Los Angeles voters approved Measure ULA in November of last year, a proposition that will create a new tax on real estate sold for $5 million or more. According to the proposition, the tax proceeds will be used to fund new affordable housing projects and homelessness initiatives. Initial estimates expected more than $650 million in additional tax revenue. While most of the headlines are focusing on high-end single family homes, including a recent New York Times article, the tax will impact all real estate asset classes, including multifamily, office, retail, industrial and more.
The bill, dubbed the “Mansion Tax,” passed by a significant margin and went into effect April 1st for all real estate sales in excess of $5 million. While there are some exemptions, including sales to non-profit entities and limited-equity housing cooperatives, most multifamily assets in Los Angeles will soon be subject to a tax of either 4% or 5.5%. The larger tax rate is for transactions over $10 million, which almost all professionally managed apartment buildings will exceed. For reference, Los Angeles multifamily transactions averaged nearly $500,000 per unit last year.
New Tax Impacts Sellers, but also Developers Long Term
Measure ULA will have a significant impact on LA multifamily, not only for existing owners looking to sell their properties but also for developers looking to build and buyers looking to acquire in the city. Los Angeles is already dealing with significant building regulation and rent control challenges and will now have to work through new taxes that will make its property transaction tax among the highest in the nation. The immediate impact will likely be felt on property sellers, but further impacts will be felt as the development continues to slow. According to Derrek Ostrzyzek, Managing Director of Investment Sales at Berkadia, “the window to sell multifamily has passed. If you don’t have to sell, you probably won’t sell in the coming months.” Some deals came to market in the immediate aftermath of the measure passing, with sellers and brokers trying to close well before April 1st; however, only a few transactions have made it to closing.
We are already starting to see some deleterious effects of the measure. According to Radix data, net effective rents in Los Angeles are down 1.1% since the measure passed in November. By comparison, rents in the nearby Riverside MSA grew 1% over the same period. In the 12 months preceding November 2022, rents in LA had increased by 4.4% while only growing by 0.8% in Riverside. There are likely other factors impacting rent, but the existing trend and recent underperformance in LA do not bode well for owners.
Developers are taking note as well and beginning to cancel projects. Data from BuildCentral shows 71 cancelled projects that were initially planned for development in Los Angeles. There are also 48 projects in various planning stages that have not yet broken ground. If developers are not too deep into the pre-construction process, many of these may be put on hold or cancelled. Local developers and investors who want to stay in Southern California will likely look to Riverside, Orange County, or San Diego as more attractive places for investment. “Developers and their equity partners are looking outside Los Angeles, as local regulations mount,” said Ostrzyzek. In addition to Measure ULA, the high cost of building, difficulty increasing rent, and challenges around eviction have made LA less favorable for many builders.
Finally, the impact on property owners will be significant. Using data compiled from a number of industry sources, nearly $6 billion in multifamily assets traded hands last year in LA. While 2022 was a record year for transactions, four of the last five years, excluding 2020, saw more than $5 billion in assets transact. If LA transaction volume were to top $6 billion over the next 12 months, that would result in more than $330 million in taxes assessed to sellers. Let’s take, for example, a 200-unit property that sells for $500,000 per unit. The total transaction value would be $100 million, and the seller would pay a $5.5 million tax. Not only would that significantly cut into the seller’s return, but it would also impact the buyer’s return, they would need to include the future tax in their underwriting. With operating fundamentals cooling from record highs, rent control burdens in place, generationally high-interest rates, and operating expenses, any added tax will make deals hard to pencil on the buy side.
Other Local Cities May Follow Los Angeles
If local municipalities view the tax as a positive source of funding, similar ballot initiatives may arise, putting additional pressure on multifamily across California. While Riverside and Orange County may not have the homelessness challenges that Los Angeles has, cities like San Diego may see this type of tax as a strong way of generating revenue to combat homelessness.
I do not want to overlook the intent of this tax, as the funds will be used to address homelessness and affordable housing, two major issues that have grown in Los Angeles, especially in recent years. These challenges need to be addressed and should be addressed with public funds. With that said, the direct effect of this tax will likely lead to fewer transactions, less development, and declining valuations for LA multifamily. Los Angeles remains a Gateway market, with significant institutional and international capital deployed. With mounting challenges and regulations, investors will likely seek other markets for stability, liquidity, and growth potential.
