Game-changing Propostition Threatens Tenants

As a tenant occupying industrial space, it is important for you to know about a looming threat to increase the property taxes passed through to you by your landlord. Necessary signatures have been obtained for a proposition to be placed on the 2020 General Election ballot that would split the property tax rolls and remove Proposition 13 protection for commercial properties.

Since 1978, the base levy for all real properties has been set at 1% of the acquisition price of the property, plus existing and future municipal assessments. The base levy cannot be increased by more than 2% each year. The so-called California Schools and Local Funding Act, would leave residential property and agricultural land under Prop 13 protection, but would allow for the annual reassessment of commercial property to full cash value for tax purposes. This would effectively eliminate the 2% annual cap on the base tax levy and expose taxpayers to large annual property tax increases.

Your lease most likely obligates you to pay all or a portion of the property taxes on the space you occupy. If you are on a net lease, you pay all the property taxes due during the term of your lease. If you signed an industrial gross lease, the property taxes for the “base” year (usually the first year of the lease) are included in your rental rate, and annual increases thereafter are passed through to you, either through a direct billing from your landlord in the case of freestanding buildings, or via an increase in your CAM charge (common area maintenance) that you pay along with your rent if you are in a business park.

The amount you pay for property tax is determined by what your landlord paid for the property. If he acquired it in the 1990’s when prices were low, chances are that your taxes are a fraction of what they would be if the property were acquired in the last year or two, when prices hit all-time highs. In fact, a typical 10,000-square-foot industrial building acquired in 1995 for $650,000 is probably worth $2,250,000 or more today.

Under the proposed law, that property could be immediately reassessed to its current value and the base levy would be increase to 1% of $2,250,000, more than doubling (after compounding 2% increases to the original base levy for 22 years) to almost 19 cents per square foot per month in a single year. That entire cost would be passed on to you unless you negotiated some additional protection against tax increases before signing your lease. But, with supply so tight and vacancy so low, few landlords are inclined to grant such a concession. If he did agree to pick up that increase of approximately $13,200 per year, it would reduce the value of the property by $264,000 at today’s market capitalization rate of 5%. If you were the landlord, you would probably dig your heels in on this one, too.

So, what does this mean to you going forward? It means you will be paying more for your next building unless property values head down, or the balance between supply and demand swings back in the favor of tenants and landlords are forced to lower lease rates or share the increase in taxes. However, even if the market does go through a correction and the vacancy rate tripled, it would still be in the 6% range. That’s how tight things really are today.

We have read the law and it is clear to us that the authors lack knowledge in terms of how the commercial property market works. Their intention was to stick it to wealthy property owners who they feel are taking advantage of a loophole by following a law that has been around for 41 years. The unintended consequences of their naivte could be disastrous to the industry, but we think it will pass anyway because the law is expected to generate upwards of $11 billion per year in additional revenue to schools and local governments. That means every school district, public employee union and local government will using its lobbying muscle to get the proposition passed. The opposition will come from commercial property owners and property services industries, which lacks the cohesiveness to mount substantial opposition. The vast majority of voters don’t own commercial property and are likely to vote in favor of raising additional revenue that won’t cost them a dime.

The issue is just now coming up on the media radar. We are doing our best to learn more and will pass information along to you as we get it. In the meantime, please contact us if you have any questions.

Joel Hutak  714.564.7169  jhutak@lee-associates.com  DRE# 01411356   http://www.linkedin.com/in/joel-hutak-6b2b933/

Joel Hutak

714.564.7169

jhutak@lee-associates.com

DRE# 01411356

http://www.linkedin.com/in/joel-hutak-6b2b933/

Phillip DeRousse  714.564.7141  pderousse@lee-associates.com  DRE# 01933061   https://www.linkedin.com/in/pderousse

Phillip DeRousse

714.564.7141

pderousse@lee-associates.com

DRE# 01933061

https://www.linkedin.com/in/pderousse

Game-changing Proposition Threatens Owner/User Property Values

As an owner/user, it is important for you to learn about a looming threat to industrial property values that we will all be voting on in the 2020 General Election. Necessary signatures have been obtained to vote on a proposition that would split the property tax rolls and remove Proposition 13 protection for commercial properties. This is the first serious threat to our current property tax system since 1978.

