California Dreamin'

A quick recap below shows the measures that failed in May:

• Proposition 1A: Increase required level of budget reserves and set a spending cap. Extend recent tax hikes for up to two more years.
• Proposition 1B: Restore $9.3 billion to schools if 1A passed.
• Proposition 1C-1E: Allow borrowing of $5 billion from the lottery earnings and reallocation of another $1 billion from children's and mental health.

Analysis of California's fiscal future in this post-ballot initiative environment requires an understanding of California's fiscal past. At the beginning of this decade, California was in a recession with the dot-com bust. Before the stock market crash, there were 44,000 households with adjusted gross incomes of over $1 million and after the crash there were 24,000 households with a $1 million, a 45% decline.

The state is heavily reliant on high-wager earners to contribute to income taxes and this contribution is volatile (related to stock gains, individual capital events). Legislators have projected non-recurring income into recurring mandates which has caused extreme volatility in how the state can balance its books.

The deficit and fiscal mismanagement has serious consequences for the state. It currently boasts the lowest credit rating in the Union at single A by Fitch and Standard & Poor's. Last year, California lost its 49th position to Louisiana. If the state loses its investment grade rating, it will have less access to capital as many bond mutual funds only want to buy investment grade rated paper and the cost of financing will increase.

The failure of the propositions, budget stalemate and the economic slow down have created a "tipping point" to revisit other sources of revenue—namely property taxes. Economists have argued that the starting point of this current crisis was started with Proposition 13 which capped property taxes 30 years ago. Famed investor and one-time California property owner, Warren Buffett, noted that the cap by Proposition 13 "makes non sense."

The cap on property taxes has made California more reliant on income taxes which are volatile in bad times. Structurally, Proposition 13 also has made increasing taxes an act that requires a super majority (66%) from both the Assembly and State Senate (47 other states require a simple majority).

The proposed reformation of Proposition 13 is to split the assessment on homeowners and commercial property owners. The Split Roll presumably would lower the property tax burden on homeowners and help close the gap on underpaying commercial property owners by removing the Proposition 13's cap of assessed value on commercial real estate. Given the economic downturn, the County of Los Angeles alone is expecting 333,000 home homeowners to have a downward adjustment on their home values leading to an anticipated drop of $440 million in property tax revenue. This fiscal reality is being played out in multiple counties across the state.

Although details from the Split Roll are slowly coming forth, it would seem that this proposal really is trying to target buy and hold investors and owners of real estate. This proposal would not have made a dent during the capital fueled buying frenzy started by the Equity Office Properties Trust—Blackstone trades late 2006 and early 2007. When a portfolio trades hands for higher prices three times in a quarter, it is presumably good for property tax revenue from a government standpoint.

Owners and investors in commercial real estate should get engaged early in this discussion of reforming Proposition 13.

The views expressed in this article are those of the author and not GlobeSt.com.

Aden W. Kun is a principal with Silver Ridge Capital. He can be reached at akun@silverridgecap.com.