New to this group, thought I'd post my current situation and see if others have opinions on it... My wife and I bought our first "starter" home in San Francisco (Eureka Valley - in between Castro and Noe Valley) 4 years ago. It is on the smaller side - 3BR, 2BA, 1,600 sq ft. It also has a lot of history: the original structure was an earthquake shelter built in 1906. There is also a small in-law cottage in the backyard and the far edge of the property. This was a great unintended and unexpected house hack that we fell into (more on that in a minute). The house was completely renovated in 2011 and has nice, high-end finishes. Not the best, but very good for sure. There are flaws: no garage (although surprisingly easy street parking for SF - we park 2 cars in front of the house daily), small for the price point, busy street but very quiet backyard and deep lot. A growing family led us to purchase a larger home about a mile away recently. So now I'm going back-and-forth between keeping the current house and renting it, or selling into a VERY hot market, both in San Francisco, as well as our specific neighborhood. More on the house hack that I fell into: I didn't think much of the in-law unit when we bought the house, but decided to list it for short-term rental. I grossed ~$60k per year on the short-term rental unit, which was a complete surprise to me, which over 4 years put us in a better position to upgrade our primary home. This may factor into a buyers willingness to pay... So a bit of the numbers: we bought the house for ~$1.5mm, currently have ~$1.15mm mortgage. Appreciation has been very strong, and based on recent comps I think we could see as much as $2.3mm. Note there were 10 offers on the house when we bought it, and it sold for almost 20% above asking, neither the 10 offers nor the 20% above ask is unusual for San Francisco (the house we just bought had almost exact dynamic). Rental comps are hard to come by for our neighborhood, but I think I could rent it for ~7.5k, maybe up to $8.5k per month. The short-term in-law cottage rental goes away of course, and I'd likely exclude this from the rental anyway and keep it vacant (could be used as a stop-gap between renters). The net result is a strong cash-flow profile. The pro-case for selling would be to roll the equity from this house into our new house and reduce the monthly mortgage and rebuild our savings and investments (which we depleted to make this move). Keeping the house would put the majority of our net worth into real estate. But I'm eager to maintain, and build, my second revenue stream. Selling the house takes that stream away entirely, for now. But a sale would be into a super strong SF housing market, with far more demand than supply. At least right now... SF rental laws are extremely tenant friendly - something to consider as I have zero experience being a landlord to long-term tenants. The con-case for selling is that they aren't making more land in one of the most desired neighborhoods. Despite the house's few flaws, it would be snapped up in a matter of days in the current frothy market. I don't really see that changing - maybe leveling off (famous last words!). I do not expect anywhere near the level of appreciation we have seen in the last 4 years. My expectation is it would stay flat for a while. 2008-2010 in SF was flat, for comparison. Without experience as a landlord, I suspect that there are nuances of renting homes vs. apartments and at this price point that I don't know what I don't know, and I'd be open to hearing any feedback...

@Jamie M. . if you don't need the money, I will say keep it. What you are not taking in consideration is the tax deductions you are probably getting from the depreciation of an over 1 million dollar investment property. Ask your accountant how much income tax you are saving per year due to owning this property. If you hold the property, you'll gain: • Tax brakes ( more money in your pocket at the end of the year) • Paid down principal • Cash flow - the most obvious saving people think of • Appreciation Look at all you'll gain and then decide if by paying down your principal on your own home makes any sense? Your own home is never an investment, it's a liability, as you are the only one paying the mortgage, while investment properties are assets due to the four factors outlined above! Good luck to you!

Keep & Rent, or sell into a strong San Francisco market?

