Best strategy for a long-term Bay Area investment?

24 Replies

Hey BP,

I'm considering buying a property to first owner-occupy, and later rent out in the Bay Area. I'm looking to accomplish a few things:

1) Take full advantage of Prop 13, by buying a fixer at a low price and locking in my tax rate at a low value.

2) Buy in an undervalued area that is expected to grow in the future. I'm looking at the East Bay, in particular.

3) Not buy at the top of the market. I am wary, seeing the amount of people leaving the bay area, at the current sky-high prices. The alternative would be to simply rent in the Bay and invest elsewhere.

4) Deal with the minimum amount of hassle with rent control/ tenant protections. For this reason, I am thinking my best option would be to buy a SFH and rent out rooms.

What are your thoughts on this? As said in #3, I am very wary given the current market conditions. That being said, I would like to take advantage as historically, the Bay Area has been an excellent place to invest. Should I go for it, and if so, what would be the best strategy to use?

Based on your criteria, I would do the following:

Buy a fixer in a great and/or up and coming school district.  Depending on your budget, I would not give up on homes in Marin, San Mateo or Santa Clara counties before looking out to the East Bay.  There are deals to be had if you are willing to fix.  I would avoid Berkeley, San Francisco and areas noted for strong rent control laws.  In most parts of the Bay, the "pro-tenant" nature of the judiciary tends to be overstated because no one - including progressive judges - has much sympathy for tenants making $175K+ and not paying their rent.  If truly interested in long term buy and hold, I would buy now while interest rates are insanely low.  I know a guy who has been waiting for the right moment to jump into the market since 1987.    

Thanks for the info.

Still, I am wary about the advice here and everywhere to "buy while you can". It seems like a total feeding frenzy, and feels like the bottom could drop out at any moment. I don't see how the average person can afford these multimillion-dollar average homes, much less how they will continue to appreciate at the current rate. It seems like the market will have to hit a ceiling at some point, if it hasn't already.

@Tyler D. I think you need to do a deeper dive into the history of the Bay Area market, and maybe that will sway you one way or the other. If you look back to what people have been saying in each of the past 4 decades, and probably longer, the masses of people have been saying the exact same words as you posted. Most people fear the market is at its peak because they have not done the research. Fear is based upon not knowing... Maybe we are at a peak, but depending on a persons time horizon it may or may not matter. Consistently the successful OG REI people I meet in the SF Bay Area are people who got in and have held for a long time. They weather the down cycles through good fiscal management and reap the benefits on the up swings. I am not advocating you go out and buy because I don't know your specific financial situation in detail. However, I will tell you that I sold 1 property last month but I used those funds to pick one up next month, and I hope to close on another one in January. I wish you the best of luck on your journey.

You are describing exactly how things stood/appeared in 1997 when I bought my first Bay Area house.  In contrast, we felt like we were holding a lot of face cards when we bought our new primary in early 2009.  Sometimes waiting pays off.  Sometimes waiting causes you to miss out entirely.  No one has a crystal ball.  Best to look at what people are doing rather than saying.  On our part, we have bought three fixers in the past year and are looking out daily for number four.     

Originally posted by @Darius Ogloza :

You are describing exactly how things stood/appeared in 1997 when I bought my first Bay Area house.  In contrast, we felt like we were holding a lot of face cards when we bought our new primary in early 2009.  Sometimes waiting pays off.  Sometimes waiting causes you to miss out entirely.  No one has a crystal ball.  Best to look at what people are doing rather than saying.  On our part, we have bought three fixers in the past year and are looking out daily for number four.

How did each of those investments turn out?

 

@Tyler D.

I have been an investor in the bay for over 20+ years and my start was buying a residential property, living in it for 3 years and renting it out. I bought that home in 2001.

A lot has changed since but seems like in many ways nothing has changed.

