SF Apartment : March 2016

MIGHTY SMALL

Tale of a Sale

by Kilby Stenkamp

Everyone who owns property in San Francisco sooner or later has a story to tell. And anyone who expresses interest in income property or tenant-occupied property in San Francisco needs to know they also may end up with a story. Before looking into purchasing an income or tenant-occupied property, I strongly advise a consultation with a good, local landlord tenant attorney. Becoming an SFAA member is invaluable, since the organization provides access to amazing resources to all their members.

My very first property in San Francisco came with enough stories to write a novel; the tales involved in that deal were the kind of things you just can’t make up. While I would love to tell my own story, a recent transaction involving my client Irving might offer some more informative and educational insights that could help preserve your property value and sanity. Let’s look at it as an example of how some stories can be avoided altogether, or at least have a happier ending.

A Humble Start
I’ve written about Irving before. He’s a self-made property baron who now owns a number of buildings in San Francisco. Irving moved from Boston to San Francisco in 1964, and a few years afterwards, his mother decided it was time to give him $5000. When Irving’s siblings had married, their mother had given them all $5000 to help them start their lives. Although Irving wasn’t married, he was the youngest child, and the last in line for a monetary leg up. At the time, he was struggling in San Francisco, making ends meet by working at Doggie Diner, Emporium and Macy’s. Irving would later make his first real estate purchase in Bernal Heights with the $5000 gift from his mother.

Irving heard that government jobs were paying good salaries and offering perks, and so he decided he would take the test for government employment. He landed a job at Mare Island and eventually was transferred to the Hunters Point shipyards. At the shipyards, all employees were asked to buy a bond for the Vietnam War effort—they needed 100% participation. Because Irving was opposed to the war, he refused. It was agreed Irving would be allowed to transfer to the Merchant Marines. During his tenure in the Merchant Marines, Irving ended up going to Vietnam five times. Eventually supplies were airlifted and most of the ship employees were laid off. He was cash flush in comparison to his early days in San Francisco, and decided to volunteer with the McCarthy presidential campaign, which later turned into a full-time job.

Irving had established a solid group of friends in the city, one of whom lived in Bernal Heights. It was an up-and-coming neighborhood; all kinds of young people were moving in and it was the “hip” place to be. Irving found a really affordable—albeit it a fixer-upper—property for $23,000, and a few of his friends agreed to live in one of the units rent free in exchange for working on the property. Irving was then able to generate modest rent from the other unit. Back in the ’60s there was no rent control, so he didn’t have to worry too much about tenants. The property took two years to renovate and Irving was pleased with the results. He soon discovered cash out refinancing and pulled equity out of his property. When the property across the street went on the market for $10,000, he partnered with his friend Alice, whom he had met on the McCarthy campaign, and together they purchased it. They then hired another friend’s husband, who had just graduated from UC as an architect and was looking for work. The three of them worked together on renovations. Back then, everything was done on a handshake, as opposed to a formal written agreement.

A Simpler Time
Irving’s purchases in Bernal were the start of something big: afterwards, he moved on to purchase many other properties. He was young and had no credit and not much money, but he did have a good work ethic and great ideas. When Macy’s hired him to work the Sunday floor shift in the rug department, Irving spent the time reading the real estate section of the San Francisco Chronicle. Until 1970, Macy’s was not open on Sundays. The regular full time employees didn’t want to work that day, and literally revolted as they were convinced customers would not shop on Sundays; it would take years before shopping at Macy’s on Sunday would catch on. Every Sunday Irving called about listings that looked interesting and that he could possibly afford. He asked questions—not just about the property he’d called about, but about all aspects of the local market. Irving considers those Sundays at Macy’s as his formal on-the-job real estate training.

With the funds remaining from his refinance, Irving bought a third Bernal Property. However while he was working on the third building, he ran out of money. He decided to go to the bank to see if he could get help to finish the renovations, but nobody he spoke with would give him a loan. He finally landed at Barclays Bank in the Financial District. The loan officer he talked to liked what he had to say, came and visited the property and finally gave Irving the loan he needed to finish the work. During the late ’60s Bernal was part of a federal program to improve neighborhoods, and an inspector from the Department of Building Inspection came out every month to check on Irving and give him tips on how to pass his final inspection. With this help and direction he successfully finished his renovation and was back on his feet.

Irving ended up buying a number of properties in the neighborhood. Prices were reasonable and lending was much easier than it is by today’s standards. On his fifth Bernal purchase he sold the property two months after buying it for more than double the price. The rest is history. He bought one property after another, many of them with the same partners. In his early days the partnerships had been a flying success. He moved on to partnerships involving two and even three or four people a time. Even today most of his partnerships have worked out rather well, with few exceptions.

A Lost Paper Trail
Fast forward to 2012. Irving has bought and sold hundreds of properties, and has had a number of different partners. Then one of Irving’s partners became embroiled in a long and bitter divorce. The properties that Irving and this partner owned together were tied up for about five years. There was no money available for special assessments, maintenance items went unattended, liens accumulated and eventually the deeds had to be reassigned. Irving and the remaining partner had to take a long look at one property in the portfolio. It was a gorgeous building, but the rents were low. The rental income didn’t generate enough funds to catch up with the deferred maintenance, or to finish projects started during the first years of the divorce. They had to decide if they wanted to keep the building and pay out of pocket for the expenses, or sell. Given the projected numbers to make repairs and upgrades they decided to move forward and sell.

Owning a property with other people can work out well. However, over the years I’ve run into some very volatile situations that could have been avoided had there have been a written partnership agreement. Partners in a property should have a written agreement up front. By creating a written partnership agreement, you have something to fall back on if an issue comes up—and they do come up. The agreement should include management structure and policies for spending funds, accounting and banking, owner draws, capital contributions, buyouts, etc. Had there been a written agreement between Irving and his partners, navigating through the divorce and the aftermath could have been a lot easier. I spoke with Boyd McSparran, attorney at G3MH, LLP, who adds, “Co-owners of investment property may not need a contract as detailed as a TIC Agreement, but they should have a written agreement detailing how to handle rights of first refusal, what may trigger a sale, and distribution of proceeds, among other things.”

In preparing for the sale of a tenant-occupied property, estoppels, leases and tenant communications are imperative. In Irving’s building that he wished to sell during his partner’s divorce, most of the tenants were second generation; they had taken over their units per Costa-Hawkins when the original master tenant vacated. New leases were created way back when, but they were nowhere to be found. It was clear the tenants weren’t going to provide them, and there was a clear sense of entitlement due to the length of their tenancies. If you choose to exercise Costa-Hawkins, make sure you review the civil code thoroughly and consider consulting a local landlord tenant attorney about the pros and cons. It may be better to get a unit back, make upgrades and start new tenancies.

Under Costa-Hawkins, the landlord may be entitled to increase the rent to market rate in certain roommate situations when the original tenants no longer live in the unit. Rules and Regulations Section 6.14 and/or Civil Code Section 1954.53(d) of the Costa-Hawkins Rental Housing Act may apply. The San Francisco Rent Board’s go-to topic number 153 outlines the rules and regulations; if you own multiunit properties this is a must-read section. The tenants in Irving’s building also refused to execute estoppels, and since there weren’t any leases there was no recourse. McSparran says, “Leases are important because they set out the terms of the tenancy. If you allow a tenant to move in on a handshake, you will be hard-pressed to disallow pets, retain ownership of the keys to the premises, prevent unwanted alterations to the property and demand that the tenants fill out and return estoppels. Leases also memorialize the original occupants, the original rental amount and the security deposit.”

Arthur Meirson, also at G3MH, added, “All landlords, but especially those subject to the San Francisco Rent Ordinance, are well-advised to utilize comprehensive and updated leases. Given tenant protections by local and state law, changing terms of tenancy or evicting tenants for violating a landlord’s rules or general expectations can be very difficult if a written lease does not clearly spell out the terms of tenancy. Matters such as attorney fee awards and cooperation with estoppels when a property is being sold should also be addressed in leases. Landlords who utilize a flexible or oral arrangement with tenants often learn the hard way how difficult it can be to control or remove problem tenants.”

With this particular property of Irving’s, we were fortunate to have the rent increase notices, and were able to confirm consecutive payments of rent with online banking. Ideally we would have also had leases to support terms, enforce execution of the estoppels and confirm the security deposit amounts. Property owners should make annual rent increases no matter how small the allowable increase is, and keep good records. Banked rent increases cannot be compounded, and over the course of several years compounded interest adds up.

I’ve also found that tenants come to expect their annual increase, and it doesn’t catch them off guard. When you send a banked rent increase notice tenants are often taken by surprise; all of sudden there are maintenance issues that need to be addressed, as well as unnecessary tension.

Keys to the Kingdom
Irving’s tenants were upset by the sale, understandably. Some were very cooperative; others weren’t. On initial contact they asked for a showing schedule, which I gladly provided. With tenant-occupied properties I find it very helpful to set a schedule in advance of marketing. Being courteous and civil is always the best approach. But with this particular property, as hard as I tried, events took a downward turn. In addition to the lack of leases, there were very few keys to the units, and the tenants would not provide them to me. I’d arrive for an agreed-upon showing and nobody would be home—frustrating, to say the least. In order to facilitate maintenance and in case of emergencies it is very important to stay on top of the keys to your property. If the tenants have changed the locks and you have an updated lease, you shouldn’t have a problem getting copies. Recently I heard a new buyer say to a tenant, “If there’s an emergency and the door is broken down, you will be responsible.” He got his keys.

What do you do if courtesy and civility don’t work? As the listing brokerage we are agents for the owner, so I called Irving. He in turn called a local landlord tenant attorney who drafted a firm letter to the tenants regarding access for the purpose of showing the building. Per McSparran, “Although the civil code allows an agent to provide oral notice of entry, I always recommend giving written notice at least a day or two in advance. A little bit of courtesy goes a long way. Of course if the tenant refuses access, he or she can be reminded that refusal to provide access is a just cause for eviction under the rent ordinance.”

Meirson added, “One of the important rights landlords have is the ability to enter a rented unit for a few limited reasons, such as to exhibit the unit to prospective buyers. Tenants who prevent a landlord’s right of entry do so at their own peril and may subject themselves to eviction. However, this is a sensitive matter for which landlords should seek legal counsel to avoid accusations of wrongful entry or harassment.”

A Happy Ending
There are so many more details to the story—some of them unbelievable. Had Irving and his partners not contacted G3MH we wouldn’t have had a happy ending. Things worked out and the property sold. Irving and his partners still haven’t settled the final accounting, but we’re close. I have to say it was one of the most challenging sales in my career. In hindsight I may have approached a few things differently—but that’s how hindsight works.

I’m truly fortunate to have a client and friend like Irving. He is truly a success story, but it didn’t come easy—nor was it without its own learning experiences. Irving has so many fantastic and colorful stories about San Francisco, and the real estate market. Ultimately, he worked hard and that hard work paid off in the end.

Kilby Stenkamp is a realtor in the Noe Valley office of Hill & Co. She can be reached at [email protected] or 415-370-7582.