For many years California was one of the darlings of real estate investment. With its significant population and industrial growth over the past 50 years and its fine climate, real estate proved to be an excellent investment in the state.
However, large numbers of investors who have invested in California real estate have recently been exiting the California market in favor of investing in other states. Because property values in the state rose at a much faster rate than either incomes or rents, capitalization rates have fallen and cash flow is poor compared to most other states.
But what pushed many investors over the edge to sell their California real estate have been the state and local legislative efforts to raise property taxes, restrict how properties are utilized and enact protections of tenants at the expense of their landlords, the investors. Some of these initiatives are on the ballot for the November 2020 elections and are expected to pass. Let us examine some of the state’s more significant initiatives both on the ballot and those already passed.
CA Prop 21– Local Residential Rent Control Initiative
This proposition allows local governments to establish rent control on residential properties over 15 years old. It repeals the Costa-Hawkins Rental Housing Act, passed in 1995, that enabled rents to be reset to the market rate upon vacancy in rent-controlled municipalities.
The ability to set rents based on market conditions is fundamental to achieving acceptable investment returns. Taking away this freedom if Prop 21 passes (as expected) will have a significant impact on owners of apartments and on owners of three or more single-family homes or condos, as both cash flow and property values will be adversely affected.
Ironically, the state stands to lose tens of millions of dollars under Prop 21. Forcing rents to lower also lowers the market value of the properties since their value is determined by the income they produce. Since taxes depend on property values, property tax receipts will fall.
There are still a few exemptions built into Prop. 21. For example, cities still wouldn’t be able to cap rent increases by “mom-and-pop landlords,” who own no more than two small properties such as single-family homes or condos.
Assembly Bill 1482 – The California Tenant Protection Act of 2019
AB 1482, already enacted on January 21, 2020, and in effect for ten years, limits annual rent increases to no more than 5% + the local consumer price index (roughly, the inflation rate), or 10% whichever is lower. It also requires a landlord to have a “just cause” in order to terminate a tenancy. As to what constitutes “just cause” is not clearly spelled out, and landlords are now open to litigation from tenants who disagree with why their tenancy was terminated. It may make it more difficult to get rid of a problem tenant.
AB 3088 – The Tenant, Homeowner, and Small Landlord Relief and Stabilization Act of 2020
In September 2020. President Trump mandated a federal eviction moratorium effective through Dec. 31, 2020, subject to tenants meeting five requirements proving hardship related to COVID. In California, Governor Newsom signed into law Assembly Bill 3088, which extends the eviction moratorium through January 31, 2021, beyond the federal mandate.
Under AB 3088, a COVID-19-impacted tenant will be responsible for at least 25% of the rents due for that period in order to receive such eviction protection. The Act doesn’t waive unpaid rent but instead converts that amount to consumer debt, collectible in small claims court as of March 1, 2021. Further, to the extent a COVID-19-impacted tenant is not able to meet that 25% minimum, AB 3088 would provide eviction protection only until February 1, 2021. Importantly, a landlord who resorts to extrajudicial self-help, such as shutting off utilities, to force a tenant to vacate will be liable for new penalties of $1,000 to $2,500.
AB 3088 replaces AB 1436, which would have granted tenants the legal right to withhold their unpaid rent until April 1, 2021.
CA Prop 15 – Changes (Raises) Tax Assessments on Commercial and Industrial Property in California
Proposition 15 would repeal part of Prop. 13 and require reassessment to market value of business properties. It would raise taxes on supermarkets, shopping malls, office buildings, factories, movie theaters, hotels, restaurants, sports stadiums, warehouses, self-storage facilities, major retailers, and other businesses.
For investors, this tax increase will significantly raise their operating expenses. Even the smallest businesses that lease space will face higher rents or will have to pay the higher property taxes as part of their “triple net” lease agreement. Those higher costs will be passed on to consumers. Proposition 15 would raise prices, increase the cost of living, and put thousands of jobs at risk as companies cut back on commercial space or leave the state. The net effect is that investment returns on commercial real estate in California will be further impaired.
CA Prop 19 – Changes Certain Residential Property Tax Rules
While there are provisions in this proposition that may benefit some homeowners over the age of 55, it would eliminate provisions that allow parents to transfer ownership of family homes without tax consequences to their children who use the residences as rental properties. It eliminates Prop 58, the 1986 measure that allows parents to transfer a home and other limited property to their children without the property being reassessed to market value. Thus under Prop 19, children taking ownership of the family home would receive a new property tax bill for 1% of the property’s current market value, instead of keeping the lower tax rate afforded them under Prop 13, passed in 1978. This would hurt keeping the family home as a rental, as it would substantially raise property taxes.
Various laws – Restriction on Short Term Rentals (e.g. Airbnb)
Many municipalities in California, such as Los Angeles, have stopped or restricted short-term rental companies such as Airbnb from renting vacation rentals for less than 30 days at a time, or not allowing properties to be used as an Airbnb unless the unit is the owner’s primary residence and they register with the city. While the laws vary throughout the state, clearly there is momentum to restrict an investor’s use of a property as an investment.
There Is a Pattern Here
There is a confluence of two events that have created turbulence in the legislative landscape: COVID-19 and the elections of November 2020. Some argue that the new laws are needed to protect the most vulnerable: the tenants. Others argue that the laws are being enacted to garner votes. Clearly, the government of California is committed to enacting laws that favor tenants over landlords and raise property taxes.
Our purpose here is not to judge or take a political stand, but observe the pattern: from a real estate investor’s point of view, the investment landscape is not as it was, and California investment real estate has become less attractive, hence the exodus of investors out of California to invest in other states. As we are observing this trend now, it is our belief that this trend will accelerate after the November elections.
At Meridian Pacific Properties, we have continuously assessed the investment landscape and sought investment locales that are excellent for investment. We are pleased that the states of Tennessee and Mississippi have remained investor-friendly, philosophically taking the position that all of us as individuals must take responsibility for our own lives while being empathetic to the effects of the pandemic.
These two states, and the Memphis region (which includes northern Mississippi) in particular, offer an excellent blend of strong capitalization rates, favorable tax rates, and more freedom for investors to freely manage their properties with relatively few government restrictions. Their state governments have chosen to interfere as little as possible with legislating how investors manage their real estate investments.
If you would like to learn more or have any questions, we’d love to hear from you. Please contact us at any time.