Prop 13 At 6:13

Early one morning back in the late 1970s, I remember watching my real estate developer father sipping his  coffee. He had our living room full of political signs urging people to vote “Yes on Prop 13” . He proudly stood admiring his work that was accomplished with some stencils and spray paint in our back yard the night before. Had it been modern day, I would have thought him a tagger.  As I hid the “morning vitamins” my mom just gave me under the rug, I wondered what these strange signs were and was more concerned with the new bike I wanted for my upcoming birthday.  But my dad obviously thought something was important enough that required him to go make a bunch of signs and hand them out to what seemed to be the entire neighborhood.

Well, I guess my dad’s grass roots political action, uncommon as it was for him, worked – because Prop 13 passed and was codified into law in 1978.

While a complex statute, it has two basic components.  First, real property tax cannot exceed 1% per year of the cash value of a property. Second, annual assessments cannot exceed 2% a year. This rule applies to all real property in California.  If you ever want some bedtime reading, try reading the definition of what constitutes a “change in ownership” under the statute.

In any case, Prop 13 remains one of the most powerful additional reasons to hang on to real property in California.  Long-term ownership is rewarded whereas constantly buying and selling is punished through higher real estate property tax base values over time.

Because real estate property taxes remain the highest percentage line item on a building/unit operating expense statement,  it is extremely important to factor in when deciding whether to sell versus hold.  While debt service is often a large expense as well, debt service is not considered an operating expense in the real property world.

A good spreadsheet exercise is to run out property taxes 30 years.  In one scenario, examine what property taxes look like on a 30-year hold.  In the second scenario, assume a property is sold every five years and the money is reinvested in another property at a higher purchase price than the former acquisition.  You will be amazed at the property tax cost difference over time between the first scenario and the second scenario.  It often is over 300%-800% more in the second scenario depending on the assumptions.

As an interesting side note, in the 2003 California recall election in which Arnold Schwarzenegger was elected governor, his advisor Warren Buffett suggested that Proposition 13 be repealed or changed as a method of balancing the state’s budget.  Warren knew that such a law change would immediately bring untold billions into the California state coffers with the stroke of a pen.  Schwarzenegger, believing that such an act would be politically unacceptable and could end his gubernatorial career, said, “I told Warren that if he mentions Proposition 13 again he has to do 500 sit-ups.”

The net-net?  Pay attention to the impact of Prop 13 on all real estate transactions.  My pop had it right.  It’s worth putting out a bunch of signs.

- John Montgomery