David Faulkner

Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes

9y

If you are not forced to sell now or in the foreseeable future and you plan to stay in the bay area long term (at least the next 10 years), then I would not sell. One thing to consider is that if you do decide to sell, make that decision within the next 3 years. If you lived in the home as your primary residence for 2 of the last 5 years and sell, then up to $500k capital gains for married couples is tax free. There are still transaction costs, but that is a huge bonus. So, I'm not saying you should sell (I wouldn't), only that if you do decide to sell, don't wait 4 years and then sell because you will miss out on the capital gains tax exclusion described above. BTW, I would expect that this landlording experience would be about as easy as they come ... of course you still need to screen your tenants and respond to occasional repair requests, but you are not likely to find a higher quality, lower maintenance tenant base anywhere. Also, I agree with you that the most likely scenario is a flattening of prices and rents in the short term, or maybe even a very slight dip, but in the long run the historical record speaks for itself and I don't see those long term pricing trends changing in the future.

The in-law cottage is interesting ... I would get some local expert investor and/or realtor (that deals in rentals/leased properties) eyes on that to get some opinions. How is access to that? Is there an alley running behind the property or is the only access through or around the main house? If alley access, you may be able to convert to a detatched garage or keep renting it as a separate unit, either long or short term ... I do not know your local laws, though, but definitely worth looking into. If none of those are a possibility, I see no reason why you would keep it vacant rather than including it with the main house rental and upping the rent charged because it is included. Talk to some pros about it ... I'd bet there is a way to bump your income from it and you may do even better than you are thinking as a result.

4 Reply

Christian Wathne

Investor · San Jose, CA, Bellevue, WA · Member since 2016 · 327 posts · 257 votes

9y

I would 100% not sell a sfh in SF. It will always be one of the most desirable cities in the world and long term continue to appreciate.

0 Reply

Andreas Ernst

Investor · San Francisco, CA · Member since 2014 · 13 posts · 2 votes

9y

Hi Jamie, in my opinion your are asking the right questions. For full disclosure I am a real estate investor and Realtor and I am having the exact same conversation with many of my clients. While at the end it all comes down to your specific goals and objectives there are a couple of things I encourage my clients to think about:

1) Appreciation potential: Historically speaking appreciation has been very strong in San Francisco

2) Return: $7.5-$8k gross per month for a $2.3M home is very low if income is important to you.

3) Tenant rights: Tenant rights in SF are very strong. A SFH with an in-law unit when rented out usually counts as 2-unit building which mean rent control. I'd be extremely careful with that since this can have a huge impact on your property value. More info: https://www.sftu.org/rentcontrol/

4) Taxes: As David has pointed out already, if you lived in the home as your primary residence for 2 of the last 5 years and sell, then up to $500k capital gains for married couples can be tax free. For investment properties you might be able to do a 1031 exchange in the future.

Hope this helps?! I'd be happy to introduce you to a good landlord attorney and real estate tax advisor if you like..

0 Reply

Jamie M.

OP

San Francisco, CA · Member since 2017 · 16 posts · 2 votes

9y

Originally posted by @Andreas Ernst:

Hi Jamie, in my opinion your are asking the right questions. For full disclosure I am a real estate investor and Realtor and I am having the exact same conversation with many of my clients. While at the end it all comes down to your specific goals and objectives there are a couple of things I encourage my clients to think about:

1) Appreciation potential: Historically speaking appreciation has been very strong in San Francisco

2) Return: $7.5-$8k gross per month for a $2.3M home is very low if income is important to you.

3) Tenant rights: Tenant rights in SF are very strong. A SFH with an in-law unit when rented out usually counts as 2-unit building which mean rent control. I'd be extremely careful with that since this can have a huge impact on your property value. More info: https://www.sftu.org/rentcontrol/

4) Taxes: As David has pointed out already, if you lived in the home as your primary residence for 2 of the last 5 years and sell, then up to $500k capital gains for married couples can be tax free. For investment properties you might be able to do a 1031 exchange in the future.

Hope this helps?! I'd be happy to introduce you to a good landlord attorney and real estate tax advisor if you like..

Thank you @andreas. This is very helpful. On #3 - this has been my biggest concern, and the reason that I would exclude the cottage and keep vacant. It seems like there is much more risk and nuance in this particular scenario. Would love a landlord attorney recommendation!

0 Reply

Cody L.

