Thousands of office tenants across Los Angeles County are getting hit with huge property tax increases, and some of them face exponentially larger bills they aren't prepared to absorb.
Thanks to California's Proposition 13 which essentially pegs property taxes to the transaction price office properties that hadn't been sold in a long time had enjoyed tax assessments far below the property's actual market value.
But lately, the volume of office buildings trading hands hit record levels and record prices. As these buildings sell sometimes for five times the previous selling price property taxes increase proportionally. Tenants feel the sting because landlords are allowed to pass along property taxes, unless a lease explicitly prohibits them from doing so.
The Alzheimer's Association of Los Angeles, Riverside and San Bernardino Counties is facing a $37,350 increase in its tax bill this year because its building at 5900 Wilshire Blvd. recently traded hands.
"If we can't increase our contributions to cover the increase we'll have to decrease our staff by one person," said Derek Dewees, the group's director of finance and administration.
Dewees said the property tax increase is putting pressure on the Alzheimer's Association on another tax front. The I.R.S. requires non-profits to use more than 75 percent of revenues for services. The higher tax rate is increasing the group's overhead costs and taking away from the amount it can spend on providing services.
Also troubling for the Alzheimer's Association is that it had no control over the sale of its building, and therefore no way to plan or budget for the possible tax implications.
"To find out half way through our fiscal year that we are having this huge increase is very difficult to deal with," Dewees said.
The situation is now coming to the fore because last year office buildings with a cumulative 22.7 million square feet or about 12.4 percent of the total office stock in L.A. County traded hands for $5.1 billion, according to Grubb & Ellis Inc.
"These sales are causing incredible increases in property tax bills," said Mike Catalano, a senior vice president at brokerage Studley, who said he has been getting numerous calls from concerned tenants. "The financial impact can be great."
Thousands of tenants will receive higher tax bills because of the sales. In one such transaction, Maguire Properties Inc. sold a portfolio of office buildings including One California Plaza on downtown L.A.'s bunker hill for $1.2 billion.
Maguire is retaining a 20 percent ownership and will continue to manage the buildings.
Regardless, Maguire spokeswoman Peggy Moretti said tenants in those buildings will face higher tax bills as a result of the deal. The company, which requires all its tenants to pay property taxes, is still calculating how much of an increase tenants face.
"Ultimately it's out of our hands," Moretti said. "Unfortunately it's the law."
This year an even larger number of office tenants could be affected, as the transaction volume is expected to be even greater.
That's mostly because Arden Realty Inc. the largest owner of office buildings in Los Angeles County is selling its 18.5-million-square-foot portfolio to a real estate division of General Electric Corp. and Chicago-based Trizec Properties Inc. for a price tag close to $4.8 billion, including assumed debt. There are about 3,000 tenants in the portfolio.
"This is becoming a very big issue," said Gary Weiss, a principal at Madison Partners, who specializes in representing tenants.
"Over the last five years the market has really heated up and more and more tenants are being affected."
Ever since voters approved Proposition 13 in 1978, office tenants in California have periodically found themselves paying substantially higher tax rates as office buildings churned during different real estate cycles.
In the late-1980s, many L.A. tenants were hit with higher bills because the region's real estate cycle was at the top of the market. Japanese investors were streaming into the market and paying huge sums for premiere office buildings.
However, the real estate market bottomed-out during the deep recession of the early-1990s, and many owners held onto their properties, waiting for values to climb back to break-even level.
Similar trends played out in Northern California during the dot-com bubble of the late-1990s.
Now, as L.A. real estate values have risen to their highest in more than a decade, many properties that were purchased at the top of the last real estate wave are among the recent sales, which are easily topping the last boom.
"This happens whenever there is an up cycle," said Tony Natsis, a partner with the Century City law firm Allen Matkins Leck Gamble & Mallory LLP, which has represented numerous tenants in landlord negotiations.
"But at these prices today, we're seeing hikes of Biblical proportions I mean real monster hikes."
Just how high are these tax bills getting? Many times it depends on how long it's been since the office building last sold.
Take the sale of 9465 Wilshire Blvd., a 9-story Beverly Hills office building purchased in September by a partnership of New York-based property manager George Comfort & Sons Inc. and Morgan Stanley Real Estate for $135 million.
The previous owner, Guess Inc. co-founder Georges Marciano, paid $27 million for the property 12 years earlier. Tenants in the building, such as Imagine Entertainment Inc.'s Imagine Films, are the hook for the increase.
Last year the tenants split a tax bill of about $292,000. Next year they'll split $1.6 million.
The same situation is true for tenants in the Wilshire Courtyard, an office complex on Wilshire Boulevard's Miracle Mile. A 90 percent stake in the property was purchased last fall by German fund manager RREEF Funds LLC for about $360 million.
Before RREEF, the complex had been purchased for about a third of the price by San Mateo-based real estate investment firm Stockbridge Capital Partners LLC. Tenants in the buildings will have to split a nearly $190,000 increase in the two buildings' property tax bill.
Tom McCarthy, a principal in McCarthy & Cook Co., which owns a 10 percent stake in the property and has managed the buildings under both Stockbridge and RREEF ownership, declined comment.
(The Los Angeles Business Journal is among the tenants in the Wilshire Courtyard complex.)
Of course, the Alzheimer's Association knows all too well about the sale of its building at 5900 Wilshire Blvd. In November, developer Wayne Ratkovich purchased the 32-story Miracle Mile skyscraper for $105 million.
The prior owner, R.M.R. Properties, had paid about $20 million for the property nine years earlier.
Tenants in the building are cumulatively facing a nearly $950,000 higher property tax bill.
The sudden change is putting the Alzheimer's group and other tenants in a tough bind.
"I would rather see our taxes go up to market value every year because then there wouldn't be any surprises," Dewees said. "All the money we raise, we turn into program services. We can't take out a loan to see us through a tough time and we don't have the reserves."
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