Back then “Prices were high”, the market was super competitive and people who could not afford or were scared to buy - often both - were calling a market top and a crash ahead. The same sentiment was 5x worse from people who did not live or invest in the Bay Area but felt they were somehow “uniquely qualified” to opine on the Bay Area market especially how it was a horrible place to live and had a dark future ahead. That sentiment is very prevalent today. Just surf the BP forums and you will see plenty of investors from tier 2 and tier 3 US markets offering their “expert” opinion on the Bay Area market and the “dark” future of California. So history will be a good guide, and history will tell you the long term returns on Bay Area RE are good.

The principles of investing are still the same. Buy low, add value and sell high or don’t sell if you don’t want to. Buy and hold works too. Listen to your gut and buy what feels comfortable with some element of risk and stretch built in.

Buy low means the cheapest property on the block and a place which you can forsee or force appreciation on. I can’t see how that is any different vs in the past. Money is made when you are buying.

There is a degree of speculation and luck surely. One property of mine shot up in value because a major tech co relocated their offices next door and many others followed. It was just pure luck. No research etc. Another one I bought with 100% research and analysis that many corporates were moving into that area, hasn’t done as well given Covid / WFH. Of course in the long term those prices will come back surely.

Originally posted by @Justin Thorpe :

@Tyler D'Alessandro

I have been an investor in the bay for over 20+ years and my start was buying a residential property, living in it for 3 years and renting it out. I bought that home in 2001.

A lot has changed since but seems like in many ways nothing has changed.

Back then “Prices were high”, the market was super competitive and people who could not afford or were scared to buy - often both - were calling a market top and a crash ahead. The same sentiment was 5x worse from people who did not live or invest in the Bay Area but felt they were somehow “uniquely qualified” to opine on the Bay Area market especially how it was a horrible place to live and had a dark future ahead. That sentiment is very prevalent today. Just surf the BP forums and you will see plenty of investors from tier 2 and tier 3 US markets offering their “expert” opinion on the Bay Area market and the “dark” future of California. So history will be a good guide, and history will tell you the long term returns on Bay Area RE are good.

The principles of investing are still the same. Buy low, add value and sell high or don’t sell if you don’t want to. Buy and hold works too. Listen to your gut and buy what feels comfortable with some element of risk and stretch built in.

Buy low means the cheapest property on the block and a place which you can forsee or force appreciation on. I can’t see how that is any different vs in the past. Money is made when you are buying.

There is a degree of speculation and luck surely. One property of mine shot up in value because a major tech co relocated their offices next door and many others followed. It was just pure luck. No research etc. Another one I bought with 100% research and analysis that many corporates were moving into that area, hasn’t done as well given Covid / WFH. Of course in the long term those prices will come back surely.


Interesting stuff, thanks for the post. Do you notice any changes in the bay area since you bought your first property? As a newcomer, it surprises me to see the huge problems that SF has in particular while being such an expensive city. Of course the pay and weather are great, but from the eyes of someone who has lived there for a short time, it doesn't seem like a city where houses should cost $1.5 million.

Originally posted by @Tyler D. :

Thanks for the info.

Still, I am wary about the advice here and everywhere to "buy while you can". It seems like a total feeding frenzy, and feels like the bottom could drop out at any moment. I don't see how the average person can afford these multimillion-dollar average homes, much less how they will continue to appreciate at the current rate. It seems like the market will have to hit a ceiling at some point, if it hasn't already.

It is hard to imagine LA and SF appreciating at the same rate as before. However, I will say that it's hard to define the 'average' person in LA and SF. There are so many folks here who make so much money. Heck, on my team alone, I don't think anyone makes less than 250K base plus 6 figure bonuses. And I'm not even 'front office'....I'm a back-office accountant. Combine that with spouses that make similar amounts, it makes a lot more sense how so many people can afford these houses. 

I like your idea about taking advantage of Prop 13. It's truly one of many great benefits of owning real estate in CA. It's one thing to never fall in love with your properties...however, I do fall in love with the tax rate on some of my legacy properties purchased right after the GFC.

@Tyler D.

