Californiaʼs Assault on the Commercial Real Estate Industry

A long-time commercial California real estate broker told the Globe he recently sold a California property for a client, but the client wanted to exchange into other properties, but with conditions:

1. Not inCalifornia.

2. Not a property with anything Amazon could provide.

The problem was solved when the broker helped the client buy three dental buildings in Reno, NV, and an apartment building in Carson City, NV.

The broker said he needed to invest in a moving company which specializes in moving items out of California.

This same broker passed along a thoughtful article by Joseph J. Ori, Executive Managing Director of the Paramount Capital Corp., a Commercial Real Estate Advisory firm, in which Ori addresses anti-real estate and business legislation in California, which over the last three years, has accelerated a myriad of anti-business laws and regulations.

“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,” Ori wrote. “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.”

The Hoover Institution’s Lee Ohanian echoed Joseph Ori’s sentiments this week. “California businesses are leaving the state in droves. In just 2018 and 2019—economic boom years—765 commercial facilities left California. This exodus doesn’t count Charles Schwab’s announcement to leave San Francisco next year. Nor does it include the 13,000 estimated businesses to have left between 2009 and 2016, Ohanian said. “The reason? Economics, plain and simple. California is too expensive, and its taxes and regulations are too high.”

If that isn’t enough, the San Francisco Business Journal interviewed one of California Globe’s business subjects, longtime Sacramento, California developer Paul Petrovich, who “says he is among the 30,400 wealthy Californians who will have to pay California’s wealth tax if it’s approved — so he’s moving to Austin.” Petrovich said “he will move both his residence and company, Petrovich Development Co., over the next two years, or as soon as he’s able to sell his holdings in Northern California and re-establish the company’s headquarters in the Texas capital.”

Fees, Tax Increases, Regulations, Rent Control

Ori reports in 2019, 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.”

“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.”

Ori also addressed that 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.”

California Globe reported on the non-partisan Legislative Analyst’s Office study which found a statewide rent control proposition would cost cities tens of millions in revenues. The LAO study found that, if Prop. 21 is passed, cities would receive less in overall property taxes due to a decline in rental property tax payments. The huge drop in revenue would lead to close to $100 million in lost state and local revenue per year. The LAO also found that many landlords would sell rentals as a result, leading to a reduction units, most notably, affordable units, in favor of houses and buildings going on the market.

Ori warns that the November 3, 2020 ballot will include a new rent control initiative which will further tighten the 2019 rent control laws by replacing the 1995 Costa-Hawkins Rental Housing Act, and allow local governments to adopt rent control on housing 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.”

Bye Bye California

Ohanian also writes about Paul Petrovich leaving California: “If you live near Sacramento, chances are your life has been made easier by Paul. He is a major commercial real estate developer whose projects include facilities involving Costco, Target, Walmart, McDonalds, Wells Fargo, and Verizon, among other major firms. But Petrovich has announced he will soon be leaving. For . . . drumroll please . . . Texas.”

Petrovich said he is leaving California for Austin, Texas because of the proposed wealth tax. As California Globe reported, Oakland Assemblyman Rob Bonta (D) announced his legislation to tax the state’s wealthiest job creators and innovators – the billionaires living and working in California. This first-in-the-nation net worth tax is estimated to generate $7.5 billion per year in new “revenues” to the state coffers.

Petrovich, a lifelong California resident, also noted the recently approved cap on rent growth for apartments, the split-roll measure on the November ballot removing commercial property from Prop. 13 protection on property-tax increases, a bill that would raise the state’s top income tax rate from 13.3% to 16.8% (AB 1253) and an idea pushed by public-employee unions to place a tax on unrealized capital gains, the San Francisco Business Journal reported. “I first started to put up my antenna on the split-tax roll and it moved higher in the air when the income tax came into focus, and finally with the wealth tax, I told my wife, ‘We gotta go,’” Petrovich said.

Ori also warned of the split-roll ballot initiative on the November ballot: “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.”

But Wait! There’s More!

The November ballot will also include the city of San Francisco “Overpaid Executives Tax.”

Ori added, “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.”

“An important and often overlooked factor is that politicians now have personal agendas that they aim to impose on other Californians, often without transparency or accountability,” Ohanian said. “This is what is going on now with Petrovich, and is what is going on with AB 5, the new law that prevents many Californians from working as independent contractors that began on January 1.  Voters must begin to hold politicians accountable for this if California is ever able to reform.”