Why there are vacant lots in Los Angeles

Have you ever wondered why there are vacant lots in Los Angeles? Blame Prop 13.

Proposition 13 is an amazing law for California property-owners. Passed through CA’s referendum process in the late 1970’s, Prop 13 sets property tax at 1.25% of a property’s original purchase price and restricts increases to 2% per year (until the property is sold).

What caused CA voters to pass this law?  CA property values were increasing very rapidly at that time. People who had bought little bungalows in the 1940s were suddenly “house-rich” and getting hit with rapidly increasing tax bills. Led by Howard Jarvis, property-owners got together, organized, and passed Prop 13 to limit the amount by which their taxes could increase.

Among the unintended consequences of Prop 13 is the underdevelopment of valuable land. Check out this map of the area just south of Wilshire on La Brea (near where I live):

See in the picture where it says “New Condos”? That’s a huge multi-use development project being built on the southeast corner of Wilshire and La Brea. BRE (a big real estate development company) is investing a ton of capital here on the assumption that many people will want to live in this improving part of Miracle Mile.

Now, see where it says “Car storage” on the pic above? Here’s an closer, overhead picture of that lot:

In real estate, we have the concept of “highest and best use” of a piece of land. The multi-use development is an example of the highest and best use. On the other hand, the owner of this lot is using it for car storage, which may be the lowest and worst use. Why is this happening?

To understand, consider what would happen if Prop 13 didn’t exist. The total size of the lot is 11,545 sq ft. and its zoning is C2. C2 can be used as R4 (400 sq. ft. per unit), meaning that the owner could develop 11,545 / 400 = 28 units on this land (you round down in zoning calculations). Even at a bargain price of $50k / unit, the land is worth $1.4MM. If it were taxed at 1.25% of value, the annual tax would be $17,500.

Ah, but Prop 13 does exist. Because the owner has owned this lot since at least the mid 1990’s (and possibly since 1973 – the public records aren’t clear), the total assessed value for the purposes of calculating property tax is roughly $239,000. The owner paid around $3,500 in tax in 2011; effectively, nothing.

From the owner’s perspective, as long as he believes the value of his land will increase by more than the 2% per year maximum tax increase (a pretty low hurdle, given that long term inflation is over 2% / year), there’s zero urgency for him to develop it.

Have you ever wondered why you can easily find big, vacant lots in Los Angeles, despite the fact that this is a huge, vibrant city with tons of demand for housing, offices, retail, etc.? This is one of the biggest reasons why.