A lot has changed. Gentrification has been huge. Parts of SF that in the old days you won’t venture in, are now home to million dollar condos. Oakland was a no no back then, but not anymore. Technology which is the backbone of the Bay Area economy is now a huge contributor to global growth making our economy even more prominent.

So yes lots of changes but like I said many things still are the same. Homelessness was a bad problem then and it is still today. The housing market was expensive and competitive then and it’s still today. Most people will tell you it’s too expensive to buy here but then homes get sold out quickly once they are listed and often for a premium. Tech companies pay well. Many go IPO and many get bought out. So wealth creation is quite frequent. That’s how it has been for as long as I have been here.

@Tyler D. I have been living in Bay Area for 15 years and have never invested here. My primary house is what I want to enjoy in a nice neighborhood and school district.

Right now, houses are gone within less than a week of listing in East Bay and all of these houses are more than $1M. These houses are already 20% above 2006 peak.

“I know a guy who has been waiting for the right moment to jump into the market since 1987.”

LOL- I know a few people like that too!

Too lazy to type, so check out my profile for my perspective on Bay Area investing

@Darius Ogloza feel free to talk more about your deals :)

That #1 strategy - buy a fixer - is a great idea that not everybody understands.  Buying low (i.e., fixers) significantly reduces operating costs (i.e., property taxes).

Here is one more line item for your list: look at neighborhoods that have historically retained their values during recessions. I have noticed that many areas that are least volatile during recessions also have the largest long term gains. Even within zip codes, different neighborhoods have significantly different value rentention characteristics. You may pay more for this sleep aid.

As is now clear from Prop 19 and the massive forecast budget deficits at state and local levels, Prop 13 remains a huge target for state and local electeds. 

1031 exchanges seem to be impaired by Prop 19.  With two children (my heirs) and multiple units, I am harmed by Prop 19.  I am upset that the state deceived voters again to increase tax revenues and real estate broker commissions.  As a "side hustle", and in response to Prop 19, I want 100,000 Millenials to become real estate brokers and chase ambulances.  

What clearly has changed since 2002 is that we have become a one party state and rolled out the welcome mat for half of the nation's homeless and even larger shares of other states' drug addicts, mentally ill and child molesters.  And within California, we have concentrated those folks in Oakland, Berkeley, etc.  

One of the long term consequences of widespread aggressive rent control has been to concentrate large populations of low income renters into high cost areas.  This in turn builds momentum to pass more rules and fees on landlords and homeowners.  If and when interest rates go up and property values (and tax revenues) spiral down, I think Bay Area real estate investments (and governance) will become very unattractive for at least a few years. This is because many cities, like Oakland, will use franchise fees to maintain the same or increased budget levels.  In other words, they will effectively and legally add pass through fees on utility services (just the privately owned services) to replenish their general funds.  Oakland has already begun applying franchise fees to waste collection.

But I am not selling yet  I may even try to buy distressed properties from distressed small multifamily owners (owner occupants) before the TOPA zombies take over that market.  

As long as the US Senate is controlled by Republicans, fewer and fewer subsidies for affordable housing will get approved because most of the rest of the US does not want to continue throwing money at new units in California that cost nearly $1 million per unit to build. That means more upward pressure on rents at existing rentals.  

The rodeo is not over yet. My bell may get rung while I wait for my bell to ring. But in the meantime, the hazard pay is pretty good.

@Greg San Martin I agree with you that prop 19 was an underhanded bait and switch scheme that most people did not understand. And yes state and especially some local gov’s are going off the deep end of stupid and ultimately crippling policies. Personal fave: SF insisting on buying and building “affordable housing” to the tune of $800k to $1 million per unit, for a few lower income (or homeless) people who literally win the lottery and get the unit at a huge subsidized price or rent. I mean, THAT makes sense!

As for future interest rate rise and inevitable inflation, I think short term that may push RE prices down. But longer term things will just get incredibly inflated, and property owners will make out like bandits. Imagine $50+ for a burrito in 10-15 years...and what homes and apartment values will be like in CA. You just have to hold on for the cycle to come to it’s natural conclusion. (stupid-gov-policies>broke-gov>high-inflation>crazy-real-estate-prices) 

But yeah, in the meantime it’s pretty annoying!

