San Francisco Pocket Listing w/Rent Control: Deal or No-Deal

21 Replies

hello BP friends ... been MIA for a while and looking to get back in the RE groove of things, hoping to seek some advice on an off-market deal that was presented to me. It's a 3 unit bldg in the hot area of Bernal Heights, each 2BA/1BA, roughly 850 sq ft. Each unit has its own garage space and storage. Asking price is $1.6M. 

One unit is going to be vacant in the next two weeks, another is rented at around $2500, but the last seems to be protected at $1200. 

An RE mentor of mine suggests moving on this deal fast, securing it by any means before the seller decides to list it. The goal is to have it seller-financed as I have no cash left. But a trusted and respectable agent I spoke with suggests this isn't a bargain. He says if I decided to sell, it would be difficult to condo convert, thus selling as TIC only, but finding buyers would be difficult due to the protected tenant.

Based on Craigslist ads, the lowest 2/1 unit in Bernal is going for $3300, but with the two units under market rent I would be at a negative cash flow. 

Would love some perspectives here :)

Gotta agree with Armond on this one in that you being MIA for a bit coming back to pull off a million dollar purchase might be a little much for you....

Kudos,

Mary

Thanks for the suggestion so far. Can I enlist a Bay Area local that might have some insight

J. M., @minh le, @johnson h or anyone else knowledgeable on SF RE. 

I have until this evening to respond to the seller. Thank you!

Kris,

I know nothing about SF properties so I'm not sure if $533k/unit is reasonable.

@Amit M. might be a better person to ask. If it were me, I'd get in contract first. You will likely have 7/14 days to do your due diligence and still back out in one piece. 

How well do you know about the SF rent control laws? Can you increase rent through banked rent, capital improvement, debt pass through, etc to bring rents up? @Johnson H. also knows quite a bit about SF rent control laws so hope he will chime in soon. 

Good luck. 

Originally posted by @Mary B. :

Gotta agree with Armond on this one in that you being MIA for a bit coming back to pull off a million dollar purchase might be a little much for you....

Kudos,

Mary

Mary,

MIA and taking down a $1MM deal are two different matters IMO. I have a friend that I haven't talked to for 2-3 years. Just found out he bought a $3.5MM house for cash. We all knew he hit it big with Facebook, but who would have thought?

My family was invited to a friend's house last Friday. I've been playing tennis with this guy for over 2 years, and all I knew was that he lives in Fremont. He's a pediatrician and his wife is a CPA.  When we showed up at his house, we were like WTH? It's an 11,000 sq.ft. custom-built home in 2011. The 4-car garage ceiling was over 18-foot high so he and his friends can play badminton indoor.  I didn't know pediatricans and CPAs are getting paid that well.  I guess it's not prudent to make assumptions. 

Thanks @Account Closed ! Rent control in SF is a nightmare even with the Ellis Act rule. It's not cheap to remove a tenant even if you're in the right.  I'm told both tenants have had their max allowance on increase. The lower unit was paying only $900 and hadn't had a increase in over ten years. The seller finally raised it to the max just last year. 

My mentor is suggesting I offer full price on the condition that the seller finances 100% with interest-only payments at 4% for 10 years (based on a 30 year loan). I calculate I would only break even ($7000 estimated rent - mortgage, taxes and insurance). This doesn't factor in vacancies or repairs. The upside is the potential increase, should those two tenants move out (potentially $3500 x 3 units) and increase in property value. 

The building seems to be in very solid shape - outdated and small but in a highly desirable area (think tech/Google bus route). 

Hi Kris, if this is really near a Google bus stop and the units and building are in good shape, with the vacant unit I believe $1.6 million is about market price for the property. If this goes on the MLS, it will appeal to some buyers looking to owner occupy a unit.

