Why appreciation matters in the SF/Bay Area

168 Replies

Originally posted by @Cal C.:
Originally posted by @Matt Rosas:

The school districts in good areas of Cali normally are far superior than 99% of private schools. There are some solid reasons you would live in these good areas even if you took a loss. You can basically get a world class education with the best schools, teachers and admistrators on the planet for free. There is no where else that this happens. Just thought  I would comment on one more reason the momentum continues for these areas.

thanks, 

Matt

It's only free if you don't pay state income tax, property taxes or pay rent to someone who is paying property taxes.  As Milton Friedman said there is no free lunch.  

 Good point Cal. Let me put it this way. Private school for two kids is 50k per year. 50k × 12 years(discounting 10% per yr increase) = 600k of private school cost you save by using the superior public school. The taxes you are going to pay either way. 

thanks,

Matt

@Kevin D. - With a cash buy, you are right the you'll be earning 4-5% cash on cash return and you maybe able to get the same kind of return with a mutual fund. The difference is that as a physical asset in a Class B+/A- location, rents are stable and you'll be receiving monthly checks like a bond. In addition, the owner will have control over the property and can increase value in different ways down the road. With a mutual fund, I have no control over the investments in the fund and I won't know for certain how it will continue to perform. Appreciation would be the cherry on top for this property if brought currently and the economic continues to hum. The mutual fund could stay stagnant or go up/down, no one will know. Finally, from a holistic approach, someone buying a $2 million apartment building in cash probably has other investments. Real estate is just one type of investment. He maybe diversifying with a real estate investment and has other security holdings. I once reviewed the financials of a person with a net worth of $700 million. Half was real estate with an LTV of 40%. The other half was in mutual funds and treasury bonds. You may say he should get out of those low yielding treasury bonds and leverage more, but at his net worth, he is in capital preservation mode, not in a capital accumulation mode like us.

With your leverage example, you can get a 3/1 or 5/1 ARM for around 4% with the appropriate down payment. With the value add of increasing rents to market, you'll be able to increase your NOI. If you can increase $200 a unit without additional expenses for 10 units, you'll have an additional $24k in NOI. After stabilization, you can get out of the property at the same cap rate or better and have a nice profit at the end. With this example of $24k increase in NOI, you'll have an increase of equity of $480k assuming a 5% cap rate.

Originally posted by @Jay Hinrichs:

@Johnson H.  I think your dead on about how the wealthy look at things vis a vi returns.

one of my bizz partners over the years loved to suck stockbrokers into this conversation.

Stock broker :   How are your investments.

Bizz Partner:  I am in double tax free muni's

Stock Broker:  Well return on those are low you could do much better.

Bizz Patner:  Well the return is fine if your like me and you have enough of them.

IE he has 8 figures and his tax free cash flow is more than that what most investors starting out and looking at that magic goal of 10k a month passive income ( or rental income which is anything but passive as we know) His double tax free's return him more than that DAILY

So yes as folks get truly wealthy they look for Safety then return... those starting out or in the middle of their careers are the one's looking for the homeruns.

And one might ask where this Bizz partner made his money.. Simple he owned a Garbage company and sold it to waste management in the day...Cashed in put it all in double tax free muni's...

Great example @Jay Hinrichs. I review many loan files in my day job and I review borrower financials all the time. Those that have a higher net worth, I always see low LTV's for their entire portfolio and plenty reserves in the form of safe investments and cash. They are no longer taking on the risk of leverage and have plenty for a rainy day or for a home run deal when the market tanks again.

I think another reason for higher prices have to do with Prop 13.  Since property taxes are the biggest operating expense, this is a huge benefit.  Seems like people don't consider this enough.

Also, I really think and have read quite a bit of research into the fact that we are splitting into two societies.  One is a knowledge based economy that innovates and is highly educated.  These areas will be concentrated in the places you think of now - the Bay Area, Seattle, Denver - Boulder, Austin, Raleigh, etc...  The places with high concentrations of blue collar workers that don't innovate will really struggle.  A lot of this has already happened.  People are finding out just being in a cheap area is enough to attract companies and people, but that just isn't true.

CA gets a lot of flak over its business climate, some of which is deserved.  However, people forget probably the most important business factor and that is the ability to innovate and foster research.  In many cases companies and ideas start in places like CA and other states can only hope to get some of the manufacturing or back office down the road, because they can't hope to start companies on the same level, because they don't have the culture and concentration of research universities.

@Kevin D.  ,

You might have butchered my number. Projected gross rents are $15,400/month. We can obtain 3% financing without any issue. Any building in a B to B- neighborhood that can get 10 GRM after stabilized, we are a buyer.

