New Construction Condos in San Francisco - Sell or Hold?

Question

Hello BP nation - I've got a development project in SF that I'd like to share some details on.

I'd like to just get this project out of my own head for a bit and try to solicit some different opinions on exit strategy.

Would greatly appreciate any and all feedback.Thanks all in advance!!

acquisition:

$1.2M, 1,600 SF single family house

development costs: $1.3M (inclusive of all construction, consultants, permitting, bank fees / interest, prop tax, insurance, utilties etc). sales costs : ~$250k (incurred upon sale only - broker fees, transfer tax, staging, closing costs)time / carry:acquired Jan 2015expected completion May 2017. finished product: 2 new construction luxury condo units, 2 floors each:Lower unit - 2,250sf - 3 bed, 2.5 bath - one car garage spot (side by side) - deeded entire backyard (approx 1,000sf)Upper unit - 2,250sf - 4 bed, 3.5 bath - one car garage spot (side by side) - two large decks (master bed and living room) plus deeded ~500sf roof deck with nice views spanning bernal hill to sutro. Shared garage between the two; approx 600sf. All in all, gross SF for the bldg is ~5000sf. Targetted sales price:Going off a relatively conservative sales per SF price of $850/sf, total sale should be $3.8MBack out all of the above and the potential profit is $1,050,000.  This project is in the inner Mission district of SF. The potential for that 1M profit obviously is very attractive. I also rented out the house for 15 months prior to construction, so if sale is triggered, it will be cap gains. For the past 4 yrs, I have been primarily in active developer mode - buying, fixing, selling. However, the goal has always been to spend a lot of time and energy in these 'earlier' years setting up a bunch of nest eggs for the future. Given the location and the price that I would eventually pay to hold onto the units (assuming I could get perm loan to pay off construction loan), I'm looking at ~$2.5M for 4500 sf of brand new San Francisco real estate - which comes out at ~$555/sf - a steal by any measure in SF. From the investor POV however, even at $20k (I know this is high, maybe achievable through homesuite furnished...maybe not) of rental income per month, with the following assumptions:- 20% vacancy- 1.15% prop tax- 3k insurance- 5k annual maint / upkeep- 10% prop mgmt fees- 4k utilities- financing 70% ltv at 4.5%the numbers come out to approx: - 3.5% cash on cash- 5.3% cap- roughly 26k annual cash flow after all expenses etc etc etcThe obvious choice would seem to be sell this off, move onto something else - another development or maybe MF rental via 1031. But given the nature/desirability of property in prime SF, it would seem like there would be an opportunity cost in selling this off for an immediate gain. The issue is of course that the potential returns from holding as rentals pale in comparison to selling it off, or so thats how I've been viewing it thus far. I feel there are different options to consider, but I've just been stuck on the fact that rentals just can't work in SF, even when you are holding at developer prices....I would greatly appreciate some different viewpoints on how to analyze this exit!

development costs:

$1.3M (inclusive of all construction, consultants, permitting, bank fees / interest, prop tax, insurance, utilties etc).

sales costs :

~$250k (incurred upon sale only - broker fees, transfer tax, staging, closing costs)

time / carry:

acquired Jan 2015

expected completion May 2017.

finished product:

2 new construction luxury condo units, 2 floors each:

Lower unit - 2,250sf - 3 bed, 2.5 bath - one car garage spot (side by side) - deeded entire backyard (approx 1,000sf)

Upper unit - 2,250sf - 4 bed, 3.5 bath - one car garage spot (side by side) - two large decks (master bed and living room) plus deeded ~500sf roof deck with nice views spanning bernal hill to sutro.

Shared garage between the two; approx 600sf. All in all, gross SF for the bldg is ~5000sf.

Targetted sales price:

Going off a relatively conservative sales per SF price of $850/sf, total sale should be $3.8M

Back out all of the above and the potential profit is $1,050,000.