The current tenants may leave tomorrow or they may never leave, that is the game in SF these days, you just never know. The deal becomes very interesting if you can get 100% seller financing. If you have other cash flow coming in and good amount of cash reserves, I think it maybe a good play. You are right that you wouldnt be able to condo convert until possibly 2024 and the only exits would be selling the property outright or selling each unit as a TIC.

It takes nothing for you to lock it up and you lose nothing if you cancel the contract within your due diligence period so I would listen to your mentor and lock it up and think about it some more. If you want to partner up on it or pass on it, please let me know, I would be interested.

hey!  California (Silicon Valley) Real estate broker and registered investment advisor here.  I would think hard and long about any 3 unit  property with one unit so far below market rent in a rent controlled environment.  That tenant has been there a LONG TIME and has a really sweet deal.  They will be an impediment every step of the way.  There is a lot of investment property around without that obstacle.  

Best of luck- Leslie

@Johnson H. yes it's in the heart of Bernal right off the most desirable part of Cortland. However  my cash reserves are not flushed at the moment. 

I do agree with @Leslie Pappas that this particular tenant isn't going anywhere anytime soon. 

With that said I'm really liking the fact this seems to be a solid building with only cosmetic needs in a great area. 

If I make an offer, would it be beneficial to use the selling agent to represent me as well (financially and/or otherwise)? And if my offer is accepted, how can one back out within the due diligence time frame (forgive the question; it's been a while since I've made an offer on properties). Thanks again to everyone!

I would work the numbers backwards as you would any other potential deal.

$2500 + $1200 + $3000 (expected rent on vacant unit) = $6700/mo gross rent

What is your ideal cap rate for the area and what would you be willing to pay for the income generated? Based on income generated and average CAP rate of the area (although not considered 5+ unit and commercial; what is it zoned as?) minus deferred maintenance expenses, is what I would offer. CAP rate in downtown SF near the Mission district I've found in the current market is at the most 5%. Based on that, the $1.6M is fair market value if there is no deferred maintenance.

Based on my experience, MFDs in downtown SF are difficult to sell unless fully vacant. And fully vacant MFD go for market value and above. If you can purchase this property at a significant discount, it might be worthwhile. Tenant buyouts are expensive in SF but are worth it if you can increase the value through the increase of the income generated from the property. Make sure you enlist a reputable RE attorney for tenant buyouts as there are legal ramifications (with all the rent control laws in SF) if not done properly. If you are able to get $3K from each unit totaling $9K, at a CAP rate of 5%, the property would be valued at $2.16M. Again this would depend on zoning and if the property is considered commercial property if you were interested in refinancing out.

Low ball the asking price and see what they say.  The worse they can say is NO and it would be no loss to you except time.

Good luck!

-Leo

Originally posted by @Leo B. :

I would work the numbers backwards as you would any other potential deal.

$2500 + $1200 + $3000 (expected rent on vacant unit) = $6700/mo gross rent

What is your ideal cap rate for the area and what would you be willing to pay for the income generated? Based on income generated and average CAP rate of the area (although not considered 5+ unit and commercial; what is it zoned as?) minus deferred maintenance expenses, is what I would offer. CAP rate in downtown SF near the Mission district I've found in the current market is at the most 5%. Based on that, the $1.6M is fair market value if there is no deferred maintenance.

Based on my experience, MFDs in downtown SF are difficult to sell unless fully vacant. And fully vacant MFD go for market value and above. If you can purchase this property at a significant discount, it might be worthwhile. Tenant buyouts are expensive in SF but are worth it if you can increase the value through the increase of the income generated from the property. Make sure you enlist a reputable RE attorney for tenant buyouts as there are legal ramifications (with all the rent control laws in SF) if not done properly. If you are able to get $3K from each unit totaling $9K, at a CAP rate of 5%, the property would be valued at $2.16M. Again this would depend on zoning and if the property is considered commercial property if you were interested in refinancing out.

Low ball the asking price and see what they say.  The worse they can say is NO and it would be no loss to you except time.

Good luck!

-Leo

 You are using gross rents as net operating income so you are overstating value by probably close to DOUBLE!!!!!