Rental Property Investor · San Diego, CA · Member since 2013 · 3k+ posts · 4k+ votes

9y

When I'm trying to decide to sell, I ask myself if I'd buy at the price I could sell for. In my case I'd sell a 2.3m property that had $8k/month of rent. That's the price I paid for my 78 unit which has $50k/month of rent roll. Really depends on if you have something better you can do with the funds.

1 Reply

Amit M.

Rental Property Investor · San Francisco, CA · Member since 2013 · 1k+ posts · 1k+ votes

9y

first question I have is if your cottage is legal (possibly legal non conforming status.) if it's not legal, the city now allows for legalizing "illegal inlaws." Doing that would add value, as you'd get credit for the cottage's sq ft- when it's not legal, the value PSF is much lower.

The main thing you need to wrap your head around is being a LL in SF (not for the faint of heart, but very rewarding...if you know what you are doing.). Be advised that even if you keep the cottage vacant, it doesn't matter. Even if it considered an illegal structure, it doesn't matter. The SF rent board still considers your property to technically be 2 units, and thus subject to rent control. HOWEVER, I believe that if you rent out BOTH the cottage and the home to a single tenant, it will not be subject to RC. Eviction controls still apply, but you can raise rent to market levels, and are not bound by the city's percent allowances. I'd check with an attorney on that. There are several well know offices that deal with this: Zacks or Gelmans office are two. Don't let them scare you off however. You just need to be informed if you can avoid full RC by renting both to the same tenant. Also remember that the people who will be spending $7-8k on rent aren't exactly poor. I doubt they will need to rely on RC to squat your unit for 10-20 years. Most likely it'll be a successful family either saving money to buy or who plans to leave the city in a few years anyways. When renting I'd also screen out any tenant that looks like they want to stay years on end. Focus on upwardly mobile tenants that are either saving money to buy themselves, or that only plan to stay in SF a limited amount of time. So practically speaking you can minimize the adverse effects of RC by renting smart. All LL's in the city with half a brain think this way, which is why suboptimal tenants have a very hard time getting accepted.

Now for the larger picture, keeping that home could be your retirement! I'll bet that your 401k will seam like peanuts compared to this 20+ years from now. You have a blue chip asset, locked in low prop 13 prop taxes, I assume a great interest rate that's fixed, you get to depreciate the asset and have other write offs, pay down the principal, plus you'll cash flow- even more if you rent out the cottage. But of course future appreciation is the real killer here, as we're talking literally millions over the next 10-20 years. This shouldn't be hard to manage as you live nearby. It's a great intro to being an SF LL. Also look at small property owners (sposfi), they have an informative newsletter and all kinds of contacts. SF apartment association has a monthly mag free online too which is helpful. Good luck!

1 Reply

Jamie M.

OP

San Francisco, CA · Member since 2017 · 16 posts · 2 votes

9y

Originally posted by @Amit M.:

first question I have is if your cottage is legal (possibly legal non conforming status.) if it's not legal, the city now allows for legalizing "illegal inlaws." Doing that would add value, as you'd get credit for the cottage's sq ft- when it's not legal, the value PSF is much lower.

The main thing you need to wrap your head around is being a LL in SF (not for the faint of heart, but very rewarding...if you know what you are doing.). Be advised that even if you keep the cottage vacant, it doesn't matter. Even if it considered an illegal structure, it doesn't matter. The SF rent board still considers your property to technically be 2 units, and thus subject to rent control. HOWEVER, I believe that if you rent out BOTH the cottage and the home to a single tenant, it will not be subject to RC. Eviction controls still apply, but you can raise rent to market levels, and are not bound by the city's percent allowances. I'd check with an attorney on that. There are several well know offices that deal with this: Zacks or Gelmans office are two. Don't let them scare you off however. You just need to be informed if you can avoid full RC by renting both to the same tenant. Also remember that the people who will be spending $7-8k on rent aren't exactly poor. I doubt they will need to rely on RC to squat your unit for 10-20 years. Most likely it'll be a successful family either saving money to buy or who plans to leave the city in a few years anyways. When renting I'd also screen out any tenant that looks like they want to stay years on end. Focus on upwardly mobile tenants that are either saving money to buy themselves, or that only plan to stay in SF a limited amount of time. So practically speaking you can minimize the adverse effects of RC by renting smart. All LL's in the city with half a brain think this way, which is why suboptimal tenants have a very hard time getting accepted.

