California’s Assault on the CRE Industry

The once-great state of California has become a minefield for commercial real estate investment and development and things will be getting worse, not better. The assault on real estate in California has been occurring for years but has been done under the radar with small anti-real estate changes here and there that overall, had little effect on the industry. However, anti-real estate and business legislation hit overdrive about three years ago and has accelerated with a myriad of new laws and regulations. During the last two years, the following legislative actions have been enacted or are on the 2020 ballot in California that will negatively affect the CRE industry.

2019

1. The city of San Francisco raised the property development fee to $69.60 per square foot from $28.57 per square foot or a 143% increase. With the high costs of land, union labor and other exorbitant costs, it now costs about $1,400 per square foot to construct a new hi-rise office building in downtown San Francisco.

2. The city of San Francisco enacted the “Community Opportunity to Purchase Act,” which provides that any owner of three or more residential units that is seeking to sell the property, must first offer it to a group of city endorsed non-profit entities, who will have a right of first offer to acquire the property. If the seller refuses their offer and sells the property to someone else, the same non-profits will then have a chance to match the sales price for the property. 

3. The state of California enacted a new state-wide rent control law even though voters in 2018, rejected the repeal of the Costa- Hawkins Rental Housing Act, which was established in 1995 that limits rent control in the state. The new rental control law allows for maximum annual rent increases at the consumer price index plus 5% and properties less than 15 years old are exempt from these rent control provisions.

2020

1. The November ballot in California will include a new rent control initiative titled, “The California Local Rent Control Initiative.” This new Initiative will further tighten the 2019 rent control laws per above by doing the following: replace the 1995 Costa-Hawkins Rental Housing Act, which as discussed above was on the ballot in 2018 and defeated, and allow local governments to adopt rent control on housing units except for (a) housing that is 15 years or newer and (b) single-family homes, condominiums and duplexes unless a person owns more than two units. It will also allow landlords to increase rental rates by only 15% during the first three years following a vacancy, compared to the current law of going to a market rent upon vacancy.

2. The November ballot in California will include a proposition titled, “The California Schools and Local Communities Funding Act of 2020.” This draconian act will seek to amend Proposition 13, which was enacted in 1978 and caps real estate taxes on all residential and commercial property to 1% of value upon sale and annual increases limited to 2%. If approved in November, the amendment will allow for the reassessment of commercial and industrial properties every three years at market value beginning on 1/1/22. This provision will increase office building costs by about 20% due to higher real estate tax charges.

3. The November ballot in California will also include in the city of San Francisco an “Overpaid Executives Tax.” This tax will be levied on businesses with at least $1.7 million in gross revenues and executives who make at least $2.7 million, including wages, salaries, bonuses, commissions, options, etc. If approved, a tax between 0.1%-0.6% would be tacked on to the annual business tax payment of companies in San Francisco that compensate their executives at a rate 100 times greater than their median employee. The tax rate starts at 0.1% for a 100:1 ratio, then increases to 0.2% for a 200:1 ratio and so on, up to 0.6% for a six-hundred-fold pay disparity between executives and employees.

In addition to the above, there have been a myriad of local tax increases on corporations including a homeless tax in San Francisco and a head tax in Mountain View. CA. The above propositions and proposed rules may not be approved at the ballot box, but as seen with rent control, the legislature will just come back the next year and enact its own new law. These types of anti-real estate and business laws are being pushed by the Democrat denominated legislature to get votes and keep their supermajority in the state. These rules if enacted will have a devastating effect on all facets of CRE investment, development and management and will lead to lower values, higher cap rates, less capital for investment and development and a continued exodus of individuals and companies out of California.

California is becoming very inhospitable to the CRE industry and business in general and with these and other anti-real estate laws, it may be time for investors to demand substantially higher cap rates or decline to invest in California real estate altogether.

Joseph J. Ori is executive managing director of the Paramount Capital Corp., a Commercial Real Estate Advisory firm.