SF Apartment : June 2017

MIGHTY SMALL

Eye of the Beholder

by Kilby Stenkamp

Two-to-four unit buildings are in a league of their own. They’re too small to be considered commercial, and they’re often overlooked by investors and potential owner-users who may prefer single-family homes and condominiums. Overlooking 2-4-unit properties is a mistake made by too many. With a little creative planning, these quintessentially San Francisco Victorians and Edwardians have real potential.

Like any San Francisco property, 2-4-unit properties are valued by the usual suspects: location, views, natural light, parking, condition, tenant profiles, leases, possible expansion, and rents. But the devil is in the details. There is much more to consider when determining the value of a 2-4-unit property. Buyers need to think beyond what the property is, and instead focus on what the building could be.

Because of the complexities of San Francisco rental laws, buyers tend to shy away from tenant-occupied properties. While the hesitation is understandable, buyers who avoid these properties altogether could be missing out on a great investment.

Buyers considering such a property should first meet with a local landlord-tenant attorney who can offer valuable information to help de-mystify rent control and assist in navigating through the available options. Second, buyers should consult a local contractor or engineer who can see potential options to increase the property’s value in the future. A calculated investment in a property will often pay off within a few years. Having a professional to help with decision making is invaluable, and luckily for us, San Francisco is chock-full of knowledgeable talent.
Buyers should also pay careful attention to a property’s disclosure documents—this is imperative when purchasing a two-to-four-unit property. Recently, I looked at a Russian Hill three-unit building, which didn’t seem like a great investment at first. After a more thorough look, I determined the property was a rock-solid investment. Sure, the property needed some work, but one of the three units was empty—perfect for an owner-user. The other two units were tenant occupied, however, one by a senior actively looking for alternative housing, as he could no longer navigate the stairs. I also noticed that a fourth unit and a garage could be added in the expansive basement through the city’s ADU program. These capital improvements could be passed through to the remaining tenant. This property would be a smart purchase for an investor or an owner-user.

Last year, I had the pleasure of working with Rodrigo Santos, principal engineer at Santos & Urrutia Structural Engineers. I was having some trouble in the sale process of a multi-unit property, and he jumped in and saved the deal. The property was categorized as tier four in the soft-story retrofit program, and the work was yet to be completed. Bids for the work were coming in outrageously high, and there was a lot of disparity between them. This, in addition to deferred maintenance and an existing notice of violation (NOV), had the buyer discouraged. This was when Rodrigo stepped in with a brilliant plan at a reasonable cost, and the buyer was able to complete the necessary work for less money than we had originally anticipated.
Soft-story retrofit requirements for three-to-four-unit buildings will begin in San Francisco in 2024. However, the city is currently allowing owners of these buildings to add an ADU and legalize existing illegal units. A lot of property owners are taking advantage of this program now, and getting the retrofitting done in the process, ahead of schedule. While owners still have to go through Planning, have an engineer draft plans, and follow the procedures set in place, at the end of the day, the process is worthwhile. Soft-story costs can be passed through to existing tenants, and market rate can be collected on the new unit.

Another favorite source of mine is the very knowledgeable SFAA member John Pollard, owner of SF Permitting, Mercury Engineering, SF Garage, and SF Construction. Whenever he evaluates a building, he thinks to himself: What would I do if this were my building? Is there dead equity to improve upon? He looks for ways to expand a building’s footprint by considering what can be done with an abundance of ground floor storage, attic space, and large over-expanded garages. When he looks at a property, he looks beyond what is there, considering how it can be altered to be its best. Furthermore, John is knowledgeable about working with existing tenants without compromising their existing services. Having a professional like John analyze a property could offer new ideas for increasing income and value, whether it’s a property you already own or one you’re considering buying.
Year-to-date, I’m pleased to report the two-to-four-unit world is holding its own. While the number of sales dropped eight percent considering the same time period last year, this is just because there are fewer properties on the market. The inventory for two-to-four unit properties is limited across the city. The median sales price went from $1,750,000 to $1,850,000, and the average sale price over asking decreased slightly. These properties tend to stay on the market longer—from 50 to 65 days—likely due to lending. The price per square foot has increased from $620.93 to $647.60. Compare this to single-family homes, which average about $1,000 per square foot.

Back when I first entered the market, as a first-time buyer in San Francisco, I purchased a three-unit building, with two vacancies, and a lot of deferred maintenance. The mortgage relief this property offered made sense in my situation and gave me the opportunity to enter the housing market. In hindsight, the property I chose had tremendous value, despite the huge learning curve and all the sweat equity we invested. Eventually, I sold this property, marketing it as a TIC building. The new owners eventually converted the building to condos.

Thank goodness for the San Francisco Apartment Association. The years of well-researched, solid advice and the number of contacts they’ve given me have helped me develop my career and grow my investments.

Kilby Stenkamp is a realtor at Keller Williams. She can be reached at [email protected] or 415-370-7582.