis. Prop 13 eliminated the reassessment of property on a regular basis to new market values to prevent property owners from being taxed out of ownership of their homes and businesses by limiting increases in property taxes to 2% of the assessed value per year. If you purchased a property for $100,000 and the market value increases 3%, your assessed value will only rise to $102,000.
Prop 15 will eliminate the reassessment model for commercial properties and they will be re-assessed based on estimated market value every two years starting in 2023. If a property is a mixed use of residential and commercial the percentage of the property that is commercial will be reassessed under the new rules and the residential will retain the 2% per year cap.
Proponents of Prop 15 are framing this as a tax on corporations—a euphemism for ultra-wealthy organizations and individuals. As is typical in these sorts of matters, and most propositions in my opinion, is either a willful ignoring of consequences or an inability to understand consequences.
This proposition, if passed, will create a tremendous burden for businesses, not just large as are being targeted in marketing and advertising by the pro-Prop 15 advocates, but small and medium size businesses as well. How?
The overwhelming majority of commercial leases in California are “triple-net” leases. In a triple net lease, the tenant pays all the expenses of the property, which besides maintenance and insurance on the building also includes property taxes. If property taxes go up, so too does the rent the tenant is paying. Think of your local neighborhood, think of the buildings you see when you drive to the freeway. On major thoroughfares you will see practically every lot developed for commercial purposes. Be it high-rise or low-rise, store front or strip mall, the vast majority of the tenants are small and medium size businesses. Sole proprietorships are the largest business segment in California, almost 75% of businesses in California, small businesses, those with less than 20 employees, consist of almost 90% of the remaining businesses if sole proprietorships are taken out of the equation.
When the property owner of a strip mall, an office building, a store front, sees the tax basis for their property increase from $750,000 to $2,500,000 million and the state’s portion of the property taxes increase from $7500 per year to $25,000 per year, this increase will be paid by the tenants of that building. The majority of which are small businesses.
What will small businesses do? Pass the costs onto consumers through higher costs for their goods and/or services. If the consumers decide not to pay the costs and take their business elsewhere then the business likely closes down.
The estimate for the additional tax burden to commercial tenants in California due to Prop 15 is between $8-$12.5 billion by 2025. That is $8-$12.5 billion commercial tenants will have to pay to retain their leases. That is $8-$12.5 billion more consumers will have to pay for goods and services for living in California.
Prop 13 is not perfect and can use some modifications, Prop 15 is not a modification but a complete restructure that puts a huge tax burden on small businesses and consumers. On top of other costs that have been added to businesses in California in recent years, this could be the final straw for many barely hanging on.
Funds generated by Prop 15 are slated to go to schools and local governments, which is why we are seeing so many ads that are sponsored by the teacher and public employee unions—who always support tax measures that put more money in public coffers. Remember, in the end all taxes are paid from the private sector, slating the funds for education and public spending puts more and more burdens on the private sector to pay for public spending that has grown without control for the past few decades.
Vote No on Prop 15.
PROPOSITION 19: Dennis says vote “Yes.”
Property Tax Transfers, Exemptions, and Revenue for Wildfire Agencies and Counties Amendment (2020)
Prop 19 is the result of the, deserved, failure of Prop 5 to pass in 2016, for which I endorsed a No vote and was glad it failed. Proposition 19, if passed, will create new exemption, and modify or eliminate some existing exemptions for property transfers.
Currently under Prop 13 parents and grandparents can transfer property they own to their children and grandchildren with either no, or limited, change to the current property tax basis. Currently primary residences can be transferred to the next generation with no change in the tax basis; transfers of vacation homes and business properties can be transferred with an exemption of the first $1 million exempt from reassessment. This clause in Prop 13 has enabled the transfer of billions of dollars, perhaps hundreds of billions, in real estate to be transferred to next generations since 1978 with no change in tax basis for the property.
