Navigating Property Tax Liabilities: A Guide for Commercial Property Tenants in California

As tenant representatives, we emphasize that ownership quality is a critical factor when comparing similar commercial properties. The long-term ownership and management of a property often result in better maintenance and stability. 
 
Understanding Proposition 13 and Its Impact on Property Taxes
 
Proposition 13, passed by California voters in 1978, limits annual property tax reassessment increases to 2%. However, a full reassessment to market value occurs if the property is sold, more than 50% is transferred, or significant new construction is completed. This reassessment can significantly impact tenants, as commercial landlords typically pass on property tax costs to tenants.
 
Lease Types and Their Implications
 
In California, commercial leases generally fall into two categories:

• Full-Service (Gross) Lease: Tenants pay a base rent plus increases in operating expenses (OPEX), including property taxes, over a "base year" amount, usually set at the start of the lease.
• Triple Net (NNN) Lease: Tenants pay a base rent plus a pro-rata share of all operating costs from day one, including property taxes, insurance, and maintenance.

 
Example of Property Tax Impact on Tenants
 
Consider a prominent San Francisco office building with 500,000 rentable square feet (RSF). A tenant leasing 10,000 RSF (2% of the building) would share 2% of the property tax burden. Assuming a 1% property tax rate and a base year of 2023, with an assessed value of $80,000,000 and property tax of $800,000, the scenario changes dramatically if the building is sold.
 
If sold in 2024 for $250,000,000 ($500/RSF), the reassessed property tax would increase more than 200% to $2,500,000. The tenant's share of the increase would be $34,000 annually, significantly higher than a 2% Proposition 13 increase before the sale.
 
The Hidden Risks of Property Tax Liability
 
Tenants in long-held properties face substantial tax liabilities if these properties are sold or transferred. Even with decreasing office property values, many buildings owned for decades by family offices carry significant reassessment risks for tenants.
 
The Role of Brokers in Mitigating Property Tax Risks
 
A key differentiator between similar properties can be the tenant’s potential property tax liability. We meticulously calculate this liability for every property option presented to our clients. As a tenant-exclusive brokerage, we strive to negotiate protections such as caps on OPEX increases, including property taxes. While landlords often resist these caps due to the impact on property sale value, the post-pandemic market shift has made it more feasible for tenants to secure such protections.
 
The Conflict of Interest in Traditional Brokerage
 
Many commercial brokerages represent both tenants and landlords, creating a conflict of interest that can prevent them from addressing property tax liabilities effectively. If your broker isn't discussing this critical issue, it might be due to the inherent risks to their business model.
 
Actionable Advice for Tenants
 
Before signing a lease, tenants should thoroughly assess their property tax liability by determining the property's last reassessment date, its assessed value then, and its current assessed value. This helps forecast potential increases due to ownership changes. Understanding and negotiating property tax liabilities is crucial for avoiding unexpected financial burdens.
 
By prioritizing ownership quality and understanding property tax implications, we help our clients make informed leasing decisions, ensuring they avoid unforeseen expenses and secure more favorable lease terms.