Redlining Los Angeles

Redlining Los Angeles


It’s been six months since Measure ULA went into effect, and one thing is certain: sales volumes are dramatically down. In addition, many developers are looking to do more work outside of Los Angeles because of it. 

Enacted on April 1, Measure ULA, which stands for United to House L.A., is a tax on all real estate sold at or above $5 million in the city of Los Angeles, which includes most of the San Fernando Valley. The tax received 58% voter support to pay for new homeless support, requiring sellers of properties valued at $5 million to $10 million to pay a 4% tax to the city and sellers of properties at or above $10 million to pay 5.5%.

“A lot of owners who would be potential sellers aren’t selling,” Greg Geraci, an executive vice president at Colliers and a Valley industrial specialist, said.

Proponents of ULA dubbed it the “mansion tax,” arguing that it would essentially take from the rich and give to the poor, but the tax is much more complex than that and affects all types of real estate. Its passage has tanked sales across all asset types, with commercial properties such as multifamily, industrial, office and retail being hit especially hard.

“I don’t think voters understood what they were voting on,” said Sean Burton, chief executive of Cityview, a multifamily investment management and development firm based in Century City. “Voters were told they were going to tax millionaires and billionaires on expensive mansions and take that money and use it to build more housing for thehomeless. And in fact, that’s not at all what it does. That’s one aspect of it. But it’s a tax on any sort of real estate, including any sort of new housing, which has led to the redlining of Los Angeles with investors and developers.”

By that, he means builders and developers are shunning Los Angeles altogether because it’s no longer an economically viable city to invest in, creating a kind of modern-day version of redlining, leading to staggering drops in sales. In the first quarter of this year, commercial real estate sales on properties valued at over $5 million hit $2.4 billion. In the second quarter, starting when ULA went into effect, sales plunged to $260 million. And in quarter three, sales increased only slightly, reaching $300 million, according to data from Colliers.

“The transaction volume has fallen off,” Sean Fulp, vice chair and head of office capital markets at Colliers, said. “We’re operating at a transaction volume that’s roughly 15% to 20%, optimistically speaking, to where it was a year ago.”

And while multiple factors affecting the current market climate – such as higher interest rates and the work-from-home trend – make it difficult to pinpoint exactly how much of this dramatic drop can be blamed on the measure, experts agree that the tax has played a big role in decreasing sales volumes. 

Asset breakdown

Sales are down across all asset types. In quarters two and three of this year, multifamily properties priced above $5 million sold for a total of $320 million. 

That’s more than 80% lower than the combined $2 billion sold between those same quarters last year, according to data from Colliers.

In the office market, in quarters two and three of last year the total transaction volume reached $199 million. In quarters two and three of this year, the total was $82 million, according to Colliers.

“Most people feel like (ULA) has been a disaster and it was a huge mistake,” David Solomon, a senior executive vice president at Colliersspecializing in the Valley office market, said. “It’s one more thing of a number of macro factors that are impacting office buildings.”

Industrial properties really got whacked. They sold for a combined $594 million between quarters two and three of last year. This year, sales were at just $37 million. That’s down more than 90%.

Geraci called $5 million an “easy number to reach in industrial real estate. It’s nicknamed the mansion tax, but you’re not talking about a mansion of an industrial building to hit that kind of number. It could be as small as a 10,000- or 15,000-square-foot building, which is a small property.”

Retail properties also suffered a 90% drop. They generated $496 million in sales across the two quarters last year, compared to only $49 million this year, according to the same Colliers data.

“It’s lost revenue,” Shlomi Ronen, founder and managing principal of Dekel Capital, a Century City-based investment real estate firm, said. “You’ve got billions of dollars of transactions that are not happening as a result of this tax. There’s a multiplier effect.”

Another asset type being impacted by Measure ULA is hotels. During the third quarter of last year, Los Angeles County had 13 hotel sales priced above $5 million.