For instance, your parents have owned the home you were born in since 1985, when they purchased it for $185,000. They are moving to a smaller home in the desert and you work out a transfer whereby you obtain a loan and pay them with the proceeds. The property is worth $800,000. Their tax basis on the property is about $425,000, therefore the property is $4250 for the current year. If you purchased the home on the open market your tax basis would be $800,000 and annual property tax would be $8000. You save $3750 in taxes the first year and more every year moving forward as your maximum assessed value can only be 2% per year from the $425,000 assessed value as opposed to the $800,000 market value.
The recipient of the transfer need not occupy the property for the benefit of the Prop 13 transfer rule to apply. If in the above scenario you convert the home to a rental or second home the exemption applies because it was your parents’ primary residence.
Note that this same transfer can occur through the distribution of assets via a trust if the parents, or grandparents, have passed away and the trust is being settled.
If Prop 19 passes the property transferred to, or inherited by, children or grandchildren will only retain the current exemption for reassessment if the property is used as the recipient’s primary residence, or if the property is a farm. If the property has a value in excess of $1 million of the current taxable value (assessed value). If this is the case there will be an adjustment to the tax basis, but not as much as if it were transferred on the open market.
Another provision in which Prop 19 alters current property tax code is expanding the provisions of Props 60 and 90. Under current rules if homeowner over 55 sells their current residence and purchases a new residence of lower value the homeowner can transfer their current tax base to their new home. The portability of the current tax base is limited as only a few counties in the state allow those otherwise eligible to transfer their current tax base into their county (i.e. homeowner selling Orange County could not transfer tax to new home in Shasta County). As well the current laws allow only a one-time transfer.
Altering Props 60 and 90 were the basis for 2016’s Prop 5. This second bite of the apple sponsored by the California Association of Realtors gets it right. Under the provisions of Prop 19 the carrying of the current tax base for homeowners of 55, those with severe disabilities, and victims of natural disasters anywhere in the state. If the new home is more expensive home than the sale of their current home there will be an adjustment in the assessment to account for the higher value, but it would be less than if the current basis could not be carried to the new property. As well, the one-time transfer increases to the ability to transfer the tax basis three times. This assists those who sold a property due to divorce, or for those widowed after a prior transfer.
I have had some interesting conversations with financial advisors, attorneys and accounts regarding my support for Prop 19 due to the changes in the way generational transfers are subject to changes in tax basis. However, I feel the intent of Proposition 13 in 1978 was to protect homeowners as they aged to be able to retain their homes, not provide next generations with tremendous tax breaks.
It should be noted those in opposition to Prop 19 (such as the LA Times editorial board) label the proposition as a gift to the real estate industry as it will result in more sales, and therefore more commissions. As mentioned above, the inability to see or admit to knowing consequences is endemic to much (most) political discourse. If Prop 19 leads to more property sales, not transfers but sales on the open market, if will also lead to higher tax revenues for the state. Consider the example above whereby your parents transfer the family home to you. If you move in the tax basis remains. However, if you rent the property the tax basis increases. If after discussing it with you spouse or significant other and decide you do not want the property, it is sold and the tax basis goes from $425,000 to $800,000 an increase of $375 per year for the state, and incrementally for the county.
If you parents sell the property and transfer the tax basis to their new property they purchased in Palm Desert for $500,000, under Prop 19 the tax basis is $425,000 plus an incremental adjustment for purchasing a higher priced home resulting in a higher tax basis than under current policy.
It should be noted proceeds generated from increase in tax collection from Prop 19 will be split between a two funds the measure would create, the California Fire Response Fund and County Revenue Protection Fund. The fire response fund would, as stated, provide funds for responding to fires in California. The county revenue protection fund would be used to reimburse counties for revenue losses related to property tax changes.
Vote Yes on Prop 19.
Proposition 21: Dennis says vote “No.”
Local Rent Control Initiative
Prop 21 is meant to replace the Costa-Hawkins Rental Housing Act of 1995 by changing the policies by which local governments can adopt rent control for residential housing.
Under Costa-Hawkins rent control could be enacted except on a) housing that was first occupied after February 1, 1995, and b) housing units that are titled as condos, townhomes, and single-family homes (i.e. single family properties). When a tenant moves out of a rent controlled property the landlord can put the unit on the market at market rates.
