Commercial sellers could face ballooning tax bills starting in April. Can they split the bill?
(Photo-illustration by Kevin Rebong/The Real Deal)
When the U.S. subsidiary of Chinese developer Greenland sold one of its trophy assets in Downtown Los Angeles for $504 million in November, the firm paid $554,400 in county transfer taxes.
If the deal had gone through five months later, Greenland would have had to pay an extra $27.7 million.
That’s because selling real estate in the city of Los Angeles is about to get much pricier. Come April, all property — residential or commercial — that trades for more than $10 million will face an additional 5.5 percent tax imposed by the city. Sales between $5 million and $10 million will be subject to a 4.5 percent tax. The city of L.A. is planning to use the revenue generated by the taxes for affordable housing development and rent relief.
The tax is expected to have a widespread impact on the city’s luxury residential market, and its commercial sector as a whole. About 70 percent of offices, 62 percent of multifamily and 64 percent of industrial property sales would be subject to the tax, according to CBRE.
“It hurts every asset class, if you’re subject to the tax,” Newmark broker Kevin Shannon said.
“It will affect sales up and down the spectrum,” said Douglas Praw, a lawyer at Holland & Knight.
Though sellers will face the burden of paying the new tax, brokers, investors and attorneys all expect them to try and push some of the costs onto other involved parties. In some cases, sellers may try to cut broker commissions or require the buyer to pay part of the tax at closing.
Regardless of how it plays out, brokers expect the tax to put downward pressure on commercial pricing — at a time when high interest rates are already doing just that.
“Sellers are going to have to recalibrate their sales prices,” said Loretta Thompson, a real estate attorney at Withers.
Kicking the can
The city of L.A.’s finance department still has to release rules and regulations around administering the new tax, but attorneys expect it to be in line with existing rules for transfer taxes. Any change in control — including a shift in underlying LLC ownership — will trigger the tax, with a custom that the seller pays.
Though the seller is burdened with paying, there are always ways to pass the costs on to someone else. “They can negotiate that the buyer shoulders some of it, or they can reprice their listing,” said Thompson.
Commercial owners could also try to hike rates for new leases and renewals — though this may be tougher for office properties in light of high vacancies — or negotiate brokers’ commissions to recoup costs.
But can investors get around the tax? Attorneys are skeptical — existing transfer tax laws provide few loopholes.
“I don’t think you’ll be able to do anything tricky,” Thompson said.
Whether the new tax will lead to an investor exodus remains to be seen, but some brokers foresee trouble.
“It will absolutely push investors out [of the city],” said Stacy Vierheilig-Fraser, a broker at Lee & Associates who primarily works with office, retail and industrial sales across the San Fernando Valley and Hollywood.
For those on the fence about a first-time purchase in the city of L.A., the tax might be a determining factor.
“It makes it harder to transact,” Shannon said. “It’s not going to attract additional investment in L.A.”
CBRE echoed a similar sentiment: “Investors and buyers may look to other parts of L.A. County not affected by Measure ULA [the transfer tax], including cities such as Beverly Hills, Glendale and Pasadena,” the report said.
Others disagree. San Francisco, Oakland and Seattle have all instituted similar taxes, and investors are still in those cities, Thompson said.
“It’s just another hurdle,” said a source at a large L.A.-based investment firm.
But big institutional investors are looking to cash out of other parts of L.A. County, too, as office vacancy remains stubbornly high across the region and other cities have imposed their own transfer taxes. Culver City taxes sales over $10 million at 4 percent, while Santa Monica voters recently passed a measure to impose a 5.71 percent transfer tax on sales of more than $8 million.
In Santa Monica, JPMorgan is marketing its 1.4 million-square-foot Water Garden office campus with an asking price of $1.4 billion. Oracle, meanwhile, is looking to offload a roughly 320,000-square-foot campus at 2600 Colorado Avenue.
The impending tax in the city of L.A. is already facing one legal challenge from a landlord advocacy group, the Apartment Association of Greater Los Angeles.
“If the Measure ULA tax increase is imposed as scheduled on April 1, 2023, great and irreparable harm will result to plaintiffs, and to all Los Angeles property owners in being required to pay unconstitutionally imposed taxes,” the group said in its complaint.
Sell, sell, sell
When L.A. voters passed the transfer tax, brokers immediately rushed to tell clients to sell their commercial properties before the tax took effect.
“If you plan on selling in the near future, if you can avoid the tax, you’re going to want to avoid it,” Shannon told The Real Deal in November.
“Current owners who close deals before April 2023 will avoid the new excise tax, so there may be an influx of sales prior to that deadline,” CBRE noted in a report.
But so far, there hasn’t been a ton of transactions — or listings.
Vierheilig-Fraser said she’s surprised she hasn’t seen a flood of listings.
Her conclusion: “People aren’t going to sell their buildings,” she said, adding that investors might decide to hold onto their properties for longer, if they can.
Whether or not an owner can do that is based on whether their debt is coming due. More than $26 billion worth of debt tied to commercial mortgage-backed securities is set to mature next year, according to Fitch Ratings. That’s more than the roughly $19 billion that came due this year.
“That’s going to be the driver — whether it’s by necessity,” Thompson said.
Sellers, especially office owners, are already having a tough time transacting at high prices, given remote work and high interest rates. The 10 priciest office deals last year all closed in the first half, according to a TRD analysis, before the Fed started hiking interest rates.
By the time voters passed the transfer tax in November, the federal funds rate was 3.78 percent, up from 1.21 percent in June.
“If you’re selling an office property, you’re already pushing the number high,” Vierheilig-Fraser said. “As a buyer, you’re going to look at it, with the new tax, and say it doesn’t work for me.”
Via The Real Deal