Bay Area BRRRR

[Adam Ashley]

I was born and raised in the Bay Area. I am still here and am doing alright renting. How does anyone BRRRR or do anything real estate related in the Bay Area with housing prices?

[Dan H.]

Quote from @Ashish Acharya:

@Adam Ashley, Great answers so far, and yeah, totally fair question, the Bay Area is one of the hardest places to make traditional BRRRR numbers work.

From a tax angle, a lot of investors here pivot their strategy instead of walking away from the market entirely. Some move equity from a Bay Area property into more affordable markets (some mentioned above the Midwest is popular) using a 1031 exchange, deferring capital gains tax while trading into higher cash-flow areas. Others focus on ADU builds or house hacking (like renting part of a primary home) since you can still deduct depreciation and expenses proportionally while living there.

The reality is, in high-cost markets like this, appreciation and tax planning usually drive returns more than raw cash flow. You can still play the game, it just looks a little different. I really like what Elealeh said above: "live where you love, invest where the math works".

Good luck, and happy to connect!

How many flipping shows do You see in cheap RE markets?  There is a reason and it is because, to word it kindly, the added value is not impressive.

last year I added a half bathroom out of existing space in a unit that had an ARV over $2k PSF.   That half bathroom added ~$50k of value per the comps (mission beach, 3 units from the ocean).   How much value would be added by adding a half bathroom out of existing space in a cheap RE markets?  My value add was over $100k above my costs.   This significant increase in value is necessary to minimize the money trapped in the RE.

The return is a function of invested amount, cash flow and appreciation, time.   The $100k of value added above cost not only provides instant boost to the appreciation, but it can reduce the investment amount.   Imagine the return if nothing was trapped in the investment.   Imagine the return is $10k was trapped.   Even $50k trapped and I have a 200% short term return from the value added above alone.

if I have $0 invested, even a couple hundred a month of real cash flow (after properly allocating for all expenses including future cap ex) produces a great return.

i suspect there is no bigger factor in the return than the value added and this is because the higher the value added, the less money gets trapped in the property.  you must add significant value in order to extract your investment.  

in my primary (San Diego) market, My worst appreciating property has appreciated $2700/month over its hold. I have a couple (maybe 3) that have appreciated over $10k/month over their hold. What do you think has happened to their market rent?  I will give a hint that there is a strong coupling of appreciation to rent growth.   Imagine the return on this if I have virtually no money or no money trapped in the property.

brrrr you make money on the value add then continue to make money on the cash flow and appreciation that produces magnified return due to minimizing the invested amount.   It is a long term strategy.

 There is poor correlation between initial cash flow and actual long term cash flow. The reason for this is that RE market prices are based on numerous criteria. Some of the big ones are expected appreciation, expected rent growth, and risks.

In most markets, the market with the highest rent to price ratio is the lowest class areas. This is because of the risks and effort to have rentals in that market.

Similarly, the markets with the best initial cash flow typically have poor historical appreciation and rent growth. The properties with poor initial cash flow often have good/great historical appreciation. Rent growth has a strong relationship to appreciation.

The higher rent growth market will always surpass a market with better initial cash flow but lower rent growth given enough time.

On a long term hold, the rent growth is much more important than the initial cash flow.

If I invested $100k in the year 2000 using the same leverage and no extraction of value in both San Diego and Cleveland, which investments do you think would have the better cash flow over the hold? Which do you think would have appreciated more? If the answer is not obvious, remember the relationship between appreciation and rent growth so the answer is the same for both questions

I have made a lot of money via brrrr and simply would not chose that strategy in a low cost market.  Rehabs are quite a bit of work.   They must add significant value to justify the work and to allow me to extract my initial investment.  

Brrrr strategy is best deployed in where RE prices are high and rehabs can add significant value.  San Francisco is such a market.

I believe everything I wrote but want to add the RE market is perhaps the most challenging ever.   It is not trivial to do a successful brrrr in any market.   

Good luck