If Prop 21 is passed rent control can be enacted by local governments except on a) housing that was first occupied within the past 15 years and b) units owned by natural persons (i.e. not corporations or LLC’s) who own no more than two housing units with separate titles, such as single-family homes, condos, and some duplexes, or subdivided interests such as stock cooperatives and community apartment projects.
Very importantly, if passed Prop 21 will require local governments that enact rent control to allow rental increases of no more than 15% over the first three years following a vacancy. Essentially eliminating the ability for the landlord to adjust a unit to market rent and due to the rate limits for the next three years to possibility of the unit’s rent to increase to market rent.
Rent control only benefit those who are currently renting. This is known by those who craft rent control rules, as evidenced of the cap on future rents written into Prop 19. By deflating the future rents of units and expanding the number of properties that will be subject to rent control, Prop 19 will severely devalue the value of residential investment properties and create disincentives for landlords to maintain properties over a prolonged period.
As costs to maintain properties increase, along with taxes, insurance and other costs, at a much faster rate than rents that will stagnate, rental property owners will have to cut costs to continue to meet fixed costs for mortgages and expenses mentioned above. If they wish to sell their property(s) due to rents covering less of their expenses they will find their property value is negatively impacted as any buyer will have the same expenses, likely higher due to tax basis and mortgage increases, and revenue.
Prop 21, like most rent control policies is short-sighted and garners attention and support due to the emotional appeal guised as “affordable housing,” and having “wealthy landlords” subsidize affordable housing. When in fact areas with rent control have seen greater increases in rents than nearby locales without rent control due to a scarcity of available units. As for “wealthy landlords,” the vast majority of rental housing in California is owned by individuals and couples who subsidize other income with their rentals.
Vote NO on Proposition 21.
Have a question? Ask me!
Spending up, incomes down, in August was the news from the Commerce department. For the fourth month in a row consumer spending rose in August. The 1% month over month increase is at a much lower rate than prior months, since consumer spending is 65-70% of our economy the low growth concerning for the future. The 2.7% drop in income was mostly due to the expiration of the additional $600 jobless stipend. In an interesting twist in economics, data and labeling, those with jobs saw salaries and wages increase in August, but the overall income still dropped.
Savings dipped in August as consumers dipped into their savings account to support their spending, but the overall savings rate of 14.1% is still almost twice as high as it was pre-pandemic. It should be noted that the consumer spending rate is about 4% lower than it was pre-pandemic.
Rates for Friday October 2, 2020: Very little is moving the rate markets as investors have priced in deteriorating economic news, lack of stimulus from Washington before the election, and their forecasts for the future. Propped up by the Fed continuing to purchase mortgages and Treasury debt, rate markets continue to be very stable and the outlook is more of the same. For those asking, “will rates go lower?” the answer is pointing to “Don’t count on it” from myself, and my Magic 8-Ball.
Please note rates are for purchase transactions, refinance rates are higher, please call for quotes to meet your situation.
FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:
30 year conforming 2.75% Flat
30 year high-balance conforming 3.00% Flat
Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.
For those who have paid very close attention over the years you know that since we just celebrated our oldest daughter’s 21st birthday a few weeks ago it must mean that Stratis Financial has also turned 21, which happened on Tuesday.
Twenty-one years of helping thousands of families become homeowners and manage their primary debt obligations through tactical refinancing. Twenty-one years of having great business partners with the lenders we work with to ensure quality service and products for our clients. Twenty-one years of tremendous support for our referral-based business from past clients and professionals in the real estate, accounting, legal, financial services and other industries.
Most importantly, twenty-one years of working with the best professionals in the mortgage industry who provide tremendous experience, wisdom, skills and integrity to our company every day to ensure our clients receive excellent service and products. Plus, they are all great people that enjoy being together! The hardest part of the pandemic has not been working from home almost every day, but not being able to see the great crew in the office on a daily basis.
Thank you to everyone who has enabled Stratis Financial to have twenty-one wonderful years!
Have a great week,
Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog