The Property Management Shop
by Marc Wilson
Q. My wife and I want to buy a San Francisco apartment building. We have been in the market for six months and have been surprised by the incredibly high asking prices. We ultimately prevailed with a successful bid on an 8-unit property in the Marina. The seller’s disclosure package contains reams of information, warnings and disclaimers relative to earthquake risk. My wife is understandably concerned. I’ve spent the last week shopping for earthquake insurance to no avail; the pricing is crazy. My real-estate agent tells me that none of her clients carry earthquake insurance and, given the price quotes that I have received, this comes as no surprise to me. What is the story with earthquake risk and property values in San Francisco? How do your clients deal with this risk? I would have expected to see decreased valuations for high earthquake-risk locations or for older, nonretrofitted properties, but the opposite is true. Why do San Francisco real-estate prices not reflect earthquake risk?
A. You would be surprised by the amount of time consumed, money spent and research performed by psychologists, sociologists and economists in an effort to answer your question. The good news is that some of the brightest academic minds in the country have tackled your question. The impact of earthquake risk on real-estate prices has been studied, probed, analyzed, discussed and published by some of the smartest people in virtually every academic discipline in existence. PhD dissertations have been laboriously researched, articles have been written and books have been published. I am pleased to present to you the culmination of these academic efforts: the San Francisco real-estate market is an efficient market.
In economists’ speak: the beauty of the market system is that when perfect information is available to all parties, the resulting price of a commodity will accurately reflect all underlying preferences and information in regard to the product. In short, the buyers and investors have spoken. The sales prices of San Francisco apartment buildings are established by knowledgeable, informed and intelligent buyers and sellers. Believe me: buyers and sellers are well aware of earthquake risk, interest rate risk, rental market risk, fire risk, liability risk, political risk, rent control risk, wrongful eviction risk, legal risk and every other conceivable risk. Real buyers simply don’t care about these risks. To them, and to most San Francisco buyers, liquefaction is a drink you buy at Jamba Juice.
One of the top producing agents in my office told me that she stops working with a buyer if he asks one of three questions: Why is the seller selling? How long has the property been on the market? What are the earthquake risks associated with San Francisco real estate? San Francisco buyers accept and understand that valuations in this town already reflect earthquake risks; the only question is do you accept earthquake risks? In ten minutes of research, I was able to find five published articles concerning the lack of accountability of earthquake risks in San Francisco property values. These economists have concluded that property buyers in markets like San Francisco fail to account for earthquake risk. Well, this may or may not be true. But what is definitely true is that the combined net worth of all five economists is well below the net worth of your typical Marina district apartment-building investor.
There is simply no empirical information that proves that real-estate values fall (in the mid to long term) after earthquakes or are even devalued in earthquake-prone locations. For whatever reason, the market makes no apparent adjustments for earthquake risks or, for that matter, hurricane risks. In fact, the opposite might be true. Carol Lloyd, a San Francisco Chronicle columnist, discussed the dizzying state of New Orleans real estate in a September 2005 “Surreal Estate” column. “In a place where hundreds of people have died, where thousands of homes are destroyed, where 80% of the land has been soaked in toxic sludge and the economy has been devastated, and with this year’s hurricane season far from over, the real-estate gods seem to be saying perversely, ‘It’s all good,’” she wrote. “The post hurricane climate has done more than simply attract property vultures from around the country; it’s also made a lot of local sellers up the ante. Some prices doubled in price overnight. People were bidding up prices, not even caring about the price. They just had to have a place to live.” Disaster? What disaster?
The last San Francisco earthquake completely ruined only six apartment buildings in a city with over 30,000 apartment buildings. Most people who completely lost their property in 1989 did not have earthquake insurance. Do you think they lost their property or their equity? On the contrary, FEMA rode into town and gave everybody loans at 3% amortized over 40 years. No doubt the experience was very stressful for the owners involved, but most either rebuilt condominiums or completely remodeled their buildings and had only a few of their low-rent tenants return when the building was finally fixed. Most lenders don’t want your broken building after an earthquake. They will usually bend over backwards to help you through a difficult time. In the long run, most owners of severely damaged apartment buildings actually benefited by the 1989 earthquake—a phenomenon only made possible by rent control. The San Francisco Board of Supervisors poses a much higher risk to property values than any kind of natural disaster. We know that buildings can be fixed. What we don’t know is whether the social damage done by Supervisors Chris Daly and Jake McGoldrick can be fixed. Broken schools, vagrancy, pot clubs, litter, graffiti and rent control are the only true San Francisco natural disasters, and they are definitely not insurable.
This is not to say that you should do nothing to prepare for an earthquake. If you own a corner building with parking on the ground floor in the Marina and you haven’t installed sheer walls and bolted the foundation, you are asking for trouble. Don’t give the insurance company $15,000 a year for earthquake insurance. Spend the money making your property as earthquake proof as possible. Then you can capitalize on the expense and pass it along to your tenants. If you want a good value for your insurance dollar, spend your money on workers’ compensation insurance and make sure your automobile insurance coverage has kept up with your net worth. You have a much higher probability of being sued by your handyman, a tenant or some San Francisco pedestrian than you do of suffering at the hands of an earthquake.
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 and has specialized in the brokerage of San Francisco apartment buildings for 20 years. He can be reached at 415-229-1275. Copyright © 2006 by the San Francisco Apartment Magazine. All rights reserved.