2020 has been a volatile year for commercial real estate investors. And with the election around the corner, many investors are concerned about how they will be impacted by proposed legislative changes. For those facing such uncertainty, we have outlined four legislative trends that could impact California CRE investors:

California Legislation, Prop 15:

California Proposition 15, also known as the Tax on Commercial Industrial Properties for Education and Local Government Funding Initiative, proposes that commercial and industrial properties, except those zoned as commercial agriculture, be taxed based on their market value rather than their purchase price. The proposition would require that every affected property be reassessed based on the market value at least once every three years. However, the proposition does include exemptions:  residential properties, agricultural land, and owners of commercial and industrial properties with a combined value of $3 million or less.

• Prop 15: Impact on CRE Investors: Higher property taxes on California real estate. Qualified landlords could expect their taxes to increase every three years, according to their assessed market value. 

• Prop 15: Fiscal Impact: Increased property taxes would provide an estimated $6.5 to $11.5 billion in new funding, directed toward local governments and schools.

California Legislation, Prop 21

The Local Rent Control Initiative, or California Proposition 21, “expands local governments’ authority to enact rent control on residential property,” specifically on “housing that was first occupied over 15 years ago.” However, those “who own no more than two homes with distinct titles of subdivided interests” would be exempt; in summary, mom-and-pop landlords would be exempt. 

• Prop 21: Impact on CRE Investors: Landlords who own more than two small properties (single-family homes or condos) would be limited on how much they could increase rent for their tenants. If passed, landlords would be limited to increasing rent no more than 5 percent plus inflation per year, or 10 percent, whichever is lower.
• Prop 21: Fiscal Impact: Unlike Prop 15, Prop 21 would actually reduce state and local revenues by tens of millions of dollars annually. A push for more affordable housing could potentially harm the housing market. Landlord’s inability to recap their expenses would reduce their initiative to maintain and upgrade their properties. 

Biden’s Proposal to Eliminate the 1031 Tax Deferral Program:

Right now, Internal Revenue Code Section 1031 permits investors to defer paying capital gains taxes when they trade from one investment property into a “like-kind property.” However, Democratic Presidential Nominee, Joe Biden, has suggested that he would work to eliminate the 1031 tax deferral program under his administration. Capital gains taxes paid upon eliminating 1031 exchanges would go towards The Biden Plan for Mobilizing American Talent and Heart to Create a 21st Century Caregiving and Education Workforce. According to the Biden campaign, the plan “will cost $775 billion over 10 years and will be paid for by rolling back unproductive and unequal tax breaks for real estate investors with incomes over $400,000 and taking steps to increase tax compliance for high-income earners.”

• 1031 Elimination: Impact on CRE Investors: Upon every sale of real estate, investors with incomes exceeding $400k would be required to pay capital gains taxes. There would be no more tax-deferral option when investors trade up from one investment property to another. 
• 1031 Elimination: Fiscal Impact: According to research, “The elimination of real estate exchanges will likely lead to a decrease in prices in the short-run, followed by an increase in rents in the longer run. These negative effects will be more pronounced in high tax states. Elimination will also likely produce a decrease in real estate investment, increase in investment holding periods, and an increase in the use of leverage.”

Deferred Maintenance Triggering New Constructions Requirements: 

As a result of lost income, many property owners have deferred maintenance pending increased revenue. However, under Title 24 of the California Code of Regulations, a landlord must adhere to specific maintenance requirements according to the California Building Code (CBC). The requirements relate to “fire and life safety, structural safety, and access compliance. CBC provisions provide minimum standards to safeguard life or limb, health, property, and public welfare by regulating and controlling the design, construction, quality of materials, use and occupancy, location and maintenance of all buildings and structures and certain equipment.” Failure to comply could trigger new construction requirements. 

• Title 24: Impact on CRE Investors: Failure to maintain a building could increase costs associated with new construction versus maintenance. 
• Title 21: Fiscal Impact: Although the investment community could be faced with increased upfront costs, new construction could improve long-term real estate values. Additionally, new construction would trigger energy-efficient changes in building codes, reducing long-term management costs. 

What Investors Should Understand About the Four 2020 Legislative Trends:

2020 has been quite a year. CRE investors have been severely impacted by the pandemic, many losing tenants and income, as government agencies prompted mandated closures. However, as we enter Q4, we see the CRE industry bouncing back. But the proposed legislation could impact CRE investor returns in the coming year. To better understand how you, as an investor, could be affected by these proposed changes, reach out to a professional today to learn more about how you should adjust your investment strategy for 2021.