Blame California. (But Don’t Be Afraid To Invest Here).


Californians have gotten used to being blamed for many ills.  Some years ago, the good people of our neighbor state to the north were said to have erected billboards declaring “Don’t Californicate Oregon.”  Sadly, many Californians understood exactly what they were talking about, and far from being insulted, were none too crazy that our own home had already suffered from this malady.  We understood the derisive expression to mean overdeveloped, overcrowded, and, perhaps, increasingly “foreign,” particularly in comparison to our northern neighbors.  Oddly, our state was also become more expensive, even as the quality of life took a decided turn for the worse. 

Who in their right mind would stick around?

From a real estate perspective, the crazy price spiral of the earlier part of the last decade put local real estate investing out of the reach of all but the wealthiest Californians – those who could endure years of negative cash flow while waiting for a hoped-for appreciation to rescue their “investment” at some indeterminate point in the future.  Many Californians could no longer even afford to buy their own home (not that that prevented them from taking out a subprime mortgage to purchase one.)  Then, as you know, along came the financial crisis and the entire house of cards came tumbling down.

Back to Earth?

The silver lining, of course, is that investment property in California is no longer a wacky proposition.  To the contrary, a savvy investor (preferably armed with cash) can purchase properties that make sense from the first day of ownership.  The reason for this is that California has an amazingly diverse economic base.  The diversity of many of our neighborhoods makes them attractive to immigrants from many different parts of the world who enjoy living in proximity with others from their homeland, to say nothing of the amazing ethnic dining possibilities.   These immigrants are a key part of the state’s ongoing economic vitality, job creation and population growth – all of the elements that fuel low vacancy and long term price appreciation.

While California has some serious budget problems (largely caused by entrenched public sector employee unions, in my opinion), it also has a very favorable tax climate when it comes to real estate, thanks to the world-famous (but poorly understood) Proposition 13.

The Lingering Effects of Proposition 13

Prop 13, as it is commonly known, is more than just a law and affects more than just homeowners.  With Prop 13, the voters of the State of California actually amended the state constitution to limit the increases in property tax that could be assessed every year on commercial as well as residential properties.  Those limitations are so drastic that, given historical rates of property appreciation, long term investors pay tax on their investments on assessed values that are far, far below the market value.  Over time, real estate investors can benefit massively from this discount on one of the largest expenses of owning property.  Take Disneyland as an example.  According to a 2003 L.A. Times article, “It’s no wonder Disneyland’s owners call their amusement park the ‘happiest place on Earth.’ For much of its land, Disney pays only a nickel per square foot in property taxes.”   (Since the property has not changed hands, Disney’s assessment would barely have budged in the interim.)

Think you own your investment property?  Maybe you should think again.  If you don’t have Prop 13’s protections you are really just renting it from the government, and always remain at the mercy of tax officials.  Just ask folks in Montana, like those of many other states, where “oldtimers” have been “gobsmacked” by soaring property taxes — with sometimes as much as a 1000% increases being assessed.

Of course, they probably blame Californians, too.  Don’t worry – we won’t take offense: we’ve gotten used to it.

Photo: Lee Coursey

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