Saturday, December 1, 2007

An interesting proposition, and a mystery...


624 10th Ave. presents itself as both an interesting set of options as well as a mystery.
The flat is a Richmond 3 bedroom 1.25 bath TIC in a 2 unit building. It is currently asking for $699,000. There are no pictures of the interior, so we don't know much about the size of the bedrooms, but judging by the bay windows it looks likely to have a nice sized living room.
The notes state that building has separate water and PG&E meters, which make it "perfect for fast track condo conversion". Another option is to keep it as a rental unit, as it is currently occupied under section 8 for $2500 a month. Supposedly the tenant is fine with vacating for the new owners (given 60 days notice) but the buyer can renew the contract with section 8 if they so choose. The question is why would they want to? And it is that question that brings us to the mystery: the notes claim the building has "no rent control!". Perhaps someone can explain to me how a two unit building built in 1919 escaped rent control? A quick check with the SF Tenants Union reveals that
"2-4 unit, landlord occupied buildings used to be exempt from rent control.
Pursuant to 1994's Proposition I, these buildings have had full rent control protection since May 1, 1994. "
but I can't find out if there is any special rule exluding a building from rent control if the building is not occupied by the owner.
At any rate, the last listed sale (with a price) on Property Shark was $324k in 1991. Clearly at that price, between the sale, and what they made in rent, those owners did very well. But what does it look like for the new buyers? Plugging the numbers into our spreadsheet reveals that if we change the sale price to reflect the same appreciation the previous owners enjoyed over the past 16 years of 8.3% (which seems to me to be an exceedingly unlikely event), we will wind up with a sale price of $2 million in 2023. Assuming the same tenant lives in the house for 16 years from 2007 paying $2500 a month with 1.5% annual increases, the owner will be poorer to the tune of $138,000 (or $656 a month). He would have better off if he had just rented the place himself! And if property appreciation actually slows down a bit (as opposed to going into reverse, as some fear) to a more typical 2.5%, the owner will be out $867903, or $4113.29/month!

10 comments:

Anonymous said...

just a thought here . . . but if this building is a TIC, then technically under rent control laws it's not a condo or an apartment building, is it? Is it viewed as a single-family home (because it is purchased in joint tenancy among the co-owners) and therefore only partially subject to rent control laws - just cause evictions, but no rental increase limitations (assuming the tenancts moved in after 1996)? Is Costa-Hawkins significant here?

anna.hibble@redfin.com said...

this spreadsheet is awesome! I am linking to it on my Redfin blog this very evening.

anna.hibble@redfin.com said...

here's the link- thanks again for making this resource public:
http://blog.redfin.com/sfbay/2007/12/sf_and_daly_city_rent_or_own_do_the_math.html

Missionite said...

I'm not sure what Costa-Hawkins is (care to elucidate?), but my understanding is the applicable law is based on the number of rental units being rented (in this case, two) not on the legal status of the building itself (TIC, Condo, etc.)

Anonymous said...

The spreadsheet is just great. I found one small issue, the total appreciation should use compound interest formula rather than the simple one.

Missionite said...

Anonymous,
It would help if you would identify which cell you are referring to.

I have a suspicion you are referring to C32 (i.e Annual Appreciation). If that's the case, that's just the percentage of growth in the market value of the house. It's there for benchmark purposes (i.e. so you can say, oh this house increased 31% in value over five years!) and has no bearing on the rest of the spreadsheet. Compound interest wouldn't apply here, because that's not money sitting in an account earning interest, that's just the percent of change in value of the building.

The only instances where money is sitting or invested (and thus is available for compound interest to be earned) is on the renter's side: the "down payment" that is available because no house was purchased, and the cash flow difference between owning and renting that is available for investment.

anon8mizer said...

Hmm. The $319k sales price was probably for the entire building, not the upper flat itself. As far as 'plugging the numbers' for this flat as a rental, I was not able to find the spreadsheet with the actual numbers for this flat plugged in so it's unclear what you did there. But in general, I think we'd need a different spreadsheet if you were buying for investment purposes...

1) As an investment property, the entire mortgage (principle and interest), as well as property tax,maintenance, etc. are tax deductible
2) There is the issue of depreciation, which you can write off against the rental income, which is some accounting voodoo that a CPA will have to help us on :) But this depreciation will have to be added back to the capital gains when you sell
3) As investment property, the rental income will be offset by the cost of operating the unit. If the result is negative (a loss), some or all of it can offset your personal income if your annual gross income is less than $150,000... And if the 'loss' on investment property cannot be used to offset your real personal income (i.e. u make > $150000 in agc), then it's carried over until the time you can do that, or until you sell to increase your cost basis.
6) you don't get the 250K/500K tax-free. When you sell an investment property you need to buy something of equal or greater value to avoid taxes, unless before you sell you remove the tenants, and live in the unit for 2 years while owning it for at least 5 years, at which point it's converted back from investment property back to primary residence and you get the $250k/500k break

At any rate, I think a spreadsheet for primary residence will be quite different from a spreadsheet for an investment property...

Either way, congratulations on mastering of the spreadsheet. It is a necessary and also liberating journey to understanding how you want to approach the home ownership issue.

Missionite said...

anon8mizer,
Great comment (as usual!).
Yes, I just learned yesterday how differently the world turns when it is an investment property. Clearly my whole post is null and void.
While I am somewhat familiar with depreciation schedules due to my business, I am in the market first and foremost for a SFH to live in, so I don't think I will be tackling an investment property spreadsheet anytime soon.

blaise5000 said...

Your spreadsheet still needs some work - if you increase the down payment, the gain/loss of ownership increases by a similar amount.
You need to take the sale price, subtract the purchase price, subtract the tax expense, plus other expenses.
The "total payments during ownership" and the "loan balance" should not factor into the equation.

Missionite said...

blaise,
You caught a bug with the down payment (more on that in a second), but your formula is flawed.
Let's simplify:
If I buy a house for $100k, and take out a 100% mortgage for $100k at 6%, I will have monthly payments of $600. I sell the house 12 months later for $100k, exactly what I paid for it. For argument's sake let's leave taxes out of it, and say the only expense is mortgage. How much money have I made?

According to you:

$100k(sale price)-$100k(purchase price)=0.
Then we subtract our expenses ($600/month) for mortgage, so our final total expense is $600*12=$7200.
So according to you we lost $7200 on the house.

But some of that mortgage payment was going towards equity, and we get the equity back when we sell the house.
So the proper way to do this is to subtract the loan balance at sale($98,771.99
) from the selling price. This gives us the amount of equity (in this case $1228.01).
We then take our equity and subtract our mortgage expense, and we get a
$5971.99 loss instead of $7200.

So knowing the loan balance is not only important, it's crucial to understanding what your gain and loss on a property is!

However you did catch a great bug with my failure to subtract the down payment from the gain/loss equation. Obviously if you put a $50k down payment and then get the same money back at the end of the sale that shouldn't be counted as a $50k profit, and that's essentially what I was doing.
That problem has now been corrected.