SF Apartment : March 2018

MIGHTY SMALL

Inventory in Flux

by Kilby Stenkamp

The real estate world is abuzz with the implications of the new federal tax laws on local and national markets. In San Francisco, 2-4-unit properties already had a strong finish in 2017 and a robust start in 2018. So, what affect, if any, will new tax laws have on 2-4-unit properties here?

Before I render my opinion on the new laws, please note that I am not a CPA and I would suggest that all owners speak with a qualified tax professional about your unique tax situation, needs and goals. Even with my own portfolio I have questions on how to maximize the new laws, hopefully in my favor.

That being said, after reading countless articles on the new tax reforms it is my opinion that the 2-4 market will benefit from the new laws and remain strong through 2018. Buyers of 2-4-units can now take advantage of the new 20 percent qualified business income deductions (rental income), making 2-4-units even more attractive to owner-users and smaller investors.

As a cautionary note, the 20 percent deduction is subject to income, filing and other considerations. Per George Morris of Calegari & Morris CPA, consulting with a tax professional when considering a purchase is more important than ever, especially for those at higher income brackets. Morris went on to say there was a big push in December for CPAs and other tax professionals to advise clients on how to prepare for 2018. Many accountants are just now focusing on the details of the new tax reform laws.

While the new tax law may be a boon for those who already own properties, it could make it even harder on buyers. There is speculation that with more income in their pockets, property owners will be less likely to sell. Our current inventory of 2-4-unit properties is already low, with less than two months of inventory. If, indeed, fewer properties make it to the market, then price and demand will come into play, driving prices upwards. Smaller 2-4-unit properties, including mixed use, are the largest percentage of residential income properties sold in San Francisco. The bulk of the 2-4 properties sold are older construction, built prior to World War II. Of those, the greater percent were built prior to 1920. These older buildings are very desirable to buyers and offer quintessential San Francisco charm and locations.

Buyers of single-family homes and condos will have different considerations. In that market, the biggest factor may be that the new tax law has dropped the $1-million mortgage interest deduction to $750,000. Additionally, taxpayers will no longer be able to deduct interest on home equity loans, often used for home improvements. However, the general consensus amongst the agents in my office is that the mortgage interest deduction, and other tax reform changes, won’t do much to dampen the appetite for single-family homes in the local market.

Will the tax changes convince more owner-users looking for a single-family home to consider 2-4-unit properties instead? I believe they will. Currently, there is a lack of inventory across the board and some have criticized the new tax reform as doing nothing to help appease the demand for housing. In a competitive market like ours, buyers are forced to consider other options. While it all depends on buyers’ short- and long-term goals, for some buyers looking to get into the market it may make financial sense to buy 2-4-unit properties. (It did for me when I first entered the San Francisco housing market.) The new 20 percent qualified business income deduction will be an attractive incentive for some, along with the other benefits of buying a 2-4-unit property. Sure, buying a rental property in San Francisco is like signing on for an extra job, but it can be well worthwhile.

There’s been plenty of speculation in the media on how the new tax reform will impact the market overall. I read one article that focused on construction and the trend towards building apartments for investors and moving away from single-family homes and condos. In San Francisco, we’ve already seen a shift towards rental property construction due to the recent below-market-rate housing mandates for developers. Under the new tax reform laws, commercial properties will also benefit with a lower passthrough rate on income, offering more incentive to rent out properties.

Others feel the new tax laws will push people from coastal cities to more affordable inland locations. In the last few years, we’ve already experienced home buyers being pushed outside of the city to more affordable destinations that still allow a reasonable commute to San Francisco. Going forward, less inventory means more competition for qualified buyers, which will push prices upwards.

It may be too soon to really know the full impact of the tax reform laws, but it’s worth looking at the state of the 2-4 market before the laws took effect. At press time, there were 70 active 2-4-unit properties in San Francisco, with a high price of $12,995,000, median of $2,827,287, and low of $799,000. The average price per square foot on an active property is $804.98, compared to fourth quarter 2017 sales at $692.97 per square foot. There are 16 properties currently asking over $1,000 a square foot, including several premier properties in Russian Hill and Cow Hollow listed at upwards of $1,500 a square foot.

It will be interesting to follow 2-4-unit sales over the next few months to see where the price per square foot averages go. If you consider the price per square foot on single-family homes and condos, 2-4 units still offer a good value and likely some additional financial and tax advantages.

In the fourth quarter of 2017, there were 114 2-4 sales reported on the MLS compared to 97 at the same time period in 2016. The price per square foot average on sold properties in the fourth quarter of 2017 was $692.97, compared to $648.84 for the same time period one year earlier. Average days on market dropped from 57 days in the fourth quarter of 2016 to 39 days in the fourth quarter of 2017. We are seeing 2-4 units being absorbed quickly and, even with a bump in post-holiday inventory, there are still not enough properties to satisfy the demand for 2-4-unit properties.

Late last year I picked up a 2-unit building. I’ve got lots of questions for my CPA regarding the property and the new tax changes. Should I hold title differently? Is the property a good candidate for cost segregation? (Cost segregation is a very interesting accounting approach and definitely something to look into at our price points.)

The one thing I keep hearing over and over is that the new tax laws will favor property owners. Personally, I’m proceeding with caution with a watchful eye for properties that make sense, some in the short term and others as a long-term hold.

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