In that same period this year, no hotel sales subject to ULA were recorded during the third quarter, according to Atlas Hospitality Group

And in the second quarter of last year, Los Angeles County had 20 hotel sales priced above $5 million. In quarter two of this year, the only hotel sale in the city of Los Angeles above $5 million was the $760 million foreclosure sale of the Fairmont Century Plaza, a 394-room luxury hotel located in Century City and acquired by the Reuben Brothers.

“If you foreclose on a loan, and that loan is over $5 million, you pay the ULA tax,” said Alan Reay, president of Atlas Hospitality Group. Reay has been tracking California hotel sales for over 20 years. “No one’s really bringing this up, but that’s a big issue for lenders making loans in Los Angeles right now.”

Reay said lenders are rethinking the choice to make loans as a result. In the case of the Fairmont Century Plaza, 5.5% of $760 million is $41.8 million.

“ULA is a tax that you pay even if you lose money on a project,” said Burton. “Usually, you pay taxes on your profits.”

Measure ULA is nonrestrictive and is imposed even on the sales of properties conducted with a 1031 exchange,a tax break which allows sellers of properties to reinvest their proceeds into a replacement property with no immediate tax consequences.

According to Reay, many hotel owners will likely delay selling, or forget selling altogether and switch to leasing, because of it.

“It’s basically really shut down the market,” Reay said.

‘Completely misguided’

“The concept of taking care of homelessness is near and dear to me,” said David Prior, senior managing principal at The Klabin Co., a Torrance-based commercial real estate firm specializing in industrial assets.

Prior’s brother died in November after being homeless for 30 years on the streets of Venice. “(Homelessness is) a pervasive issue,” Prior said. “(However) I think the intent is completely misguided.”

Intentions aside, with transactions pretty much at a standstill, the city has not been generating nearly the revenue it sought to achieve with ULA.

In the first four months since the tax was enacted, the measure raised roughly $55 million, according to city officials. That’s 25% of that period’s projected revenue needed to reach the $672 million goal within the tax’s first year.

In August, the City Council approved a plan for spending the first $150 million in Measure ULA funds, but since the tax had raised only $55 million the city pulled from other pools of income in order to meet its promised deliverables.

“There was a lack of information and communication and understanding of what it was that voters were voting for,” Solomon said. “It sounded great on paper to a bunch of people. But it wasn’t really thought out. And the impact has not been nearly what they anticipated.”

However, regardless of where the money came from, only a third of that budget will actually go toward the production of more affordable housing and none will help subsidize  costs to encourage more production.

The remaining two thirds will go toward programs including an eviction defense and prevention program, a short-term emergency assistance program for low-income tenants, a tenant outreach and education program, a tenant harassment protection program and rent subsidiary programs for low-income seniors and people with disabilities.

“The government policy with homelessness is mercurial,” Prior said. “It’s very difficult. Believe me, I lived with it for a long time. But the solution isn’t to tax people and spend more money. I don’t know what the answer is. But this is not it.”

Since April, multiple lawsuits have come forth challenging Measure ULA, including a combined dispute from the Howard Jarvis Taxpayers Association and the Apartment Association of Greater Los Angeles.

“If this unlawful tax is allowed to stand, it will be the last straw that will cause property owners to invest elsewhere and never come back to Los Angeles,” Dan Yukelson, executive director of the apartment association, said in a statement at the time of the suit.

Looking ahead

While it’s been only two quarters since ULA took effect, many real estate experts agree that sales aren’t going to pick up anytime soon.

“Activity will stay muted as long as ULA remains in effect,” Fulp predicts. “Anytime you change policy, that brings uncertainty. And investment markets do not like uncertainty.”

And that seems to be the case, as many top-level investors and property managers now say they are looking to invest in markets outside of Los Angeles.

“You have investors who are avoiding Los Angeles because they base their pro forma analysis on a purchase with an exit strategy,” Geraci said. “We’re having conversations with investors that are saying, ‘I’ll look into Ventura. I’ll look into Burbank. I’ll look into other cities within the county, but avoid the city of Los Angeles just because of the extra cost’”

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