Originally posted by @Tyler D. :

1) Take full advantage of Prop 13, by buying a fixer at a low price and locking in my tax rate at a low value - Buying fixer uppers is a great strategy; however, it is highly competitive.  Depending on the condition of the fixer, it may not qualify for traditional financing and require cash only offers.  In areas like SF, most fixers have cash offers and contractors are also very busy and very expensive in SF like everything else.  I own a duplex in Ingleside SF with positive cashflow.

2) Buy in an undervalued area that is expected to grow in the future. I'm looking at the East Bay, in particular.  I purchased a property in Livermore for around 800k in 2017 and it is now worth over 930k today.  Livermore is an up and coming area.  Once BART extends from Dublin to Livermore (7 more miles down highway 580), I'm predicting the house will be over 1 million.  Livermore is definitely  a long term play as my property has slightly negative cashflow monthly.  To overcome the negative cash flow, I plan on converting the living room into a 5th bedroom with permits to force appreciate the property value and rent property at a higher value.  Once completed, this property will have positive cash flow.

3) Not buy at the top of the market. I am wary, seeing the amount of people leaving the bay area, at the current sky-high prices. The alternative would be to simply rent in the Bay and invest elsewhere. My motto is "don't wait to buy real estate", but "buy real estate then wait." Real estate needs to be viewed with a long term perspective assuming you have a nice W-2 job. Having negative cash flow for the first few years or even paying PMI is no big deal, the key is to get started and figure out solutions as you go.

4) Deal with the minimum amount of hassle with rent control/ tenant protections. For this reason, I am thinking my best option would be to buy a SFH and rent out rooms. I've rented room by room for my Livermore property and there are definitely pros and cons. Pros - higher rent. I was able to rent out all 4 room for about $4500/month (for perspective entire house rented out for $3700/month) including utilities. Cons - nobody really takes care of the house and treats it like a hotel, higher turnover as these tenants want month to month, dealing with more conflict. Personally, it has been way much less headache renting out the entire property to a family vs room by room despite less cash flow.

What are your thoughts on this? As said in #3, I am very wary given the current market conditions. That being said, I would like to take advantage as historically, the Bay Area has been an excellent place to invest. Should I go for it, and if so, what would be the best strategy to use?  I purchased a property in 2017, 2 in 2019, and 1 in Nov 2020 and have no regrets.  Even if the market dips 20%, if the properties are rented correctly, that 20% dip will not matter in 20 years.  If the market does dip 20%, I plan on purchasing more.  My personal recommendation is to buy a property with 10% down or less, live in the property for 1 year, do minor cosmetic fix up if needed, can rent room by room for 1 year, then buy another house with 10% down to move into and then rent out the entire house to a family.

I hope this information helps.  Please DM if you want to discuss further.

 

The future will of course not necessarily conform to past history but the rate of appreciation in the Bay Area since I have been investing here (1997 was my first purchase) has been simply astonishing.  People often talk about Bay Area prices being "inflated"; however, what I find valuable is to compare what has happened here in the Bay Area versus in other parts of the country relative to true inflation rates.  One anecdote typically does not prove a trend but my 23 years of experience has been consistent with the following real-life examples:

I purchased a small 1,500 square foot home in Mill Valley in May 1997 for $445,000.  The aggregate inflation rate since 1997 has about 62.1%.  What this means is that in today's dollars I bought the Mill Valley property for about $721,345.   Today, with about $40,000 in additional repairs, I am confident I can sell this property for about $1,600,000; at $1,400,000 it would probably sell in a few hours - all cash no contingencies 15 day close.  So, what you basically have is a doubling of the property value above the underlying inflation rate.  Paid off, this home is generating about $50,000/year in cash in excess of property taxes and insurance.  A home warranty policy costs an additional $55/month so that service calls are limited to $75/call.  The home has not experienced a vacancy since 2009.  Cap ex is what you would expect in the Bay Area's mild climate.    

