SF Apartment : December 2016

MIGHTY SMALL

Small Wonders

by Kilby Stenkamp

Change is the one thing you can count on. That is certainly true of the San Francisco real estate market, but the San Francisco housing market is another story entirely. While our housing market directly relates to our real estate market, according to Eric Fischer’s blog, Experimental Geography, the housing market is in a years-long crisis. The reality is that we have a shortage of housing, which means that the right investment in the San Francisco real estate market can be lucrative.

For many income property buyers, the question is what to buy: single family homes, condos, 2-4-unit buildings, or multi-family properties. My preference has always been the 2-4-unit buildings, even mixed use. The cost per door is higher than multi-unit housing; however, the initial investment is more affordable, and smaller buildings are far easier to manage. The 2-4-unit properties ultimately can become cash cows, a long-term retirement plan, or mortgage relief for an owner-user.

While some parts of the market are showing signs of a shift, the 2-4-unit market appears to be healthy. In my standard Multiple Listing Service (MLS) search, I found that the 2-4-unit market, on the surface, seems to have improved in comparing Q3 in 2015 to Q3 in 2016. In Q3 of 2016 there were 103 sales with an average of 62 days on market. The high sale was $4,995,000, the median sale was $1,826,211, and the low sale was $760,000. In Q3 2015, there were 133 sales and the average days on market was 50 days; we know lending changed and this could account for the additional days on market in 2016. The high sale in Q3 of 2015 was $4,900,000, the median sale was $1,630,000, and the low sale was $485,000.

My internet search eventually led me to Paragon’s SF Bay Area Apartment Market Report. The report is very well written and offers some amazing statistics; for example, the Average Rents by Unit Size in Marin, San Francisco, and Oakland. What I found particularly interesting were the Average Cap Rates and Gross Rent Multipliers (GRM) reports, which show that the multi-unit market has remained relatively stable from 2015-2016. According to the report, from 2015 to 2016, the overall YTD cap rate remained unchanged in San Francisco, and the average GRM bumped slightly from 17.6 to 17.9.

I spoke with Bob Dadurka, the CEO of Paragon, who told me the reports are written by Patrick Carlisle. In regard to the reports, Bob emphasized Patrick’s thoroughness, knack for analytics, and his many sources, including the MLS, Co-Star, LoopNet, and his own independent research. I recommend that anyone interested in real estate read Patrick’s reports; they’re full of useful information for any San Francisco investor.

Bob went on to say that part of the stability of the 2-4-unit market is that it appeals to owner-users. With the rising cost of San Francisco’s housing market and with rates as low as they are, it is often cheaper to buy—and for the right buyer, mortgage relief is very appealing. The 2-4-unit market also appeals to entry-level investors, or those looking for a long-term hold. A colleague of mine always says that buildings outlive tenants. Once that long-term tenant finally moves out, the income skyrockets. For now, long-term interest rates and loan programs are attractive, making a 2-4 investment even more appealing.

My friend and client, Irving, has a number of 2-4-unit buildings he’s purchased over the years; he currently owns somewhere around ten 2-4-unit buildings, two of which he purchased in the last few years. He has always liked 2-4-unit buildings as investments. They are easy to manage, and he can afford them on his own. He also feels the tenant profile generally offers more stability, as the living environment is much more intimate. The more quintessential 2-4-unit properties in San Francisco can command higher rents than some of the larger apartment buildings. His portfolio also includes larger properties that he predominantly co-owns with partners. However, over the years he has had partner issues. Recently, he has been faced with partners who have gotten older and want their funds out of the investment. He has been forced to sell, or buy partners out, which has increased his property taxes. Most of these partnerships were entered into on a handshake. Having a written agreement is always the best-case scenario and offers a road map when and if issues come up.

Recently I’ve had the pleasure of working with Mark Harris at Kal Financial. According to Mark, there are more loan programs for the 2-4-unit market than he’s seen in the past, and they are less complicated. Most of his 2-4-unit buyers are owner-users, including mixed-use properties. Some of his buyers couldn’t find what they wanted in the condo market and found that their money went farther in the 2-4-unit market. Some of his lenders are backing off the old model of 30-40% down, and will loan with as little as 20%. Rates and terms are attractive on both 2-4-unit and mixed-use properties. There are far more options than there have been in the past for this niche market. For the perfect pre-qualified buyer, with their paperwork in order, the purchase timeline can be 21 days or less.

My passion for the 2-4-unit market began in the early 90s on my first property purchase in San Francisco. At the time, we were leveraging everything we had and needed the mortgage relief to live in San Francisco. The property went street to street. It had two units in the front, one long-term tenant occupied, and a cottage in the back. The property had good bones, but needed work. There was a lot of sweat equity involved, but I was much younger then. The learning curve was huge and at times painful. Eventually the tenant vacated the property and I was able to sub-divide off the back cottage. It was a win-win. I could write an entire book on that property. At the end of the day, it was a great investment that gave me entry into the San Francisco market.

In closing, I see potential deals in the 2-4-unit market all the time. Every property needs to be analyzed thoroughly for its potential investment value and return. There are different approaches and strategies, especially with tenants involved. With some 2-4-unit properties, the upside is years out. With others there can be a return sooner than later, depending on how you navigate your investment. At some point, soft-story retrofitting will be required on some of the 3-4-unit properties, but that’s probably ten years from now. The trend, at least for now, seems to be stable for the 2-4-unit properties.


Kilby Stenkamp is a realtor at Keller Williams. She can be reached at kilby@KW.com or 415-370-7582.