The Property Management Shop
by Marc Wilson
Q. My wife and I own a fully occupied, six-unit apartment building in Cow Hollow. All the units are large two bedrooms with parking. The yearly gross collected rent is around $120,000. We have recently been inundated with calls and letters from local realtors. We have owned the property for over 20 years and have never experienced this kind of interest from the brokerage community. Apparently the market is flush with TIC developers who are paying a premium for such properties. One agent told us that our property would sell for over $3,000,000! Is my property really worth $3,000,000? And just what is a “TIC developer?”
A. In the San Francisco market, a TIC developer is someone who is in the business of buying apartment buildings (usually 2- to 8-unit properties), invoking the Ellis Act, evicting the tenants, remodeling the property, creating and implementing a tenants-in-common agreement and selling the individual units to homeowners as tenants-in-common interests. As opposed to a long-term investor, the TIC developer is in the business of owning the property for the least amount of time possible. The TIC developer is in the business of converting rental property into individual, for-sale units.
The TIC developers' business is dependent on the continued legality of two things: the Ellis Act and tenants-in-common ownership rights. The Ellis Act is a state law dictating that a landlord may evict all tenants in a building in order to take the building off of the rental market. It is a fundamentally simple and straightforward law. While the Ellis Act is currently under some non-trivial legal and legislative attacks locally from tenant activists and their tenant-friendly supervisors, it is difficult to imagine any permanent damage that these activists can or will inflict on your rights relative to the Ellis Act. Similarly, the tenants-in-common form of property ownership is essentially governed by property law, which concerns the various forms of ownership in real property. In property law, tenants in common are co-owners of real property and are regarded by the law as each owning separate and distinct shares that may differ in size. Upon death, the share of a tenant in common does not pass directly to the survivor or survivors but is instead passed through inheritance as directed in the deceased's will. Typically, this form of ownership is common where the co-owners are not married or have contributed different amounts of cash in the acquisition of the property.
As a vehicle toward home ownership, a TIC is considered to be inferior to ownership of a condominium. The TIC share is difficult to finance and TIC properties are more likely to incur ownership and partnership disputes. TIC neighbors will simply find it easier to argue and disagree with each other than condominium neighbors. TIC forms of ownership are popular in San Francisco because the Board of Supervisors—and the voters, I might add—have made it essentially impossible to convert residential properties into condominiums. But making condominium conversion impossible has not diminished the motivation of our residents to own their own homes; so the “would-be” buyers move on to their next best option: tenants-in-common ownership.
Ellis Act evictions and TIC conversions have historically been restricted to smaller, 2- to 4-unit properties. The inability to finance individual TIC units has meant that all buyers had to qualify, cosign and be jointly responsible for a single loan on the property. Any experienced real-estate broker can tell you that coordinating more than four buyers is worse than herding cats. So what's changed? Why all the buyer interest in your 6-unit property? The financial markets are now taking baby steps into the TIC lending market. Some lending institutions have already made loan commitments to TIC developers—forward commitments to provide individual loans to “end users,” or the “home buyers” of the individual TIC units. The lack of available financing for individual TIC units is what has kept 5-unit and larger properties essentially immune from Ellis-Act evictions and TIC conversions. The emergence of lenders into the TIC-lending business has expanded the product base for TIC developers, who are no longer restricting their property search to 2- to 4-unit properties. I personally know of some 14- and 17-unit properties that have recently been Ellis Acted for TIC conversion.
Ellis Act evictions and TIC conversions will explode in numbers if and when the financial markets provide reliable, predictable financing for individual TIC units. God willing, this will happen over the next 12 months. Unfortunately, it is impossible for me to overstate the amount of political pressure that is currently being directed toward the Board of Supervisors. Tenant activists and tenant-friendly supervisors hate the Ellis Act and they hate TIC conversions. Tenant-friendly supervisors hate TIC conversions because they result in more homeowners and less renters. Supervisors like Jake McGoldrick, Tom Ammiano and Aaron Peskin were elected by tenants, not by homeowners. These supervisors, and all tenant activists, owe their livelihood to a San Francisco tenant base that exceeds 50% of total voters. Jake, Tom and Aaron could not replace their current salaries and benefits in the private sector—they are literally fighting for their lives.
The question is not whether these supervisors will do something to stop Ellis Act evictions and TIC conversions. The question is whether or not their actions will survive legal scrutiny. Remember, the Ellis Act is a state law and TIC ownership rights are rooted in both state and federal law. Notwithstanding this fact, be prepared for a litany of anti-Ellis Act and anti-TIC conversion legislation over the next six months. It will be interesting to see how this all shakes out. I honestly don't understand what the tenants are complaining about. The TIC developers are, for tax purposes, dealers. Do you know what that means? It means that most TIC developers will give 50% of their profits to the government in the form of taxes on ordinary income. It seems to me like a redistributionist's fantasy come true.
Is your property worth over $3,000,000? Maybe. 5- to 10-unit properties with large units, parking, low rents and some ownership appeal are currently selling for absolutely crazy prices. TIC developers are driving this market and, in some cases, paying 20 or 25 times the yearly income for these properties. I have to admit that I have mixed emotions about this development. The good news is that some of the buildings that I own have enjoyed spectacular appreciation. More good news is that it is relatively easy for me to make a good living as a real-estate broker specializing in the sale of San Francisco apartment buildings. The bad news is that it's impossible for long-term investor/operators like me to compete for these properties. I always thought that I would pick up a building or two every 5 or 7 years during the course of my career. But how can I justify paying 20- or 25-times gross for a 6- or 8-unit apartment building? What's the end game? Owning and managing San Francisco apartment buildings is hard enough when one is breaking even or experiencing positive cash flow. I remember buying apartment buildings in the mid 90s for 8- or 9-times gross with 25% down. Because of deferred maintenance, these deals would lose money for years 1 and 2, break even in years 3 and 4, and finally make money in year 5. What in the world happens when one pays 20- or 25-times gross with variable-rate financing? I don't think that I want to find out.
Feel free to call if you think that you have a TIC developer's “dream property.” You might be very surprised at its current value.
The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of SFAA or the San Francisco Apartment Magazine. Marc Wilson is the president of SFAA. He has been managing and selling San Francisco apartment buildings for 20 years. He can be reached at 415-229-1275. Copyright © 2005 by the San Francisco Apartment Magazine. All rights reserved.