Is now the time to find "gold" in California property tax appeals?

Base assessments and mandated increases

California has a unique approach to determining assessed values for property taxation. Since Proposition 13 (“Prop 13”) was implemented in 1978, values for assessment purposes are generally set when properties are purchased or constructed. The California Constitution mandates that once the base assessment is established, it may be increased by no more than 2% each year. For the 2023 tax year, a property purchased or newly constructed in 2018 will be taxed based on an assessed value that is 10% higher than its 2018 value. A property purchased or completed in 2022, on the other hand, will be assessed 2% higher in 2023 – while the market values of most properties have dropped. In some cases, a property may be worth even less in 2023 than when it was acquired five years ago.

Commercial real estate transactions have recently screeched to a halt in response to the Fed raising interest rates. Right now, uncertainty around future hikes remains and, at the same time, markets are still missing price discovery. Owners are walking away from assets like the San Francisco Centre or as in the case of 350 California, and other former flagship buildings which are selling at steep discounts.

While these may be extreme examples, a review of valuations prepared by Altus Group since 2018 indicates that average values per square foot determined for each property category have declined, with some falling below 2018 levels.

Figure 1 - Average values per square foot in Los Angeles – Long Beach- Anaheim CBSA, 2018-2023

Figure 2 - Average values per square foot in San Franciso- Oakland-Hayward CBSA, 2018-2023

Note: Values are based on aggregated data from Altus valuations and are not necessarily representative of individual properties or the population as a whole.

Altus analytics data shows that both San Francisco and Los Angeles rank among the most challenging office markets in the country. Measuring risk based on occupancy and weighted average lease terms of 7 years or less, 80-90% of non-medical space in these cities is currently reflecting medium or high risk. Indicated 3-year appreciation return is estimated at -23% in LA. In San Francisco the indicated decline is more than 30% in making it one of the five most challenged office markets in the US.

Figure 3 - Office risk and 3-year appreciation return analysis Q2 2023

Do you have an opportunity to reduce your property tax?

While properties purchased or completed a decade or more ago are likely still benefiting from assessments that are well below market value, those with base assessments set more recently should consider a thorough review of values.

Income-producing properties: Property tax experts can demonstrate that as interest rates rise, capitalization rates are also likely to rise. Sales of properties with occupancy challenges indicate dramatic drops in value for properties in CBD.

Special purpose properties: As construction costs rise and values decline, obsolescence should be accounted for.

Business personal property: When buildings are experiencing a decline in value, the value of the building contents may be impacted as well. County Assessor Offices and Appraisal districts use reported costs and trend tables to value equipment, other personal property, and fixtures. The age/life tables do not generally take market conditions or extraordinary obsolescence into account.

In addition to the general sector-by-sector impact of market conditions, individual properties may also be underperforming. The continuing impacts of remote work, in addition to layoffs in the tech sector, have had dramatic impacts on central business districts. According to reports by CBRE, office vacancy in downtown San Francisco ballooned from 3.9% in 2020 to more than 29% in the first quarter of 2023.

Recent sales can also be used to support arguments for reduced values. Although a limited number of transactions are available for analysis, these sales do provide a benchmark for analysis of current market values.

Unlock value with a property tax appeal

Where a property has considerable vacancy, or where lease agreements are based on a “gross” rent basis (inclusive of taxes), a reduction in property tax liability can have an immediate impact on net operating income (NOI). Where lease agreements are primarily net/net, property tax reductions decrease the gross costs to tenants. This can assist in retaining or attracting tenants, while also providing room to increase future base rents. All of these outcomes contribute to increasing value.

A modest 10% reduction in the assessed value of your property can increase net operating income by 2-3%, even in a state with tax rates as low as California’s.

Figure 4 - Potential impact of 10% property tax reduction

Action you can take right now

California law provides the opportunity to appeal your assessment if the market value drops below the assessed value. To protect your rights to a lower assessed value, you must file an appeal prior to the deadline. If the value is not found to be less than the assessment, the appeal can be withdrawn.

There are two deadlines to file assessment appeals in California, which vary according to county. Eleven counties, including San Francisco, have an appeal deadline of September 15, 2023. The deadline in the rest of the state is November 30, 2023.

Figure 5 - California assessment appeals filing deadlines 2023