Now for the larger picture, keeping that home could be your retirement! I'll bet that your 401k will seam like peanuts compared to this 20+ years from now. You have a blue chip asset, locked in low prop 13 prop taxes, I assume a great interest rate that's fixed, you get to depreciate the asset and have other write offs, pay down the principal, plus you'll cash flow- even more if you rent out the cottage. But of course future appreciation is the real killer here, as we're talking literally millions over the next 10-20 years. This shouldn't be hard to manage as you live nearby. It's a great intro to being an SF LL. Also look at small property owners (sposfi), they have an informative newsletter and all kinds of contacts. SF apartment association has a monthly mag free online too which is helpful. Good luck!

@amin - thank you! This is helpful. The in-law unit is a legal Accessory Unit. This makes it part of the main structure from a legal perspective. It seems that I need to dig on this issue and will seek out some expert advice. Thanks again!

0 Reply

Chris MasonPro Member

Moderator

Lender · CA · Member since 2015 · 9k+ posts · 10k+ votes

9y

Originally posted by @Jamie M.:

To add to the above about the section 121 exclusion for a place that has been your primary residence for 2 of the last 5 years, you can rent the place out for two years, and there will be a 12 month window where you can stack sec 121 on top of a 1031 exchange and get BOTH tax goodies -- no cap gains tax on the first $500k if married, and no cap gains tax on net proceeds used to re-invest as part of a 1031 exchange. You know, just in case this choice wasn't convoluted and complicated enough already. :)

There's some additional nuance to it that a 1031 facilitator, which I am not, could/should comment on.

4 Reply

David Faulkner

Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes

9y

Originally posted by @Chris Mason:

Originally posted by @Jamie M.:

To add to the above about the section 121 exclusion for a place that has been your primary residence for 2 of the last 5 years, you can rent the place out for two years, and there will be a 12 month window where you can stack sec 121 on top of a 1031 exchange and get BOTH tax goodies -- no cap gains tax on the first $500k if married, and no cap gains tax on net proceeds used to re-invest as part of a 1031 exchange. You know, just in case this choice wasn't convoluted and complicated enough already. :)

There's some additional nuance to it that a 1031 facilitator, which I am not, could/should comment on.

Great point! And only SF'ers would know this, since their gains frequently exceed $500k :)

0 Reply

Dave FosterBusiness Member

Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes

9y

@Jamie M., I can flesh out the relationship to the 121 primary residence exception to a 1031 exchange allowing you make 100% of your gain from that property either tax free or tax deferred.

If you don't have to sell it now and can make the numbers work you could purchase a new primary residence (maybe with a refi on the current one) and move out and rent the current one. As @Chris Mason said, to qualify for the sec 121 exemption you must have lived in the property for 2 out of the 5 years prior to sale. So you could move out and rent your current place actually for 3 years before selling as long as you pay close attention to the calendar so you still meet the 2 out of 5 criteria at the time of sale. So since that property is an investment property it also qualifies for a 1031 exchange. So the mechanism is that you complete a 1031 exchange but taking boot of $500K. The boot would normally be taxable but because you meet the 121 criteria the tax is eliminated on the boot. Meanwhile the rest of the sale is tax deferred through the 1031.

This doesn't fully solve your dilemma of whether to sell or not. But it does let you kick the can down the road a little, enjoy three more years of equity build and cash flow, and offer a long term solution to the excess gain over the 121 limits.

The 1031 Investor5137 Reviews

Website View Page

2 Reply

Sam DogenPro Member

San Francisco, CA · Member since 2017 · 40 posts · 17 votes

9y

I'm going through a similar dilemma, but I bought my house in The Marina in 2005 and it is up 80% based on a written offer. I was going to sell it for $1,000,000 LESS in 2012 why I put it on the market for 28 days, but I received zero offers!