A lot of folks who have concluded that Bay Area prices are "too high" or "too inflated" are looking for investment opportunities in Ohio, a state I know pretty well as I lived there for 7 years.  My father-in-law purchased a home on the East Side of Toledo back in 1959/60 for $14,000.  The inflation rate since that time has been about 848.75%, meaning that in today's dollars my father-in-law's purchase price was $118,825.  The same house would sell in today's market for somewhere between $60,000 and $80,000 (max).   It would likely rent for about $650/month.  Not the qite the equivalent of putting your money under a mattress but not that much better.  In short, the house value failed to pace the inflation rate.  The purchaser in 1960 has lost real dollars.  

Investors who are snapping up $40K-$80K houses today in the same areas are following the same losing trajectory.  When you add the real loss in value to the requirement for substantial cap ex to maintain the old typically under-improved and weather-beaten housing stock, nothing short of an economic miracle is going to generate sufficient "cash flow" over 5 to 10 years to offset these real losses/expenditures.   

Originally posted by @Darius Ogloza :

The future will of course not necessarily conform to past history but the rate of appreciation in the Bay Area since I have been investing here (1997 was my first purchase) has been simply astonishing.  People often talk about Bay Area prices being "inflated"; however, what I find valuable is to compare what has happened here in the Bay Area versus in other parts of the country relative to true inflation rates.  One anecdote typically does not prove a trend but my 23 years of experience has been consistent with the following real-life examples:

I purchased a small 1,500 square foot home in Mill Valley in May 1997 for $445,000.  The aggregate inflation rate since 1997 has about 62.1%.  What this means is that in today's dollars I bought the Mill Valley property for about $721,345.   Today, with about $40,000 in additional repairs, I am confident I can sell this property for about $1,600,000; at $1,400,000 it would probably sell in a few hours - all cash no contingencies 15 day close.  So, what you basically have is a doubling of the property value above the underlying inflation rate.  Paid off, this home is generating about $50,000/year in cash in excess of property taxes and insurance.  A home warranty policy costs an additional $55/month so that service calls are limited to $75/call.  The home has not experienced a vacancy since 2009.  Cap ex is what you would expect in the Bay Area's mild climate.    

A lot of folks who have concluded that Bay Area prices are "too high" or "too inflated" are looking for investment opportunities in Ohio, a state I know pretty well as I lived there for 7 years.  My father-in-law purchased a home on the East Side of Toledo back in 1959/60 for $14,000.  The inflation rate since that time has been about 848.75%, meaning that in today's dollars my father-in-law's purchase price was $118,825.  The same house would sell in today's market for somewhere between $60,000 and $80,000 (max).   It would likely rent for about $650/month.  Not the qite the equivalent of putting your money under a mattress but not that much better.  In short, the house value failed to pace the inflation rate.  The purchaser in 1960 has lost real dollars.  

Investors who are snapping up $40K-$80K houses today in the same areas are following the same losing trajectory.  When you add the real loss in value to the requirement for substantial cap ex to maintain the old typically under-improved and weather-beaten housing stock, nothing short of an economic miracle is going to generate sufficient "cash flow" over 5 to 10 years to offset these real losses/expenditures.   

That is why you purchase houses in Columbus, Ohio. The cash flow is there and the appreciation is wild! 

@Amit M. Interesting you point out. "stupid-gov-policies>broke-gov>high-inflation>crazy-real-estate-prices". Granted U.S. inflation has been low compared to other countries historically, but it's really hard to keep it that way.

Fed has discovered the MAGIC solution (printing money) and sent signal that they should keep long term unemployment rate lower and NOT worry too much about inflation.

What people don't realize is the average home affordability is still only 33% in the bay area, it is typical of an expensive area nationwide but not the most expensive. The most expensive relative to affordability is Miami, FL. Even Denver CO is relatively more expensive than the bay area. Having said that, there's still room for houses in the Bay Area to appreciate although it may be different in every city.  

When the affordability is reaching 40%, that's where the overbought territory is.