I know you probably love San Francisco and your property will hold its value and then some but consider in other areas you can as much as double your money within 18 months. I would be thinking of doing something like that first and then coming back to San Francisco and considering a similar deal . 

No matter how you look at it in real estate as in most businesses cash and credit are king. There is nothing like having enough money to do whatever deal you want and not be afraid. $1.6M and this deal is not going to cash flow for you. I think that is a given. You are going to tie yourself up on a big big maybe and if but your costs are going to be real and long lasting. If your cash is tight now it will get even tighter if you make this deal. 

Regardless of the type of financing you can get now , owner financing or not that debt will become and ball and chain around you ankles and all the time you will not be cash flowing and without the benefit of an empty building and being able to rent at market rates the property is also not going to go up in price. Buyers in San Francisco have to be savvy because of the high cost of real estate in your market and buyers will generally be an educated bunch as well. 

Originally posted by @Bob Bowling:
Originally posted by @Leo B.:

I would work the numbers backwards as you would any other potential deal.

$2500 + $1200 + $3000 (expected rent on vacant unit) = $6700/mo gross rent

What is your ideal cap rate for the area and what would you be willing to pay for the income generated? Based on income generated and average CAP rate of the area (although not considered 5+ unit and commercial; what is it zoned as?) minus deferred maintenance expenses, is what I would offer. CAP rate in downtown SF near the Mission district I've found in the current market is at the most 5%. Based on that, the $1.6M is fair market value if there is no deferred maintenance.

Based on my experience, MFDs in downtown SF are difficult to sell unless fully vacant. And fully vacant MFD go for market value and above. If you can purchase this property at a significant discount, it might be worthwhile. Tenant buyouts are expensive in SF but are worth it if you can increase the value through the increase of the income generated from the property. Make sure you enlist a reputable RE attorney for tenant buyouts as there are legal ramifications (with all the rent control laws in SF) if not done properly. If you are able to get $3K from each unit totaling $9K, at a CAP rate of 5%, the property would be valued at $2.16M. Again this would depend on zoning and if the property is considered commercial property if you were interested in refinancing out.

Low ball the asking price and see what they say.  The worse they can say is NO and it would be no loss to you except time.

Good luck!

-Leo

 You are using gross rents as net operating income so you are overstating value by probably close to DOUBLE!!!!!

 Doh!  You are correct, Bob.  I was likely half asleep when I wrote this last night.  After all the excitement from the Warriors/ Cavs game, I was beat!

Factor in the expenses and calculate backwards using NOI. This would be a good baseline for your offer.

1. Only real upside here is if the low rent tenant takes a reasonable buy out. Maybe agent can ask current owners if they've had that discussion with the tenant before. But I wouldn't be surprised if the tenants  are not interested. It's VERY contentious now in SF, especially in the mission district (which is next to bernal) with tenant dislocations. Basically your $1200 tenants will need to be willing to leave the city, so it'll be a big deal for them  

2. I can't imagine owners would want to self finance for 10 years at that rate. Why, when they can get all cash offers. And 100% financing?  They'd be nuts to do that. Even in 2009-2010 sellers didn't have to resort to that. 

3. Bldg may be in good shape, but I doubt it's been fully modernized and renovated. So I'm not thrilled with it at $1.6. And I doubt they would sell it for much less. 

As long as the layouts are decent, the units have decent light, etc., they will probably get 1.6 on the open market; probably from someone that will live in the vacant unit. This is an ok deal for someone who loves bernal and wants to owner occupy and hold it for a few years for appreciation...while they pray that the $1200 renters decide to move out 😅

Saving grace: is there independent garage parking for 3 cars?  Do the existing tenants get 2 spots, or are they yours?  At $250 each, that could add $750 to your income. 

Bottom line: not a great deal, but this is not a great market to be buying in either. 

