Hi! I'm a new member trying to decide whether to sell a rental property and would appreciate any opinions.

The property is a SFR in San Francisco. It has 2/1 upstairs in the main house and 2/1 downstairs as an illegal in-law unit at the ground level. We purchased it last fall for $605K and the whole house was rented at $3000/month. The goal for purchasing the house was to move into it when we retire and live for free on the income from the in-law. (We thought we would be able to rent the in-law to tourists, ala airbnb, but SF has shut down that option.)

SF just approved legislation to allow in-law units to be legalized, but the actual process to follow through the building department has not been defined yet. All the tenants just moved out, so we need to decide whether to re-rent it or sell it.

Option 1: Rent out the top half and try to legalize the in-law

Since the in-law is illegal, we don't want to rent it out to 2 different tenants. Our lawyer already explained to us that tenants in an illegal unit can successfully sue you for all the illegal rent they've paid you. Your neighbors can turn you in to SF who will make you strip the illegal unit down to the studs (if the space was constructed without permits) plus paying huge fines for doing construction without a permit. The fines apply even if you bought the house that way.

The previous owner had rented the whole house to a master tenant who had in turn sublet the in-law to another family (not allowed in the lease by the way). We think we could rent out the 2/1 main house for $2500/month and leave the in-law empty while we wait for the city to finalize the process to legalize in-law units. Because the in-law was built with permits, except for the separate entrance and kitchen (added after the inspection), we think it's likely that it would be approved as a legal unit.

One problem with this plan is that we can't cover our mortgage + property tax ($2700) with the rent from the top half alone. We don't know when we could start renting the in-law, so we could lose money for a long time. Another issue is that if I legalize the in-law, the property will be permanently under rent control. I'm okay with that except that it will make it nearly impossible to get the tenants out if I need to sell it later.

Option 2: Remove the in-law kitchen and rent out the whole house

Even though the house is set up as 2 units with 2 front doors, 2 back doors, 2 kitchens, I could remove the lower kitchen and rent the whole house to one master tenant with roomates. I think we could get around $3200 for the house under this arrangement.

This plan would keep us from losing money in the short term, but we could get quite a bit more per month if we wait to rent it as 2 units. One problem is that it would be so easy for the master tenant to put a stove back in the in-law and sublet it again without our approval. (The master tenant who just moved out was subletting the in-law for $1700 despite the lease agreement.)

Option 3: Sell

The legal trickiness of renting this property plus the pro-tenant laws in SF make us think that we made a mistake in buying it. We don't have enough income to qualify for a third mortgage, but we could sell to get our downpayment money back and buy a true duplex or triplex in the East Bay for about the same price. Since we haven't owned it more than a year, we don't qualify for a 1031 exchange. The market is very hot in SF right now, so we think we would get all our money back but not make any real profit after the real estate agents took their cut. Does 1031 even matter if you're just breaking even on the sale?

Any opinions would be appreciated.

Thanks!

Elizabeth