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Upside and downside of investing in multi-units in San Francisco

A reader asks: I am thinking about buying multi-units in San Francisco as an investment and renting them out for income as well as building equity. Do you think this is a good idea?

Our answer: Buying multi-unit buildings in San Francisco for rental income is a challenging because of several factors. First of all, San Francisco properties are governed by rent control which restricts yearly rent increases to 60% of the CPI (consumer price index) and allows some tenants to be “protected”…. in other words they cannot be evicted even if you, as the owner, wants to live in their unit. (There is what’s known as the Ellis Act which is explained briefly in an article on the San Francisco Tenants’ Union which also has a link to a PDF of the actual law.) However, the Board of Supervisors is pro-tenant and tries to discourage individual ownership of units by passing laws that prohibit owners from converting their units to condos if there is more than one eviction. Go to the City of San Franciso webpage and do a search on condo conversions; you will see all the laws that are being proposed or that have been passed to limit the amount of condo conversions being done. Needless to say, there is too much to cover in the space we have here!

You might ask, why would a city government be anti-condo conversion if the producing of more real estate properties adds to the property tax base and increases the city’s revenue? Good question. At this time many building owners do not live in San Francisco so there are more renters who vote. Given this dynamic, I think you understand who the politicians tend to cater to. The San Francisco Tenants Union is one of the most powerful lobbying forces we have. Fortunately, the San Francisco Association of Realtors (which tends to be more pro-property rights) is another strong lobbyist.

Another reason your idea is challenging (you thought we forgot the question, didn’t you?) Many of the units sell for a large gross multiplier which means you will not get positive cash flow unless you put more than 50% down. And in that case you lose the advantage of the normal leveraged investment that real estate normally provides. Horizon Financial Associates has an article from 2004 which explains leveraged investments rather nicely.

So what do investors do? Therefore, investors in San Francisco Real Estate depend upon appreciation to recapture their investment. That appreciation has been due in part during the past few years to reselling multi-unit buildings as TIC’s (Tenancy – in – Common) and/or doing conversions to condominiums. However, with the passage of the new law mentioned above, it undermines the ability of owners to vacate their buildings so they can sell the units individually. (Owners have been using the Ellis Act to be able to deliver vacant buildings to potential buyers or sell to individual parties as TIC’s.)

So before buying any units as investments, analyize the current income, understand that any increases will be limited by rent control, and have a good attorney to talk to when and if you have tenant issues. I would never suggest you negiotiate with any tenant without using an attorney who specializes in tenant/landlord issues. Tenants have successfully sued well meaning landlords for simple misunderstandings. Also be sure to have good insurance with protection for tenant issues. As we like to tell our clients: “It’s not how much money you make, it’s how much money you keep”.

Note: Since we wrote this article, we found details on the condo conversion process from legal consulting firm G3MH which we have downloaded to our website in PDF format. We hope you find this useful.

– Mick Orton and Janis Stone

San Francisco Real Estate housing bubble and renting versus buying!

A reader asks: I keep reading in newspapers and magazines about a San Francisco housing bubble and wonder if I should buy now or just keep on renting. What is your opinion?

Our answer: About our San Francisco Real Estate market… You’ve heard of supply versus demand? Low supply and high demand equals a great seller’s market. The San Francisco Real Estate market is somewhat unique to other places in the United States in that there are a lot of factors that help create a strong market. One is that there are not many places to build. San Francisco is land locked by the bay on the north and east sides, the Pacific on the west and incorporated cities to the south. And because the city government is so restrictive, it is hard to get building done, thus decreasing the supply. With lots of cultural events, beautiful architecture and great weather most of the year, San Francisco is a much sought after place to live. This increases the demand. These two facts keep the San Francisco Real Estate market in pretty good shape most of the time. (Check our website to look at our history of market reports to see the numbers for the past several years and you will see what we mean.)

Now for the bubble. What bubble? What we have been experiencing with soaring prices, multiple offers driving home values up and up; this is not a normal market. Up until recently, the average marketing times for properties have been anywhere from hours to 10 days to 2 weeks! And over asking price sales have been common. When a frenzied pace like this begins to slow down, it’s easy to assume that there is a bubble as things settle back toward a “normal” market.

As of this writing, according to the Realty Times in its June 16th, 2006 edition (and other sources such as the California Association of Realtors have said it as well), marketing times in San Francisco and other hot areas are changing: “…The market has shifted from a Seller’s market to a more normal market, requiring 6 months or more to sell a home, far removed from the market of just a year ago. With 5-6 months worth of inventory, price negotiations between buyers and sellers are common place…” This actually could mean that buyers have move leverage than they have had in the recent past. Our suggestion? Make an offer!

In our opinion, there is no reason to rent when you can buy, as long as you buy something you can afford. Here’s what Fox News contributor, Jonas Ferris, said in a March 2005 article on MaxFunds.com, “The main reason investors should worry about real estate bubbles is this: most experts say that real estate bubbles are simply impossible…” and about buying versus renting and investing in real estate he says, “…There are three main reasons real estate has generally been a successful investment for most people: 1) by buying a home, investors are effectively paying themselves rent 2) a mortgage is essentially a forced savings program paid into each and every month 3) because of the nature of the investment, real estate investors tend to avoid the poor decisions they make when they invest in other major asset classes…”

– Janis Stone and Mick Orton

How can I change my credit score to help me get a better rate on my loan?

A reader asks: Recently I was denied a loan because my credit score was lower than the lender wanted to see. I got my credit report from Free Credit Report but could not tell from what I saw that thing that was hurting my score. Do you have any suggestions?

Our answer: We posted a little explanation about how the reporting agencies work in our September 2005 market report which came from our friend and associate, Jay Bransfield. It showed how different factors are weighted to come up with your credit rating.

Most recently, Dennis Kowalski of Princeton Capital introduced something new and really exciting for those who have been turned down for loans or had to accept higher rates due to their credit rating. Princeton has a new CREDIT SIMULATOR which they use to show how people might improve their credit rating if they, for example, paid off their credit card debt or made other financial changes to their credit report. Call him at (415) 229-1241 for details!.

– Mick Orton, Dennis Kowalski and Jay Bransfield

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