Los Angeles ‘Mansion Tax’ Shakes Up Commercial Property Sales

Levy on Real Estate Deals Over $5 Million Takes Effect in April

The roughly 685-unit Thea at Metropolis in downtown Los Angeles at 1000 W. 8th St. sold for $504 million in November 2022. A $27.2 million transfer tax would have been levied on the seller had it sold after a new measure takes effect in April. (CoStar)

By Jack Witthaus
CoStar NewsJanuary 30, 2023 | 1:31 P.M.

Executives at developer Greenland, which had a 59-story tower up for sale in downtown Los Angeles, began growing concerned when they heard a future major tax loomed for sales of commercial and residential property in the city.

So last fall, the China-based developer wrapped up the $504 million sale of the Thea at Metropolis ahead of the so-called mansion tax taking effect on all properties selling for more than $5 millionin April. The high-rise’s sale and price resulted from the expectation that the higher tax would reduce demand and make it harder to close a deal, said Matthew Gottesdiener, the CEO of Newton, Massachusetts-based apartment developer and investor Northland, which now owns the property.

Critics of the tax say these types of major transactions would be harder to complete under the new levy. In the case of the Thea, the tax would have driven up the cost by more than $27 million, an amount that could easily buy a mid-sized apartment complex in Los Angeles.

“Active market participants began expecting and pricing in the transfer tax by early 2022, and it was a contributing catalyst to the successful Thea transaction,” Gottesdiener said. “This provided a price-based incentive for a developer who planned to sell in the near-to-intermediate term.”

The tax is formally known as Proposition ULA, an acronym for United to House L.A. It represents an effort by tax proponents to raise an anticipated $600 million to $1.1 billion annually to fund projects promoting housing construction and alleviating L.A.’s worsening homelessness problem. The levy is a property transfer tax measure that passed in November with 57% support in the city of Los Angeles.

Los Angeles faces a homelessness problem: the city recorded 41,980 people who were homeless in February 2022, which was up 1.7% from 2020, according to the Los Angeles Homeless Services Authority. California accounts for 30% of the nation’s homeless population and half of all unsheltered people in the United States, according to the U.S. Department of Housing and Urban Development.

Dulling Effect on Investment

Come April, the 4% tax will be applied to all properties — commercial and residential, despite the mansion moniker — sold or transferred for more than $5 million, and 5.5% will be levied on properties sold or transferred for more than $10 million. Those rates will replace the current 0.45% transfer tax rate.

Opponents, mostly in L.A.’s real estate industry, say the tax couldn’t come at a worse time as rising interest rates nix deals in the city of Los Angeles. They argue it may have a long-term dulling effect on investing in L.A., driving investors to seek lower-tax cities to buy property. Further, opponents are skeptical that the money will be used effectively to solve the intractable problem of homelessness and housing affordability.

“It’s abhorrent. It’s a disaster for the commercial real estate business,” Bob Weiss, attorney at Los Angeles law firm Valensi Rose PLC, told CoStar News. “The tax itself will create tremendous decline in value.”

Opposition is mounting to dismantle the tax that analysts say more cities may support in coming years, and a lawsuit was filed in the Los Angeles Superior Court in December to block the tax. The suit is supported by the Howard Jarvis Taxpayer Association and the Apartment Association of Greater Los AngelesThe suit is in its preliminary stages and a court date hasn’t been set yet.

Meanwhile, signatures are being gathered to put a proposal called the Taxpayer Protection and Government Accountability Act on the statewide ballot in 2024. Simply put, the act will make it more difficult to pass tax increases on a statewide and local level.

Some real estate analysts say the efforts to upend the new levy are folly.

“It is too late to campaign after the election,” Jeffrey Palmer, partner of Los Angeles-based property investment firm PMI Properties, posted on Linkedin. “Most real estate people ignore politics. We need to campaign for the Taxpayer Protection Act.”

Property Tax History

California might be known for its high income taxes but less well known is the state’s relatively low taxes on commercial and residential properties, said Susan Shelley, vice president of communications for the Howard Jarvis Taxpayers Association.

Shelley’s group was founded in 1978 by Howard Jarvis, who lobbied for the successful passage of Proposition 13, which was enacted that same year. That law limits commercial and residential property taxes so that, in many cases, Golden State properties can only be taxed at 1% of their assessed value. That value is assessed at the time of sale, not annually, and typically can only reset when the property sells again. That means taxes on property increase little after it’s purchased even if the real estate’s value has soared.

Proposition 13 has long been popular among property owners, and politicians for decades have attempted to avoid dismantling the law out of fear of being voted out of office. But Proposition 13 also has been decried as creating wider wealth gaps, limiting power of local governments, hurting local school funding and resulting in an unbalanced state budget. California’s low property taxes on commercial properties are not the norm nationally. Many states require commercial properties to be taxed at newly assessed values annually.

