Taxing Times
Sep 1, 2009 12:00 PM, By Brad Berton
To fill California's gaping budget deficit, the government may squeeze retailers and retail real estate owners.
Perhaps predictably given the recessionary shockwaves, vacancies in all the California markets were higher at midyear than they were a year earlier. And all will be even higher by year-end, Marcus & Millichap projects.
On the flip side, landlords boasting infill locations in densely populated coastal counties typically have had a much easier time finding replacements when tenants vacate than their counterparts inland, according to Dan Samulski, a senior vice president at Grubb & Ellis in Newport Beach. Inland, amid the higher vacancies and idle subdivisions retailers know they can drive hard bargains. “If landlords there aren't lowering their rents [voluntarily], tenants are demanding that they do,” he adds.
So as bankrupt larger-format outfits like Mervyns, Gottschalks, Circuit City and the like vacate space, retailers looking to grow in the Inland markets are often encountering a bevy of attractive upgrade opportunities. Accordingly, higher-quality, higher-profile centers in struggling inland submarkets are capturing far greater interest than B and C properties these days.
The generally discount-oriented operations looking to boost footprints today aren't yet enough to back-fill all the large spaces, which has led to deals with nontraditional tenants. In addition to amusement-minded outfits such as go-cart tracks and laser-tag combat centers, churches are finding empty big-box space an economical alternative, Samulski says.
Dressed for distress
Logically in this environment, some retail real estate investors are endeavoring to raise capital targeting high-yield opportunities to acquire properties in financial distress in California and elsewhere.
According to data from New York City-based real estate research firm Real Capital Analytics, more than $108 billion in commercial real estate assets have entered default, delinquency, foreclosure or bankruptcy. Of that, some 1,420 are retail assets worth an aggregate $31.1 billion. To date, very little of that distress — $4.1 billion — has been resolved. Many in the industry have been expecting a wave of investment in such assets. Observers think the investments may begin soon with the emergence of new funds and other vehicles targeting these assets.
For example, veteran investor Tony Thompson's Thompson National Properties in Irvine is seeking $1 billion in equity for a new REIT dubbed TNP Strategic Retail Trust. And a trio of veteran property pros have formed Los Angeles-based LBG Realty Advisors, which is looking to raise $250 million for a venture targeting opportunistic retail investments.
However, given California's longer-term economic strength, Marcus & Millichap's Green and Samulski question whether all that much real distress will materialize before tenant demand and rental revenues recover. “The vulture funds say they're ready to jump into it, but in all honesty we haven't really seen much in the way of distressed sales,” Green says.
With any luck, a rebounding economy will help the state government get its fiscal house into at least relatively reasonable order — and in turn allow redevelopment agencies to again retain and reinvest property taxes into successful commercial environments. That would be the smoothest resolution the California retail real estate scene could hope for. At the very least, however, the industry is hoping the 2009 budget crisis doesn't have a sequel.
Lawmakers Eye Proposition 13 Reform
As seems to happen whenever California state and local governments fall into a fiscal funk, some politicians and other interested parties are now suggesting serious consideration of raising the state's strict limits on property taxes.
And as in past times of public-sector financial crisis, much of today's discussion focuses on moving to some sort of “split-roll” system through which different tax rates and annual inflation limits would apply to residential and commercial properties.
Since the Golden State's voters approved the landmark Proposition 13 in 1978, both commercial and residential tax rates can't be higher than 1 percent — and assessments can't rise more than 2 percent annually unless a property changes hands (which returns its assessment to its market rate).
But with local and state coffers crying for more revenues, a panel dubbed the Commission on the 21st Century Economy is assessing prospects for shifting to a split-roll — among numerous other ways and means of stabilizing California's budget. The commission is scheduled to report to the governor and legislature in late September. Adjustments under consideration include varying combinations of: re-assessing commercial properties at market rate every year (while retaining the 1 percent rate), boosting the tax rate beyond 1 percent and raising the 2 percent annual limit to a higher cap.
Much of the debate boils down to whether a split-roll constitutes another threat to landlord and business profits or a long-needed rectification of perceived tax inequities. Predictably, commercial property and business interests generally oppose any split-roll system that would tend to pass higher property taxes on to tenants. “It's one thing to generate net additional revenues,” says Harvey Green, CEO of Marcus & Millichap Real Estate Investment Services. “It's another to just shift responsibilities to third parties who will ultimately pass them on to consumers.”
Split-roll proponents downplay any negative economic effects, citing a far greater impact on long-held real estate (and mostly wealthier owners) relative to newer and more recently traded properties — not to mention much-needed billions (estimates vary) in new revenues in a state relying too heavily on volatile income taxes. Indeed a split-roll would almost certainly increase the property tax component of overall revenues, implying greater reliance on a more stable source than sale or income taxes, says University of California-Davis Economics Prof. Steven Sheffrin, who has also analyzed the potential impacts of altering Prop. 13 provisions.
It's also a matter of fairness to some degree, he adds, as the greatest impacts would fall mostly on owners of older properties that haven't sold for long periods and are hence assessed at small fractions of market values.
Newer properties, and those sold more
recently, for the most part are already assessed at far closer to
actual market values. Hence their owners wouldn't be compelled to pass
on significant rent hikes in order to maintain a reasonable income
stream, Sheffrin says.
— BB
Vacancy Rates Around the State
|
| 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | 2009* | 2008 2Q | 2009 2Q |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Los Angeles | 3.7% | 4.3% | 4.1% | 4.0% | 3.0% | 2.7% | 2.4% | 2.8% | 4.5% | 6.6% | 3.5% | 5.7% |
| Oakland/East Bay | 4.9 | 7.2 | 6.6 | 5.5 | 3.6 | 3.1 | 4.0 | 4.3 | 5.5 | 7.9 | 5.0 | 6.8 |
| Orange County | 3.4 | 4.0 | 3.8 | 4.0 | 2.6 | 2.8 | 2.9 | 2.7 | 4.3 | 7.2 | 3.2 | 5.7 |
| Sacramento | 5.2 | 4.9 | 4.9 | 5.2 | 4.6 | 4.1 | 4.7 | 6.2 | 7.9 | 11.2 | 7.1 | 10.0 |
| San Bernardino/Riverside | 7.7 | 7.0 | 6.1 | 6.5 | 7.1 | 5.0 | 5.7 | 6.7 | 8.8 | 11.8 | 7.9 | 10.6 |
| San Diego | 3.3 | 3.9 | 3.6 | 3.3 | 2.9 | 3.1 | 3.2 | 3.3 | 3.8 | 6.1 | 3.4 | 5.3 |
| San Francisco | 2.9 | 4.8 | 4.1 | 4.2 | 4.1 | 3.7 | 3.8 | 4.2 | 3.9 | 4.4 | 3.9 | 4.1 |
| San Jose | 3.1 | 3.3 | 4.2 | 4.4 | 2.6 | 3.8 | 3.3 | 3.2 | 3.9 | 6.0 | 3.1 | 5.0 |
| U.S. Metro Total | 5.9 | 6.8 | 6.9 | 6.8 | 6.6 | 6.5 | 6.9 | 7.2 | 8.4 | 10.5 | 7.8 | 9.5 |
| * Forecast | Sources: Marcus & Millichap Research Services, CoStar Group, Reis | |||||||||||
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