What Every California Tenant Should Understand About Property Tax Liability

As tenant representatives, we advise our clients that ownership matters. The differentiator between two similar buildings and spaces with like amenities and rent can often come down to the quality of ownership. Buildings that have been owned and managed by the same entities for a long period of time tend to be better managed.  

 Under Proposition 13, buildings like these may not have been reassessed at market value for years and in some cases decades. Proposition 13 was approved by 65% of California voters in 1978 and currently limits property tax reassessments (increases) to 2% annually but allows for full tax reassessments if the building is sold, more than 50% is transferred, or substantial new construction is completed. 

In California, commercial landlords typically pass on a pro-rata share of building operating expense (OPEX) including property taxes to their tenants. In the most common “full service” office lease, tenants are only responsible for OPEX increases over the “base year” amount which is most often the year of the commencement date or the year following the commencement date. 

​As a result, tenants in buildings that have been owned by the same entities for a long period of time carry a large tax liability if the property is sold or transferred during the term of their lease. In San Francisco, tenants with the largest pass-through liability are looking at as much as $10 per square foot per year for the remainder of their lease if the property is sold and reassessed.

 Why is property tax liability a third rail issue for brokers?

The differentiator between two similar buildings and spaces with like amenities and rent may come down to the size of a tenant’s property tax liability. For this reason, we do the math on the property tax liability for every alternative we put in front of our clients.

As a brokerage working exclusively for tenants we always pursue some level of protection for our clients by seeking a cap on OPEX (including property taxes) increases throughout the term of the lease. Not having cap on property tax increases can be devastating for tenants but building owners are extremely resistant to agreeing to this protection. Simply put, commercial property is harder to sell if tenants have OPEX caps. So, it’s understandable that landlords are somewhat inflexible and seek to pass the full tax reassessment burden onto tenants. 
 
For the last decade only the largest tenants in softer markets have been able to negotiate caps on OPEX increases. But a black swan event like the coronavirus pandemic shifted leverage in markets that once favored landlords to favoring tenants overnight. Seeking and obtaining OPEX protection is easier said than done but it should always be subject of negotiation. 
 
Somewhat harder to explain and understand is why property tax liability is a third rail issue for brokers. The dirty little secret in commercial leasing is that most commercial real estate brokerages represent both tenants and landlords which creates a built-in conflict of interest. If your broker isn’t discussing your property tax liability or seeking a cap on OPEX, it’s probably because like a third rail, touching it is extremely dangerous for their business.  
 
At a minimum, it’s important to do the math on your property tax liability before entering a lease in any building in California. Tenants need to know when the property was last reassessed for Proposition 13 purposes, what its assessed value was and what its assessed value is today to forecast the potential liability due to a transfer of ownership. The longer it’s been since the last reassessment, the greater your exposure to property tax increases.