Sam

Podcast Guest on Show #46

0 Reply

Jamie M.

OP

San Francisco, CA · Member since 2017 · 16 posts · 2 votes

9y

So what are you going to do?

0 Reply

Jamie M.

OP

San Francisco, CA · Member since 2017 · 16 posts · 2 votes

9y

Originally posted by @Sam Dogen:

I'm going through a similar dilemma, but I bought my house in The Marina in 2005 and it is up 80% based on a written offer. I was going to sell it for $1,000,000 LESS in 2012 why I put it on the market for 28 days, but I received zero offers!

Sam

Interesting - I read through your thread and it looks like you are seeing softening in the rental market. That would make sense given new supply coming on, but also hard to reconcile over a longer period given the dynamics of this particular market...

0 Reply

Sam DogenPro Member

San Francisco, CA · Member since 2017 · 40 posts · 17 votes

9y

@Jamie M. - The SF real estate engine is fundamentally sound. The amount of high paying jobs is incredible, as is the amount of liquidity looking to buy assets. Add on an international demand curve and I think it's wise to be long SF property forever.

I've just reached a point where I want to grab back some time and simplify life. Therefore, I want to go from 3 properties in SF down to 2.

Podcast Guest on Show #46

0 Reply

Jamie McGurk

San Francisco, CA · Member since 2017 · 2 posts · 1 vote

9y

@Sam Dogen totally makes sense... I think I'm holding, which will bring my total properties UP to 2 :)

1 Reply

Lumi Ispas

Real Estate Consultant · Chicago, IL · Member since 2014 · 720 posts · 439 votes

9y

@Jamie M. . if you don't need the money, I will say keep it. What you are not taking in consideration is the tax deductions you are probably getting from the depreciation of an over 1 million dollar investment property. Ask your accountant how much income tax you are saving per year due to owning this property.

If you hold the property, you'll gain:

Tax brakes ( more money in your pocket at the end of the year)
Paid down principal
Cash flow - the most obvious saving people think of
Appreciation

Look at all you'll gain and then decide if by paying down your principal on your own home makes any sense? Your own home is never an investment, it's a liability, as you are the only one paying the mortgage, while investment properties are assets due to the four factors outlined above!

Good luck to you!

1 Reply

Ethan Cooke

Rental Property Investor · San Francisco, CA · Member since 2016 · 227 posts · 365 votes

9y

@Jamie M. - I agree with @Amit M. if you screen your tenants carefully, you can greatly reduce risks and identify folks who are less likely to stay 10-20 years. So renting your cottage as a second unit could be more lucrative than renting the home and cottage together. As David Faulkner asks, is the cottage accessible separately?

2. How do you value long-term wealth-building vs. immediate debt pay down vs. ongoing cash flow? SF real estate is a great investment to build long-term wealth. I own 3 SFR's in SF which hopefully will fund a big part of my retirement in 15-20 years. But this may not be your goal. I've found that SFR's in SF generally produce little or no cash flow initially (with a typical 25% down payment). On the other hand, if you sold the house and bought a multi-unit in a lower-cost area, you could cash-flow immediately but probably with much less appreciation.

PM me if you want to chat. Good luck!

Ethan

0 Reply

Jamie M.

OP

San Francisco, CA · Member since 2017 · 16 posts · 2 votes

9y

Hello everyone - I appreciate everyones advice and replies to this thread. We ended up renting out the house with the in-law cottage included in the rental. We sought and received legal advice on the in-law: it is deeded as an "accessory unit" and when rented together would not subject us to rent control. We rented the property for $8,700 which is above my original expectations. Net of all costs we'll still cash flow about $4,500 per month. My plan is to aggressively pay down the mortgage, and in a few years consider where we are at. Thanks again all!

0 Reply

Amit M.

Rental Property Investor · San Francisco, CA · Member since 2013 · 1k+ posts · 1k+ votes

9y

👍🏻

0 Reply

Keep & Rent, or sell into a strong San Francisco market?

Keep & Rent, or sell into a strong San Francisco market?

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