@Ezra Nugroho  , in fact I do. My little sister just turned 29. She's 5'6" and around 130-135 pounds. She wants to keep my 2-bed condo at 2240 Galveston Ave, #A in San Jose so I deeded it to her. I bought it at the courthouse steps for $137k in Jan 2012. That unit can be rented for $1,950/month without an issue. 

@Minh L.  sounds like you'll have to bring her to the next meetup to meet @J Martin. Are you sure about this? lol

Originally posted by @Johnson H. :

@Kevin D. - With a cash buy, you are right the you'll be earning 4-5% cash on cash return and you maybe able to get the same kind of return with a mutual fund. The difference is that as a physical asset in a Class B+/A- location, rents are stable and you'll be receiving monthly checks like a bond. In addition, the owner will have control over the property and can increase value in different ways down the road. With a mutual fund, I have no control over the investments in the fund and I won't know for certain how it will continue to perform. Appreciation would be the cherry on top for this property if brought currently and the economic continues to hum. The mutual fund could stay stagnant or go up/down, no one will know. Finally, from a holistic approach, someone buying a $2 million apartment building in cash probably has other investments. Real estate is just one type of investment. He maybe diversifying with a real estate investment and has other security holdings. I once reviewed the financials of a person with a net worth of $700 million. Half was real estate with an LTV of 40%. The other half was in mutual funds and treasury bonds. You may say he should get out of those low yielding treasury bonds and leverage more, but at his net worth, he is in capital preservation mode, not in a capital accumulation mode like us.

With your leverage example, you can get a 3/1 or 5/1 ARM for around 4% with the appropriate down payment. With the value add of increasing rents to market, you'll be able to increase your NOI. If you can increase $200 a unit without additional expenses for 10 units, you'll have an additional $24k in NOI. After stabilization, you can get out of the property at the same cap rate or better and have a nice profit at the end. With this example of $24k increase in NOI, you'll have an increase of equity of $480k assuming a 5% cap rate.

@Johnson H. I never even considered ARM loans. That's why you guys are pros and I'm not. With those types of loans, what happens when the loans get called in 3 to 5 years? I assume these investments are for resale rather long term buy and hold?

Originally posted by @Joe B.:

While I agree you can't discount appreciation in CA... There has to be a ceiling at some point. Housing can't continue to double every 10 years if incomes don't keep pace. At some point even the professional DINK couples are priced out of the market and opt to take a good job in Austin, Portland, Nashville or Raleigh.

 Yes there is an ever adjusting ceiling in these prime Cali areas. Decade after decade it raises. When it can it does reach it and then resets the height of the ceiling. It comes down to if you have money to invest in world class cities eventually you will. The caveat, Chinese don't sell, they look at real estate as multiple century buy and holds. The affluent Chinese are loving these prices and paying all cash as is. Just another reason to invest in Cali.

thanks, 

Matt

Originally posted by @Kevin D. :
Originally posted by @Johnson H.:

@Kevin D. - With a cash buy, you are right the you'll be earning 4-5% cash on cash return and you maybe able to get the same kind of return with a mutual fund. The difference is that as a physical asset in a Class B+/A- location, rents are stable and you'll be receiving monthly checks like a bond. In addition, the owner will have control over the property and can increase value in different ways down the road. With a mutual fund, I have no control over the investments in the fund and I won't know for certain how it will continue to perform. Appreciation would be the cherry on top for this property if brought currently and the economic continues to hum. The mutual fund could stay stagnant or go up/down, no one will know. Finally, from a holistic approach, someone buying a $2 million apartment building in cash probably has other investments. Real estate is just one type of investment. He maybe diversifying with a real estate investment and has other security holdings. I once reviewed the financials of a person with a net worth of $700 million. Half was real estate with an LTV of 40%. The other half was in mutual funds and treasury bonds. You may say he should get out of those low yielding treasury bonds and leverage more, but at his net worth, he is in capital preservation mode, not in a capital accumulation mode like us.

With your leverage example, you can get a 3/1 or 5/1 ARM for around 4% with the appropriate down payment. With the value add of increasing rents to market, you'll be able to increase your NOI. If you can increase $200 a unit without additional expenses for 10 units, you'll have an additional $24k in NOI. After stabilization, you can get out of the property at the same cap rate or better and have a nice profit at the end. With this example of $24k increase in NOI, you'll have an increase of equity of $480k assuming a 5% cap rate.

@Johnson H. I never even considered ARM loans. That's why you guys are pros and I'm not. With those types of loans, what happens when the loans get called in 3 to 5 years? I assume these investments are for resale rather long term buy and hold?