Since Proposition 13’s passage, local governments have scrambled to find ways around the law to raise taxes on real estate. Property taxes can account for three-quarters of local tax collections and fund K-12 education, police, fire department, parks and more, according to Washington, D.C.-based nonprofit Urban Institute. Chicago attempted a similar property transfer tax in November that failed.

Shelley sees ULA as another workaround to Proposition 13 and believes her group’s lawsuit will prove the law is illegal. Furthermore, Shelley said she doesn’t support how the tax money will be used in Los Angeles. She said homeless people need medical treatment and temporary and emergency shelter instead of the permanent housing that the levy is designed to fund.

“I don’t think it’s fair to say that money can be taken from people trying to pay their own bills and housing costs to give free apartments to anyone who wants one,” Shelley said.

If the lawsuit against the Los Angeles tax fails, groups opposed to the tax hope that the Taxpayer Protection and Government Accountability Act will prevail in the years ahead. This initiative, if passed by voters, would ensure that voters would have the final say on all proposed state tax measures after these measures passed the state Legislature by a two-thirds vote and had the governor’s signature.

On the local level, the act would require citizen-sponsored new taxes to need a two-thirds vote. With 57% of the vote, the new tax wouldn’t have passed if the Taxpayer Protection and Government Accountability Act were enacted.

Proponents of the Taxpayer Protection and Government Accountability Act say that California’s taxes are enriching a state government that, according to Bloomberg, had a $98 billion state budget surplus in 2022, However, the state of California’s taxes mostly rely not on property but on income, which can vary widely because of economic conditions, and after a slowing economy in 2022, California faces a $22.5 billion budget deficit this year.

What’s Next

Dan Yukelson, executive director of the Apartment Association of Greater Los Angeles, said he fears other cities may attempt to pass similar transfer taxes.

San Francisco already has one that calls for 0.75% to be paid on properties selling for more than $1 million, 2.25% for properties selling for more than $5 million, 5.5% for properties selling for more than $10 million and 6% for properties selling for more than $25 million. Santa Monica near Los Angeles enacted a transfer tax in November 2022 of $56 per $1,000 of value for property transfers of $8 million or more.

Culver City, also near Los Angeles, enacted a transfer tax in April 2021 that’s tiered and no higher than 4% on property sales of more than $10 million. Culver City’s transfer tax also is capped at 0.45% for sales involving affordable housing and the first transfer of newly constructed multifamily housing.

Yukelson said there’s less incentive to invest in commercial real estate in Los Angeles now with the new tax versus more “business friendly” cities like El Segundo or Culver City.

“Ultimately, I’d prefer no taxes,” Yukelson said. “But L.A.’s concept is egregious.”

That said, the city of Los Angeles soon may have new tax monies that can be directed at solving homelessness and building housing.

The newly elected mayor of Los Angeles, Karen Bass, did not respond to a request to comment from CoStar News on how that money will be spent. Under the law, the mayor is required to appoint 15 people as part of a citizens oversight committee to oversee the new tax money, with the appointments requiring city council approval. The committee would recommend to the city council funding guidelines and housing-needs assessments while monitoring and auditing the new tax revenue.

The city’s treasury also is required to create the House LA Fund to collect the new tax revenue.

Mayor Concerned

Bass told the Los Angeles Times on Jan. 12 she was concerned about the efforts to repeal the new tax.

“I’m worried that the real estate community is definitely going to come at this full force,” Bass told the Los Angeles Times. “So in my opinion, we have to get everything we can out of it.”

Peter Dreier, an Occidental College professor who worked with people who drafted the tax, did not respond to requests to comment from CoStar News about the potential effects. Dreier did tell the Los Angeles Times on Dec. 15 that the tax is needed because the private sector has failed to build enough affordable housing in Los Angeles. He also said that, to offset the tax effect, real estate brokers should consider asking for a smaller fee in sales to help sellers pay the tax.

“Realtor fees are onerous compared to the size of this transfer tax,” Dreier told the Times.

Aaron Cohen, the chief operating officer of L.A.-based real estate investment firm CGI+, told CoStar News he is 100% opposed to the tax but has more nuanced feelings about its long-term fallout. He said the timing of the tax will hurt commercial property sales in the city of Los Angeles as higher interest rates curb demand. He also doesn’t have faith the funds will be effectively used to address homelessness and housing shortages in Los Angeles.

However, Cohen said that in the long term, real estate buyers and sellers will adapt to this new tax. Cohen doesn’t expect there will come a time when people won’t want to invest in Los Angeles, a city known for its mild weather, massive job base, enormous population and internationally famous attractions — to name a few factors that have long contributed to the city’s robust economy.

“The blunt fact is L.A. is forever. There’s not going to be a point where people don’t want to live in L.A.,” Cohen said to CoStar News. “Real estate is going to buy and sell in LA,” adding that it would be “foolish” to think the tax “will freeze real estate for a long time.”

(Posted with Permission from CoStar)