Why New LA Area Transfer Taxes are Dangerous and Will Not Last
Recently, voters passed two new measures in the cities of Los Angeles and Santa Monica to establish additional transfer taxes on the sale of real estate. These taxes kick in for sales over a certain price with the additional revenue going to curb homelessness. In Los Angeles, this measure is called ULA and passed with approximately 57% of the vote. This creates a new transfer tax of 4% on sales of least $5M or 5.5% on sales of at least $10M, in addition to the already existing transfer taxes of about 1/2 of 1%. In Santa Monica, passed by a 53% majority, Measure GS levies a 5.6% tax on sales of $8M or above. These are immense taxes that are a minimum of $200,000 for the lowest tier in Los Angeles and on a $15M sale in Santa Monica (a not unusual amount for a luxury property or mid-sized apartment building), the tax would be $840,000.
While it is understandable why taxes targeting wealthy homeowners who have benefitted greatly from appreciation in order to combat homelessness passed at the polls, these are poorly written laws that take affect almost immediately (March 1st for SM and April 1st for LA), and are punitive to those who will have to unexpectedly absorb them. These taxes apply to both residential and commercial properties and do not make an exception for a seller who is selling for a loss. While most people selling homes for $5M and higher will be okay, what’s dangerous about the law is that it disincentivizes apartment development. Most larger apartment buildings in the city of LA or Santa Monica are over $5M, certainly on the sale after completion, but oftentimes on the purchase of land as well. If a developer needs to figure in several hundred thousand dollars to potentially a million or more in extra taxes, is the developer’s expected profit margin still sufficient to build large complexes in these cities?
If developers do decide to build and then sell a medium-sized property (for example 20 units) to an apartment operator for say $12M, a tax of $660,000 will be due on sale. They could inflate the price and then the new owner may pass this along to tenants in the form of increased rents. If this is 20 units, they will probably need $100-$150 per month per unit more to attain a similar capitalization rate as prior to the additional tax. In a city where more affordable homes are desperately needed, adding these extra pass through costs to renters defeats the purpose.
Much of the time, with the additional tax, a developer’s margins will be too small or ability to sell at a 5.5% higher price too uncertain to undertake large scale development at all. These developers will build a smaller project or go elsewhere such as Culver City, Beverly Hills, or the South Bay where these taxes do not exist. Maybe they’ll pursue projects out of the area or state entirely. Home buyers who anticipate this tax may just decide to move out of the area as well, as many Californians already are doing as a result of high taxes. This translates to fewer homes constructed, purchased and sold, and less transfer tax revenue and other tax revenue from wages and ancillary services that LA or Santa Monica would be receiving.
Since the results were announced, people have been speculating about creative ways to avoid paying the tax. One proposal is to split up the cost of the real property to stay under the threshold and sell personal property at an inflated price. Another has been to have multiple entities complete multiple purchases on different days to keep each portion of the purchase under the threshold. There are lawyers and real estate professionals currently scheming to figure out new ways to skirt the law. Any of these methods are impractical, illegal or fall outside the spirit of the law, and will lead to additional enforcement costs by the cities to regulate.
There are also big players making moves to try to get this repealed or set it up for a new vote. Kilroy Realty, a large REIT, has sponsored a proposal which states that “All new taxes passed by the California State Legislature would have to be approved by voters. And for any local special tax increases, voters would have to approve the measure by a two-thirds vote, rather than a simple majority as at present. While the ballot initiative does not mention Measure ULA, it states that any local tax imposed after January 2022 but before November 2024 that “was not adopted in compliance” with the two-thirds requirement will be voided.” (The Real Deal 2/7/23) The Apartment Association of Greater Los Angeles has also challenged the measure in court. The complaint filed in LA County Court says, “transfer taxes that are ‘special taxes,’ however, are prohibited for all local governments,” continuing that “Measure ULA is actually a special tax because the revenue it would generate is “specifically dedicated to housing and homeless services.” (The Real Deal 12/22/22)
It is likely that these hastily passed measures with many unintended consequences will be back on the ballot in 2024 with a more healthy debate prior to voting and potentially higher required margin to pass. For that reason, I would not recommend that a seller fire sale their homes in this price range prior to March or April to beat the new tax, as some brokers have suggested, and instead wait to see what happens. There is no question homelessness is a major concern and very sad situation in California, however previous taxes have been passed to curb the homelessness problem, yet it has only gotten worse. Building more housing and more mental health treatment facilities would solve a lot of problems, but the inability of local government to focus on these makes one wonder if they are more committed to helping desperate people, improving safety, and cleaning up the city or using the homelessness issue for political gain or grift by inefficient systems.