Kevin, multifamily with 5+ units can only obtain commercial financing. Commercial financing is 3/5/7/10 year loan with either a fixed or variable rate for the life of the loan. There can be a 15/20/25/30 year amortization rate and a balloon payment at the end. Before the loan matures, the borrower will need to refinance or sell the property. For a long term investor, the property is refinanced to the market rate depending on the term of the loan with the appropriate LTV to keep in line with the bank's underwriting guidelines and risk appetite.

@Minh L. Too bad that I am married, with two kids, and have my primary residence. So neither the sister nor the rent work for me, bummer! But congratz for getting the nice property at the court steps!

@Johnson H. Nice examples! I also think that some of these ultra high net-worth people split their investments to both capital preserving assets and highly speculative ones. They have access to the ranks of Bay Area VCs! If they can put their capital to the next google wannabe, common real estate investing may sound rather boring. 

I am a typical Silicon Valley engineer. For the foreseeable future, I'll be employed by these high net worts via VCs. At some point ago, I was directly employed by one, so I got to peek first hand on their life style and a bit of their investment style. Do they buy real estate? The do, but when they do the buy something like a whole undeveloped beach strip or a sky resort.

@Ezra Nugroho   - Thanks, for the feedback. I have no doubt that the filthy rich in Silicon Valley are angel investors in numerous start ups and hedge funds. For the rich in other parts of the US, owning a well known building is just as glamorous.

Some of these smart people who made their money in other industries, tech/medical/etc, sometimes make unsmart investments that they can't afford. The undeveloped beach strip reminds me of this article:

"In 1990, Club Mediterranee SA (CU) paid A$15 million to buy an existing resort on Lindeman and then spent an additional A$85 million transforming it into a 218-room faux-Polynesian village. In 2012, the Paris-based operator shut it down -- selling out to Han two months later for less than an eighth of its A$100 million investment."

http://www.bloomberg.com/news/2014-03-26/billionaires-buying-islands-off-australia-find-perilous-paradise.html

@Manch Hon - The 436 Clinton St. location mentioned is not in a bad area of RWC (far from the Fair Oaks neighborhood).  It is near the middle school in High School.  It is not a high end area, but far from a low end area.  Probably a B- to B location.

@Andrew Eaton  ,

Welcome to Biggerpockets. Thanks for chiming in. So what do you think? Should we invest in the Bay Area for appreciation or invest in the Mid-west for cash-flow? That's the debate we're having here. 

Originally posted by @Johnson H.:

@Minh L.  sounds like you'll have to bring her to the next meetup to meet @J. Martin . Are you sure about this? lol

Johnson,

Believe it or not, I asked my sister before and she said no thanks. Per your request, I asked her again yesterday. She smiled and said no again. Sorry J. Martin . I tried. 

I was looking for warehouse space on CL and saw some listings of "industrial condos". They have maybe around 2k feet of warehouse space at the back with a small office up front. Saw some selling for 500K on the peninsula. This piques my interests. Anyone look into the appreciation and cash flow potentials of these? 

If you are buying for your own use I think you can finance 90% of purchase price with a SBA loan. Very high leverage play. 

Originally posted by @Andrew Eaton:

@Manch Hon - The 436 Clinton St. location mentioned is not in a bad area of RWC (far from the Fair Oaks neighborhood).  It is near the middle school in High School.  It is not a high end area, but far from a low end area.  Probably a B- to B location.

Yeah, anything on the hilly side of El Camino is kosher. Up in Burlingame even the wrong side is asking 1M for a not-so-large house. 

An interesting debate for sure. My own experience is this - The capital outlay it takes for dealing in the bay area made me look for out of state deals and that is how I really got started. Cash flows on these out of state deals are good but the capital appreciation potential in the bay area has again and again pushed me to look local. Slowly getting there. But yes, capital appreciation + reasonable cash flow in the bay area has a lot of appeal to me personally than pure cash flows. But one has to stay disciplined and not get carried away by the multi offer situation every where + be patient because deals are drying up. As deals are drying up here in bay area, are any of you doing or considering any of these:

1) New Build: Have any of you made a tear-down build up in the $600K range work in the recent past? (Hypothesis = $150K-$200K in land acq + $400-$450K in build costs for a 1500-2000 sq ft that can retail for $700K or more). My due diligence and analysis is suggesting a new build (to the new codes), the high labor costs, carrying costs (as it can easily take more than a year) are making it prohibitively expensive to make a new build deal work. thoughts?

2) Buying at courthouse: Seen sizeable number of deals blow past me in the past two years - in good school neighborhoods in Alameda and Contra Costa counties. But lately, none whatsoever. What are you all seeing? Anyone still buying at court steps?

