Does an appreciation-only play in San Diego make sense?

[Cat Woodman]

Hi Bigger Picket Folks,

My business partner convinced me last year to go in on a Work/live space in San Diego. It's in a great neighborhood. The upstairs is residential and downstairs is storefront office with a separate room in the back. I liked that it was versatile and we could rent out different areas. At the time I said, "Well, as long as it can get near positive cashflow." And just kind of trusted him and didn't do more research. Duh. 

So the total cost is probably around $5k per month. We purchased the property for $765k. We do need office space in San Diego for our business, but we let go of our full time employee there and now have staff in other states working from home. And my business partner has taken over a business in another state as well AND is now planning on moving out of the area, just returning as needed to service clients there. So he'll need office space when he's there 4 months out of the year (at the most).

He says he hopes he could rent out the top for $2k and the bottom front for $1k per month, which leaves a $2k per month negative cash flow not including things like vacancies and upkeep. I have said that $2k per month for an office (really just the back room of an office) used 1/3 of the year doesn't seem like a great use of $$ and I've asked him to buy me out or sell. So on the business side, we could use an office at a coworking space for $650 per month and have use of all the conference room. He's argued that the space will help close more deals and makes us (him) look good. And that we have to be spending money on an office anyway so why not pay ourselves to own real estate. So he's pushing back saying I should stay invested and that in 10-30 years I'll be sitting on a $2m property and really happy about it.

(Oh, and he makes fun of the ways I'm frugal - which is a whole other story.)

So my question is...am I missing something? Is this really a great deal that I'm just not appreciating because of my risk aversion or should I push him to buy me out even though he doesn't want to and use the proceeds to purchase positive cash flow properties - likely in other states?

And in terms of my goals, I would like to retire in the next 5-8 years. I don't want to work for 30 more years. Hence the FI/RE penny pinching and frugality that he finds silly.  

Any feedback is greatly appreciated. Thanks so much!

Catherine

[Dan H.]

I agree with all your points and would be real hesitant to forecast appreciation that takes a property purchased in 2018 for $765K to $2M by 2028.  Even if that were to happen, it is beyond your retirement plans.  Also your -$2K/month negative cash flow is significant.  If you were cash flow negative a small amount, relying on appreciation would not be as significant.  What you would need for this to be a good investment is enough appreciation to absorb the many months (years) of large negative cash flow.

If he needs an office and you do not, he should be paying office rent to the partnership.  I suspect if he was paying fair market rent he would realize the inefficiencies of renting an office space all year for use 1/3 of a year.

If he thinks it is a good investment he should be eager to buy you out.  I suspect he wants someone to share in the risk because he realizes there is significant risk.

It does not look like a good investment to me but I will say San Diego has an incredible history of market appreciation.  It is possible that your partner ends up being correct on it being a good investment but without crystal ball I would not forecast it being even an OK investment.

I have friends who poke fun at whatever.  Unfortunately my son and his best friend do it non-stop with each other (they bicker like an unhappy couple in a marriage).  I could say it is their insecurities but for some people I think it is just the way they are.  If it bothers you, I suggest you indicate so.  It may not stop as it could be ingrained but it may stop.  There is nothing wrong about being frugal and it does not seem like your frugality is stopping you from investing in non-low risk investments or from leveraging your assets (Do not want the nickel to hold up the dollar).  It is not my path, my investments have done well and I spend more than I can fathom on mostly things that I have no idea how I spent so much (so I possibly should be more frugal).

Good luck