The so-called California Schools and Local Funding Act, would leave residential property and agricultural land under Prop 13 protection in place, but would allow for the annual reassessment of commercial property to full cash value for tax purposes. This would effectively eliminate the 2% annual cap on the base tax levy and expose taxpayers to large annual property tax increases.

If you have structured your industrial property ownership like most owner/users, you own your building personally and lease it back to your company. One of the key advantages of this structure is that you decide how the costs and income are allocated between you and your company. If you want more income on the personal side to accelerate the pay-down on your mortgage, you can raise the rent on your company. If you want to reduce your personal cash flow for tax reasons, you can lower the rent on the company and free up that cash to finance growth initiatives like hiring new employees or investing in new equipment. The choices are yours because you wear both hats, and that has been a key demand driver for industrial properties for decades.

But this proposition, which we believe will pass, is a game changer for owner/users. In an arm’s length investor scenario, the owner leases to an unrelated third party and passes the property tax burden on to the tenant in addition to rent payments. Investors with leases in place at the time the law passes will be insulated from paying higher taxes, at least until those leases expire and new leases are negotiated. Since you are both owner and tenant, that cost would fall to you and either drive up the operating cost for your business or reduce your personal cash flow.

Occupancy cost control is one of the main reasons the owner/user structure has become so popular. Business owners can borrow at low fixed interest rates for up to 25 years and Prop 13 tax rules fix property tax increases to just 2% each year. Interest rates are already on the rise and if property taxes increase sharply, the occupancy cost equation will be significantly impacted. This could reduce the demand for owner/user properties and precipitate an increase in supply of product at the same time, as more risk-averse owner/users decide to exit their investments. That double-whammy would put heavy downward pressure on property values, which are currently at an all-time high.

Those who own highly appreciated assets currently protected under Prop 13 rules will be hit the hardest and the fastest. The proposed law allows for the immediate reassessment of all commercial property. So, if you paid $750,000 for your building back in the 1990’s that is now worth over $2,250,000 today, your new base levy would rise to 1% of $2,250,000, or nearly triple what you currently pay. Not good.

Why do we think this proposition will pass? That’s an easy one. With $11 billion per year in extra tax revenue to schools and local governments up for grabs, you can count on every school district, public employee union and city government to back it with the full force of their combined lobbying power. Those opposed will be commercial property owners like you that have no common voice. Since the vast majority of voters are not commercial property owners, they are likely to vote for an increase in funding for good causes that won’t cost them a dime.

There is much more to discuss in terms of the impact of this proposed law. We will be sending regular updates as we learn more. In the meantime, it may be a good idea to take a fresh look at your investment strategy. We are just a phone call away to assist you in that effort.

Joel Hutak  714.564.7169  jhutak@lee-associates.com  DRE# 01411356   http://www.linkedin.com/in/joel-hutak-6b2b933/

Joel Hutak

714.564.7169

jhutak@lee-associates.com

DRE# 01411356

http://www.linkedin.com/in/joel-hutak-6b2b933/

Phillip DeRousse  714.564.7141  pderousse@lee-associates.com  DRE# 01933061   https://www.linkedin.com/in/pderousse