This project is in the inner Mission district of SF. The potential for that 1M profit obviously is very attractive. I also rented out the house for 15 months prior to construction, so if sale is triggered, it will be cap gains. For the past 4 yrs, I have been primarily in active developer mode - buying, fixing, selling. However, the goal has always been to spend a lot of time and energy in these 'earlier' years setting up a bunch of nest eggs for the future. Given the location and the price that I would eventually pay to hold onto the units (assuming I could get perm loan to pay off construction loan), I'm looking at ~$2.5M for 4500 sf of brand new San Francisco real estate - which comes out at ~$555/sf - a steal by any measure in SF. From the investor POV however, even at $20k (I know this is high, maybe achievable through homesuite furnished...maybe not) of rental income per month, with the following assumptions:- 20% vacancy- 1.15% prop tax- 3k insurance- 5k annual maint / upkeep- 10% prop mgmt fees- 4k utilities- financing 70% ltv at 4.5%the numbers come out to approx: - 3.5% cash on cash- 5.3% cap- roughly 26k annual cash flow after all expenses etc etc etcThe obvious choice would seem to be sell this off, move onto something else - another development or maybe MF rental via 1031. But given the nature/desirability of property in prime SF, it would seem like there would be an opportunity cost in selling this off for an immediate gain. The issue is of course that the potential returns from holding as rentals pale in comparison to selling it off, or so thats how I've been viewing it thus far. I feel there are different options to consider, but I've just been stuck on the fact that rentals just can't work in SF, even when you are holding at developer prices....I would greatly appreciate some different viewpoints on how to analyze this exit!

The potential for that 1M profit obviously is very attractive. I also rented out the house for 15 months prior to construction, so if sale is triggered, it will be cap gains.

For the past 4 yrs, I have been primarily in active developer mode - buying, fixing, selling.

However, the goal has always been to spend a lot of time and energy in these 'earlier' years setting up a bunch of nest eggs for the future. Given the location and the price that I would eventually pay to hold onto the units (assuming I could get perm loan to pay off construction loan), I'm looking at ~$2.5M for 4500 sf of brand new San Francisco real estate - which comes out at ~$555/sf - a steal by any measure in SF.

From the investor POV however, even at $20k (I know this is high, maybe achievable through homesuite furnished...maybe not) of rental income per month, with the following assumptions:

- 20% vacancy

- 1.15% prop tax

- 3k insurance

- 5k annual maint / upkeep

- 10% prop mgmt fees

- 4k utilities

- financing 70% ltv at 4.5%

the numbers come out to approx:

- 3.5% cash on cash

- 5.3% cap

- roughly 26k annual cash flow after all expenses etc etc etc

The obvious choice would seem to be sell this off, move onto something else - another development or maybe MF rental via 1031. But given the nature/desirability of property in prime SF, it would seem like there would be an opportunity cost in selling this off for an immediate gain. The issue is of course that the potential returns from holding as rentals pale in comparison to selling it off, or so thats how I've been viewing it thus far. I feel there are different options to consider, but I've just been stuck on the fact that rentals just can't work in SF, even when you are holding at developer prices....I would greatly appreciate some different viewpoints on how to analyze this exit!

Ariel Smith · Answer

@Charles Ma yes we did speak via email! I believe you met David at the J Martin summit. Photos are huge when marketing your property as a short-term rental. Most tenants won't be able to view the property prior to leasing (either due to a tenant occupying it, being located out of town, etc.) so the photos are a huge driver of your marketing. Great photos also set your unit apart from other listings.

Amenities are also very important. Make sure every comfort of home is included in your property at that price. Spend time researching other rentals at that price point and look at what they offer. If you want top dollar, you have to provide a top quality product.

Best of luck and feel free to reach out directly with any questions!

Jason Hsiao · Answer

Hi @Charles Ma, from what you share I'd sell and 1031 exchange it to a property that cash flows, maybe even out of state at a higher cap rate (that's what I do), or move onto another development project. None of my developer friends and colleagues hold and rent because the math doesn't really work and so much of capital tied up.

A few input on what others have said:

• Duplex selling price $/sqft is lower, plus you have committed the fees and paperwork so that doesn't make sense.
• If you really want to hold it, self-manage is not as hard as you think, especially since the building is new
• Maintenance budget could be lower as well by the same logic. I have an unit that's built in 2014 and I basically haven't had to fix anything this year (knock on wood)
• I would say your comps are more in the $1,000/sqft range, especial for new construction in that part of Mission
• Build in separate meters and have the tenants pay utilities

A lot of signs indicate this is the top for SF market, that's another factor to consider. All the best on this project, let me know if there's anything else or other questions I can help with.