@Amit M. thanks for the advice. I calculated he right price for a pure investor would be in the $1.2m range after expenses. Each of the parking spots are deeded to each tenant. One is currently using the space as a workout gym!

The idea of seller financing would be the seller avoiding a huge capital gains hit whereby she would only pay ordinary income on the installments since there is no principle involved until I make the balloon payment, or if she decides to sell the note. 

There's no doubt it will be purchased by a techie that loves Bernal. Personally I think it's too foggy at times and prefer Noe Valley for the same price. 

Thank you to everyone with their insights. I've decided to pass on this one and seek other opportunities. I should have another pocket listing coming to me located in the Castro. Hopefully it will be a different rent control situation. 

@Johnson H. PM Me if you are interested. I'll pass the agents name and number to you. He may have already listed it on MLS today though.

Kris, in my opinion, using the income approach with the cap rate is not the right way to value properties in San Francisco 4 units and less. There are different values for SFH, condos, duplexes, 3-4 units, 5-8 units (some would say there are niche pricing in 5 units and 6 units), and 9+ unit buildings because of different factors for each sector. The best way to value 3-4 unit buildings is using the sales comparison approach with nearby sales comps with similar attributes to the property. Although there isnt any equity in the deal, the terms make the deal interesting for me, PM on the way.

@Leo B. - I have not been able to find a true 5% cap rate property in San Fransisco excluding SRO's and buildings in the Tenderloin. Usually, the listing brokers cap rate is inflated and using more realistic numbers I come away with a 4% cap and lower. Where have you been finding these 5% cap rate properties, I would love to know!

I was looking at an off-market 4 unit apartment complex in downtown SF that was zoned NC-1.  Residential lending is 1-4 units and commercial is 5+ unit and above.  Speaking to a couple lenders, I was told that the zoning is non-residential and they would only lend based on commercial lending guidelines.

I had a realtor check comparables and they were all over the place. For this particular property, it was $1.5-$2.8M. The large variance in price was due to values based on CAP rates as I was told by the realtor. Maybe there are other lenders out there that lend on this as a residential, but I didn't go into further depth.

@Johnson H.

The properties I looked at at are off-market and direct from the owner.  The property described above was located in Hayes Valley.

Originally posted by @Account Closed :
Originally posted by @Mary B.:

Gotta agree with Armond on this one in that you being MIA for a bit coming back to pull off a million dollar purchase might be a little much for you....

Kudos,

Mary

Mary,

MIA and taking down a $1MM deal are two different matters IMO. I have a friend that I haven't talked to for 2-3 years. Just found out he bought a $3.5MM house for cash. We all knew he hit it big with Facebook, but who would have thought?

My family was invited to a friend's house last Friday. I've been playing tennis with this guy for over 2 years, and all I knew was that he lives in Fremont. He's a pediatrician and his wife is a CPA.  When we showed up at his house, we were like WTH? It's an 11,000 sq.ft. custom-built home in 2011. The 4-car garage ceiling was over 18-foot high so he and his friends can play badminton indoor.  I didn't know pediatricans and CPAs are getting paid that well.  I guess it's not prudent to make assumptions. 

Sorry I should've elaborated a little more on my reasons. Its true that there's a difference between being MIA from the business and closing on a seven figure deal is not one in the same. That's not what I meant in the least. Basically, by reading the OP, it seemed like a lot to take on for a rookie with no skin in the game. I never said it couldn't be done, maybe it can but it doesn't seem like something to take on by the OP at the moment. Course its a matter of my opinion so feel free to take it with a grain of salt.  I really don't see where your doctor and accountant friends related to the situation, *shrugging*, but ok....

Kudos,

Mary

@Johnson H. is right. More than the price, the term matters a great deal. If you can at 100% financing, I don't see a downside lock up the deal and do further due diligence on whether the current tenant will take a strong buy out. 

I'm curious about the tax deferring part though. Does the terms prevent you from paying off the loan early? If not, won't they get a direct tax hit when you sell early?