Phillip DeRousse

714.564.7141

pderousse@lee-associates.com

DRE# 01933061

https://www.linkedin.com/in/pderousse

Split Tax Roll Proposition Coming Your Way

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The so-called California Schools and Local Communities Funding Act, if California voters pass it in 2020’s General Election, would be a game-changer for Commercial Property owners. Tax rules for residential and agricultural property would remain in place, but the property tax rolls would be ‘split’ and properties designated for commercial use would no longer enjoy the protection of Proposition 13. Industrial, retail and office properties are specifically identified, but other types of commercial property like hotels and recreational properties are expected to fall within the new law’s shadow. Under the proposed law, commercial property could be reassessed every three years at a minimum, which means taxing authorities could simply not reassess for up to three years when market values are falling. We have read the law as proposed and it contains no mechanism for a property tax appeal process that is part of current law. The proposal makes a meager attempt to appear friendly to small business by exempting property owners who own less than $2 million worth of commercial property and whose businesses occupy the majority of the space in a property they own. The text of the law makes no reference to small third-party investors who own commercial property under the $2 million threshold. This is disingenuous at best, given the fact that 95% or more of commercial properties already have a value in excess of $2 million. The promoters of the proposition are using the well-worn mantra of “sticking it to the rich” who use loopholes to avoid paying their fair share. So, how will this impact the commercial real estate market? To be sure, almost every owner and occupier of a commercial property will be paying more. Long term owners, the group that enjoys the protection of Proposition 13 the most, will get slammed, as the proposed law would allow taxing authorities to immediately reassess their property to its current market value. That could double, triple or even quadruple the tax bill for these property owners in a single tax year. Tenants on net leases requiring them to pay all real property taxes, and tenants on gross leases that pass through tax increases to them over a base year, will all take a hit. Property values would likely fall immediately, especially for those investors and owner/users who pay their own property taxes as an operating expense, which reduces Net Operating Income, the amount capitalized to determine a property’s value. In those cases, every $1 in additional property tax decreases the value of that property by $20 at a current market cap rate of 5%. We will be following this issue very closely going forward and we will make sure to keep you informed.

Joel Hutak  714.564.7169  jhutak@lee-associates.com  DRE# 01411356   http://www.linkedin.com/in/joel-hutak-6b2b933/

Joel Hutak

714.564.7169

jhutak@lee-associates.com

DRE# 01411356

http://www.linkedin.com/in/joel-hutak-6b2b933/

Phillip DeRousse  714.564.7141  pderousse@lee-associates.com  DRE# 01933061   https://www.linkedin.com/in/pderousse

Phillip DeRousse

714.564.7141

pderousse@lee-associates.com

DRE# 01933061

https://www.linkedin.com/in/pderousse

Why Are Sale-Leasebacks Trending?

As the local industrial real estate market continues to march along in what feels like zero percent vacancy, it’s actually 1.5% to 3.0% depending on which report you read and to what size range that report is geared, we are beginning to see a trend among owner-occupied buildings. Something we haven’t seen since mid-2000s, can anyone guess?

Sale-leasebacks.

If you have owned a building for 15 years, or have purchased in the last 5 years, you likely have a substantial amount of equity in your building. A tool to access that equity, short of selling the building and moving to another location – which can be costly and time consuming – is a sale-leaseback. You sell the building to an investor and remain in place as a tenant. The equity that was tied up in your building can now be used to grow your business, have a cash reserve for a rainy day, or buy a bigger boat than your neighbors.

Here’s the process:
• Step 1: Ask us what the current market monthly NNN lease rate is on your building
• Step 2: Multiple the NNN lease rate by 12 months for your annualized income
• Step 3: Divide by 5.5% (Current Cap Rates)

Example:
A 20,000-square-foot building that rents for $.80 NNN

20,000 sf x $.80 psf nnn = $16,000/mn x 12 months = $192,000 annualized income. Divide $192,000 by .055 (5.5% cap rate) = $3,490,909.00 ($175 psf)

The primary reason the sale-leaseback process now works is driven by two factors:
1. Low interest rates (search for higher returns than you would get at the bank has driven cap rates down into the 5% range)
2. Increase in lease rates

If you would like to discuss sale-leasebacks in more detail or would like to know current lease rates, please do not hesitate to contact us. We would appreciate the opportunity help out.

9/1/2016Current RateChange Since 6/1/163 Yr. Treasury.91-15%5 Yr. Treasury1.18-15.2%7 Yr. Treasury1.44-13.8%10 Yr. Treasury1.57-15.2%

For more information about the Industrial Real Estate Market in the Orange County, Los Angeles County & Surrounding Areas, give us a call:

Joel Hutak
Principal
714-564-7169

Philip DeRousse
Associate
714-564-7141

When There are No More Fish in the Fish Market…Go Fishing!

