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Lease Audit Articles

Why California Tenants Need “Prop. 13 Protection"


Proposition 13 is a statutory limit on increases of the assessed value of real estate for property tax purposes in California. In short, it limits the annual increases of assessed value to no more than two percent (2.0%) per year unless certain events / transactions occur which allow the property to be re-assessed. These events / transactions boil down to “transfers” (of anything equal to or more than 50% of the property), such as a sale of the building, or construction of “improvements”, such as new tenant improvements or other physical structures. In addition, the state general levy (ad valorem tax rate) is limited to one percent (1.0%). There is no limitation on municipal tax rates and/or special assessments (voted indebtedness), although the voters in the subject area must approve such additional taxes with majorities of either 55% or 66.67% depending upon the proposed use of the funds. As such, the total tax rate can exceed 1% and ranges from just over 1% to a little over 2% in a number of California jurisdictions. That said, in California the biggest driver, historically, of a building’s property tax fluctuations has been tied to reassessments under Proposition 13, and it is these reassessment events commercial tenants should pay particular attention to when negotiating new leases in California.


Assume you occupy 25,000 square feet of a newly constructed, 250,000 square foot building (i.e., 10%). Assume further you occupied your premises on the day the Building opened, and that your lease is structured as a “Base Year” lease, with the first year of the Building’s operation being the Base Year. The Landlord, who was also the developer, paid $150 per square foot (including all tenant improvements), to construct the building, or $37,500,000. Upon the Building’s completion the county assessor assessed the building based upon its construction value, meaning the assessed value during the first year – your Base Year – would be $37,500,000. If the tax rate is 1.50% of the assessed value, the property taxes included in your Base Year would be $562,500 ($37,500,000 x 1.50%). If the taxing authority concludes next year’s increase in assessed value is 2.0% (the maximum), assuming the tax rates stay the same, the building’s subsequent year’s taxes would be $573,500 [(37,500,000 x 1.02) x 1.5%]. Thus, in this scenario, you would effectively pay your pro rata share of the difference between the $573,500 and $562,500 in Base Year taxes. This difference amounts to $11,000.00. At a 10% pro rata share, you would pay $1,100.00 for taxes during the second year of the lease term, which is the first comparison year following the Base Year. Assuming the same two percent increase in assessed value for the third year of the lease term, you would pay $2,272.50 as your share of that year’s increase in taxes over the Base Year.


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