Amit M. · Answer

@Charles Ma to get buy and hold to work out in SF you need to pretty much need to line up some stars. You first need to find a good value add play (given recent legislation, adding inlaw units is now a new twist on that).  You usually have to deal with some tenant issues, but unfortunately it's gotten more complicated (legislation again) and more expensive to so. Picking the right up and coming/gentrifying neighborhood is also a key. And finally, you usually need to score an off market propoperty, as there are lots of punters out there looking for the same thing. So it's hard. It can be very hard. But fortunatly you don't need to do it many times to create significant wealth. A few home runs and you're pretty much done :)

Charles Ma · Answer

Thanks all for chiming in - all good points. A lot of the things mentioned solidify the original intention of selling. I'd have to agree with you @Amit M. on the fact that building out luxury and renting would just really be a disservice when comes time to sell...and if a rental in the first place, it should be built to suit. I think the 20K is feasible but it's not fully reliable. Regarding construction costs - generally speaking, yes, construction costs are high, but it just really depends how many people are in between you and the person who is swinging the hammer. My background is architecture, and I'm now GC'ing my projects. So in most cases, I do my own drawings / permitting and cutting out the GC is a huge savings, and decrease in headache (depending how you view it of course). While subs can still demand project pricing, I keep many parts of the construction process in house with my own crew that I pay by the hour. Of course this all means that I end up doing a ton of the work, but keeping it as lean as possible has been working so far....though scaling and pulling myself a bit further away from the 'working in the business' part of it goes hand in hand with building up the nest eggs.

Cap rates are low, and buying into tenants are a headache. Curious to hear how your buildings pencil out as it seems like you are buy and hold in SF.

Amit M. · Answer

there's a few problems here.

1- $1.3 mil costs for 5000 sq ft, you're looking at about $200 sq ft to build, which is very hard to do, especially for high end work. You're talking steel beams, lots of concrete at basement level, high quality windows, high end finishes, fancy back yard, etc, which I doubt you can do for $200 psf.

2 - $20k in rental revenues, even short term, is precarious IMO. If the economy slows down a lot of corp. clients will put the kabosh on this kind of spending. Plus you're also competing with all the higher end single family homes up for short term rent.

3- Actually issue #1 can make this a risky flip too. But your $850 sell psf is at least conservative, given most good condos are selling at $1000 psf in the misssion.

4- for this size of a building it's more practical to buy/hold more units (also smaller and less high end). It's also less ideal to rent out units with high end finishes, as the wear and tear can make reselling them in the future expensive. So I don't think this is the best buy and hold property, unless you're rich already and just want to keep it as blue chip/trophy property. You're better off looking for a more rent appropriate property, but the cap rates in SF are pretty low these days...oh want to do, what to do?!?

J. Martin · Answer

First, congrats on your project Charles Ma :) Furnished rentals are definitely an option, but you'd have to do >30 days to get out of all the SF laws. So something to think about. Fortunately, HomeSuite focuses on 30+ days (thanks for the Summit shoutout @Ariel).

You talked about setting up nest eggs for the future.. How about 2 luxury condos in an awesome area of a timeless city? Do you need/want the cash flow? Today or later? What do you think about the future of the SF market now vs the future? @Amit M. what do you think? Market does seem to be about as good as it gets, so maybe it depends how much of a "market timer" you are also..

Charles Ma · Answer

@Gil Vaisman - if I were to rent it to full time tenants, then I'd agree. but I lean more towards monthly rentals as tenants have a finite time period in which they have possession of the property. I think 20k is feasible for some key months, but my gut says it might be hard to maintain that consistency.

@Jake Van Vorhis  - Hopefully you're right! As mentioned, it is hampshire and 25th.

@Ariel Vincent - your name sounds familiar - i think we've traded emails before regarding another property. Good to know the stats on 3 bed places and lower demand. What are your thoughts on how to position the property to capture these types of rates?

Ariel Smith · Answer

@Charles Ma I work for HomeSuite and we don't have as much demand for 3+ bedroom properties, simply because we usually lease to corporate tenants who are looking for studios, 1 and 2 bedrooms. However, we do get inquiries for larger properties and depending on the amenities and the way you market the property, I think you can get the rates you are looking for.

Jake Van Vorhis · Answer

Hello @Charles Ma,

Where in the Mission is this project? It depends on your floor plan, location, and finishes, but I think there is a good chance your projected sale price is too low if you were to sell upon completion in May next year. Congratulations for you taking on this project when you did!

Gil Vaisman · Answer

Hi Charles,

If you don't need the money, hold. You have a great rate and if the SF market keeps appreciating in a couple of years you should have enough equity to refinance, cash out and use the money as you please. At a certain point you want to start building your passive income.

I also think your rental income estimates are too conservative. 80% occupancy is way too low, in a hot market like SF you will barely have 5% vacancy.

If you live in SF why not manage the property yourself? for $20k monthly rent, that's $24k a year. Now your cashflow could be ~50k

Managing 2 units is easier than you think. I personally manage 7 units (old building) while having a full time job and it takes me on average 1 hour a week to do it. In a brand new building managing the property should be simple.

Sell it when you need the money for a more profitable deal.

New Construction Condos in San Francisco - Sell or Hold?

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