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Joel Hutak and Phillip DeRousse had a requirement they needed to fulfill for one of their local, trusted clients. The client was looking to purchase an industrial building under 10,000 SF in the North Santa Fe Springs market.

At the time, there were no matching properties on the market; this is a very common problem in 2017, being that vacancy levels are below 1% in Santa Fe Springs.

A common response given to a client looking to purchase a building like this would be, “We will let you know when something comes up that matches your needs.”

Joel and Phillip used their passion for fishing the waters of the Pacific Ocean, relating it to their CRE expertise on the ground, and they went fishing!

Cold calling multiple building owners in a specific size range in a specific part of the city resulted in a property where the seller and potential buyer had aligned interests. Hookup!!!

“We were able to agree on a solid number for the property where the seller and buyer were both excited about the transaction,” said Joel.

In this case, time was not of the essence to “get the fish over the rail,” so a longer than normal escrow was agreed upon to eat up some time attached to the pre-payment penalty that the Seller was going to have to endure.

This wasn’t the easiest of battles on or off the water. The property had a lease in place with a tenant that initially expired more than six months out. In addition, the tenant had an Option to Purchase the Property.

In today’s age, most people would think there are too many snags and snares in the transaction and move on.

With a fisherman’s persistence and patience, Joel and Phillip assisted the Seller in navigating through these obstacles. After negotiations, the tenant waived the option to purchase the property, and in turn, the seller and tenant agreed to advance the lease expiration date by four months.

This was a plus for the seller, tenant, and buyer. This was an off-market sales transaction completed by the Mid Counties Industrial Team of Lee & Associates Orange of the property at 11945 Rivera Road, a 6,792 square-foot industrial building in the city of Santa Fe Springs, California.

For more information about the Industrial Real Estate Market in the Orange County, Los Angeles County & Surrounding Areas, give us a call:

Joel Hutak
Principal
714-564-7169

Philip DeRousse
Principal
714-564-7141

Be Prepared for “You Better Jump On This One”

I have heard business owners say, “I’ve moved my business before, It won’t cost that much or take that much time to sell, I know what I am doing.”

The industrial real estate brokerage community at large has been saying, quarter after quarter after quarter, that the “market is tight.” “It’s one percent vacancy.” “Rents are going up,” etc,. Although this is true, the noise has been the same for so long now that it seems to have turned into white noise. It has taken tenants and buyers losing out on one or more building opportunities to realize that we’re being honest when we say, “You Better Jump On This One.”


Before the jump, remember that preparation is the key to success when it comes to the rapid sale of commercial real estate. There are several reports to help you stay ahead of the game.

Necessary Paperwork

  • ALTA surveys

  • as-built drawings

  • Phase 1 and 2 environmental assessments

  • property condition reports

  • zoning reports

  • insurance studies

  • tenant lease files

  • income/expense reports

  • appraisal

  • earning potential statements

  • financial details

  • surveys

  • loan documents

Check Title

  • obtain a preliminary title report

  • pay or dispute any overdue taxes or liens

  • search for any pending lawsuits (extremely time-consuming)

  • research for covenants, conditions, restrictions, or other ongoing obligations

  • investigate for a discrepancy in ownership

Taxes

  • plan for and structure a 1031 tax-deferred exchange if the seller intends on

  • selling the property as part of this type of transfer

  • check if all members or indirect owners agree to this proposal

  • possibly restructure ownership before sale

Property Preparation

  • interior cleaning

  • exterior cleaning

  • landscaping

  • parking area repair

  • window cleaning

  • roof report and/or repair, if necessary

  • specific small improvements, if needed

  • HVAC inspection and report

Real Estate Agent

Property owners may choose to sell their property themselves, however here a few reasons why licensed professionals, such as Hutak & DeRousse can be of service to you in your area.

  • Access to appraisals of similar properties

  • Comparable sales

  • Marketing tools & Materials that produce a Sale

  • Multiple Listing Services

  • Maximize Exposure to Buyers

  • Evaluating Legal Disclosures, Contract Negotiations, and Escrow

  • Management

  • Local Market Experts and Off Market Properties

Hutak & DeRousse, a Lee & Associates Team, have real solutions to all of your property needs.