Originally posted by @Minh L.:
Originally posted by @Johnson H.:

@Minh L.  sounds like you'll have to bring her to the next meetup to meet @J. Martin . Are you sure about this? lol

Johnson,

Believe it or not, I asked my sister before and she said no thanks. Per your request, I asked her again yesterday. She smiled and said no again. Sorry J. Martin . I tried. 

 Hilarious!!! J is going to be wealthy with his bay area holdings. She's needs to know this! lol

@Deepak P.  ,

Where did you invest out of state? Sounds like these deals are working out for you. Where do you invest in the Bay Area? Hayward?

I have been looking into new construction, but haven't figured out a good way to make it the numbers work. I know a couple of persons that do tear down and new build in Palo Alto and Atherton. It's one of those higher risk higher return market, and you need a lot of capital. 

Courthouse steps are completely dried up. I wished I was more aggressive back in 2011 and 2012. I knew the market would go up, but didn't expect it to shoot up 30% - 50% YoY. 

@Minh L. My projects are/were in OH, TX and NJ. Learnt some lessons the hard way but doing alright now. Yet to take up a deal in bay area though, but Hayward/San Lorenzo area is definitely one source. Someone mentioned good schools in Castro Valley, and they are right on. It is a hidden gem in my opinion and makes a strong case for tear down + build. If there is one place where numbers might work, that will be here.

Re: courthouse deals, back in 2012, you went to the steps yourself or paid someone for proxy bidding? Re: new builds, do you know per sq ft hard+soft costs that the folks that you know are able to manage to?

Originally posted by @Deepak P.:

Someone mentioned good schools in Castro Valley, and they are right on. It is a hidden gem in my opinion and makes a strong case for tear down + build. If there is one place where numbers might work, that will be here.

That someone is me. :) I was surprised by my find too.

Regarding new builds, I know people doing them in Sunnyvale. Another play is picking up something zoned higher than R1 and build condos. Per unit building cost is lower and you maximize the land value. You need to have 1M+ capital to deploy though. Definitely on my "When I grow up I want to do" list.

@Deepak P.  ,

You're looking at $250-$275/sq.ft. for new build depending on city. That price includes permit and engineering fees. Talking to architects last year, I was getting quotes for $250/sq.ft.

I started buying properties at the courthouse steps in 2010. I went there myself. That's how I know a lot of the players/flippers/investors in Santa Clara County. 

Originally posted by @Manch Hon:

I was looking for warehouse space on CL and saw some listings of "industrial condos". They have maybe around 2k feet of warehouse space at the back with a small office up front. Saw some selling for 500K on the peninsula. This piques my interests. Anyone look into the appreciation and cash flow potentials of these? 

If you are buying for your own use I think you can finance 90% of purchase price with a SBA loan. Very high leverage play. 

 Manch,

I was looking at buying a new or newer office building to open my real estate brokerage company with a partner. My wife shot down this idea. I know why, but happy wife = happy life, so I flushed that idea down the drain. 

If one has a sustainable business model, buying a building then expanding from there would make one very rich. 

@Manch Hon   Agree. Multi-unit is the way to reduce per sq ft costs but long way out for me too (capital needs, like u said)

@Minh L. If it is $250/sq ft on the peninsula, wonder if that could be a tad bit lower for east bay

Anyone know if there are significant building code differences between bay area neighborhoods that building new in, say, Fremont might be lot less expensive than in San Jose? Or say, from building in Palo Alto vs. building in Fremont?

@Jeffrey Reyes  

,Just finished a 4plex in E Oakland w/ lots of CF, and got into contract in "gentrifying W Oakland" on a duplex last Friday w/ a partner originally from here on BP. @Minh L. 

,not looking for a partner right now (relationship) lol But if I stumble across one, maybe its meant to be... And you have a point about "di-worse-ification vs diversification. But I think of it as balancing CF w/ appreciation. Just like Buffet bought insurance companies because he liked the consistent cash flows. That allows him to go buy some other undervalued companies that may need some time to turn around.. I kind of think of that like my E Oakland and new W Oakland property. The CF from E Oakland pays for the turnaround over some years on the W Oaklnd property.. @Matt Mason  

bad/long evictions do happen, but far and few between. If you maintain good relationships with your tenants, it should be very rare. I would do a buyout before it ever got to that.. "carrot and stick" so to speak. @Johnson H.  

, I love talking about appreciation lol I'm really taking a big personal step here by buying a property that will be cash flow negative for me to start, betting a bit on some big turns in rents, and big appreciation ...

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