More than a year after a Los Angeles tax increase on property sales of at least $5.15 million took effect, local officials say it has generated nearly $500 million for building affordable housing, a main goal for one of the world's most expensive cities.
But property professionals say there's a big downside.
Commercial real estate executives are grappling with a new normal as the tax exacerbates challenges the city faces in recovering from the COVID-19 pandemic, entertainment industry turmoil and financing headwinds. The so-called mansion tax has added another expense to an already pricey market, and is driving institutional buyers and private equity from the city of Los Angeles, brokers tell CoStar News.
“Everyone is scared of LA" as a result of the tax, said Carl Muhlstein, head of MuhlsteinCRE and a former international director of JLL in Los Angeles.
The tax that took effect in April 2023 places a 4% levy, up from 0.45%, on property sales topping $5.15 million, and a 5.5% charge on deals exceeding $10.3 million. Property sales above $5.15 million have dropped by 70% since the launch of the tax, according to a study by the Sol Price School of Public Policy at the University of Southern California. That stands in contrast to commercial property transaction activity across the country that's forecast to be up by nearly 30% this year from 2023, according to a J.P. Morgan report.
The effects of the tax in Los Angeles may provide lessons for other cities watching from the sidelines as they consider enacting similar taxes to address housing challenges. Chicago voters this year rejected a similar tax on properties over $1 million, while Seattle voters recently approved a property tax aimed at helping low-income renters. Other cities such as New York and San Francisco have also increased their property transfer taxes to go toward affordable housing, while Boston is considering a similar property levy, too.
In Los Angeles, some property owners have decided "they just don't need to sell," said Chris Jackson, CEO of NAI Capital Commercial. “It’s like a second commission that they have to pay,” Jackson said, adding that the tax "is doing the opposite of what the city thought it was going to do.”
Supporters of the tax tout it as a Robin Hood move — taking from wealthy mansion owners to fund affordable housing, with more than half of the $443 million in funds generated from the tax so far stemming from high-end home sales. About 42% came from commercial sales.
"We have raised $440 million that otherwise would not have materialized to address the greatest existential crisis of our time: housing insecurity and homelessness," said Greg Good, the director of strategic engagement and policy at the Los Angeles Housing Department, who helps coordinate as part of a six-member committee the implementation of the funds raised through the levy.
Some of the money is already being spent to keep at-risk citizens from being evicted and "unsticking" stuck affordable housing developments with capital injections. The tax measure, officially called ULA, or United to House LA, after the referendum that created it, passed with 58% approval of LA voters in November 2022.
The measure "has helped prevent people from being evicted and being on the street," Good said during the first anniversary meeting of the ULA Citizens Oversight Committee.
Chilling effect
While a number of cities across the country remain in recovery mode from lower real estate demand caused by the pandemic and higher interest rates, the transfer tax is keeping Los Angeles from making a quicker rebound, real estate professionals say.
Los Angeles has struggled to maintain its former status as one of the country's top office markets for investment after the pandemic sent office vacancy to historic highs of more than 16%, up from 10% in early 2020 and above the current national average of 14%.
Job losses in the entertainment and tech sectors have also restrained demand for offices and apartments, with the city ranking below other major U.S. metropolitan areas for those property types, according to a CoStar market analysis. Investors are already wary of labor costs, perceived high crime and regulations, and have pulled back on new development in the city, analysts say.
"For those considering deals, expected returns must be attractive enough to offset these concerns," said Ryan Patap, CoStar senior director of market analytics for Los Angeles.
These more established buyers have historically accounted for almost 30% of Los Angeles office acquisitions; that has dropped off to about 20% in the past year, according to Patap.
The transfer tax has contributed to significant year-over-year sales declines across property types as of the third quarter, with industrial sales down by 63%, office down by 45%, retail by 33% and multifamily down by 15%, according to NAI Capital Commercial research.
This led to a 40% year-over-year drop in total commercial property sales through the third quarter, or $1.9 billion below the total during the same period last year in the city of Los Angeles, according to the firm.
Frustrated with being dismissed when mentioning they're from Los Angeles, some local commercial real estate executives say they now tell colleagues they're from Southern California when pursuing deals, Carl Muhlstein said.
“It’s scaring lenders, it's scaring developers, it’s scaring everyone,” Muhstein said of the transfer tax.
Sitting on the sidelines
Some owners aren't putting their properties up for sale because they can’t make a profit under the tax, said Sean Fulp, a vice chair and head of office capital markets in the Southwest for Colliers.
Potential profits are down by about 20% because buyers and sellers must underwrite assets at lower valuations to account for the transfer tax, Fulp told CoStar News.
“Owners have done the work, and they’ve added value. They’ve repositioned the asset, but they're not seeing it in the valuation and so they're stuck," Fulp said. "So, they just have to hold it until somebody dies or there’s a major reversal.”
As maturations come due, more of these owners are forced to give in and pay the tax, he added.
"It’s either going to be the new norm and people just have to deal with it if they're going to sell their property, or they decide they don't need to sell.”
Some owners are likely to pass on the added costs to tenants in the form of higher rents, said Jesse Gundersheim, senior director of market analytics for CoStar in Los Angeles.
That will particularly affect industrial building occupiers, tenants who typically pay all taxes and insurance in their lease, Gundersheim said.
The companies most affected by the transfer tax are developers and buyers who typically assume exiting their investment at some point when underwriting deals, Patap said. The tax is less concerning for private buyers, many of whom plan to own assets over the longer term, he added.
'Citizen-led, ballot initiative'
Between its 2023 launch and the end of this October, the Los Angeles Housing Department said the ULA transfer tax has raised $443 million. Next year, ULA administrators plan to spend millions on affordable housing.
"In order to be successful we had to do something that couldn't be done within City Hall," said Joe Donlin, director of United to House LA, who helped lead the push to write and pass the measure. "It could only be done if it was a true citizens-led, ballot initiative."
Los Angeles is under pressure from California to build 450,000 new housing units by 2029, half of them to be earmarked as affordable — or discounted rents reserved for individuals earning between 30% and 60% of the area median income — as part of statewide efforts to boost inventory and ease cost concerns.
“The housing crisis is acute, and there's no one that's not impacted by it,” said Michelle Espinosa Coulter, associate director of finance at the California Housing Partnership and chair of the United to House LA Citizens Oversight Committee.
Among its next-year efforts, the program will give $20,000 cash to 500 at-risk seniors and persons with disabilities to help them stay in their homes. The tax will also spend $6 million to prevent landlords from evicting tenants.
Moving forward
Higher transfer taxes on pricey property sales have been employed in various U.S. cities. In New York, for example, a roughly 2.6% transfer tax is charged on some commercial transactions above $500,000 in addition to a state tax on certain transactions above $2 million. In San Francisco, a transfer tax of 2.25% is charged on some properties selling above $5 million with larger taxes enacted on applicable properties selling above $10 million and $25 million.
While court cases to repeal the measure are still pending, a number of LA owners and developers say a sudden reversal of the measure is far-fetched.
“These things take a long time to change, but for now it feels like it’s the new reality,” Fulp said, pointing to a similar mansion tax measure passed in San Francisco in 2020 that is still going strong.
Kitty Wallace, vice chair at Colliers, said some edits could possibly be made to exempt more multifamily properties from the transfer tax.
"The best thing to do is to let people build things," she told CoStar News. "We need adjustments on policy instead of spending money" on these types of measures.