Nice Guy Equals Bad Investment?

Question

I'm co owner of a 1.5M property with my sister. Can you think of a scenario where I can buy my sister out of the La Jolla property:

2841 Caminito Merion, La Jolla CA 92037

...and still get a great return? It may be impossible. The tenant paid 66k in advance for one year which was likely 24k under the going rate. That notwithstanding, they are asking to stay another year or more. Lease ends July 31 2020.

The house is paid for. Expenses are about 10k (tax, hoa, repairs, CapEx water, gardener, pest control).

5 year lease option? What kind of deposit would the renter have to put up and what monthly payments to make that work? Sensible or senseless idea?

Word has it the tenant may not want to buy. They moved from Canada to conclude a large development project in San Diego that I have few details on.

I'd have to finance to buy my sister out so thinking it may be impossible to get a decent return, but don't know enough about it from an investment standpoint.

I know we can boot them next year, but I hate to be a jerk about it, so if there is a solution that would work for all parties I want to consider it.

Thoughts?

Dan H. · Answer

I thought the property may be worth more than you indicated but checked both Trulia and Zillow and they both listed it as $1.55M (so your estimate is close). On my house, the two sites differ by $100K on the value (Trulia is higher and more accurate on my house). Virtually all houses cash flow with enough equity. At 50% LTV there is a good chance your house will have positive cash flow when rented as a LTR. What most people view a new purchase as cash flowing, they are using higher LTV. At high LTV, your property does not have positive cash flow when accounting for all expenses as a LTR. Even though I suspect you will have positive cash flow (at 50% LTV), I do not expect it to be much for the level of equity. Here are two things to consider: San Diego historically has outstanding appreciation. I personally expect the next few years to have minimal appreciation due to the recent run up, but I expect long term there will continue to be appreciation in San Diego RE above inflation. This is both market and rent appreciation.I would never suggest someone purchase in San Diego with STR as an option but seeing that you already own the RE, I would look into converting it to an STR with professional PM. Do this until regulations prohibit it. My guestimate is over $15K month in rents to start (we have a duplex in Mission Beach worth around $1.3M (so less valuable than your place) that we get ~$15K/month in rent but our RE is very seasoned (>20 years STR) and therefore is at peak rent/min vacancy (virtually zero vacancy). Property near the coast is precious. If it were my property, I would be less concerned about owning it 100% than maximizing the return. If I could buy out my sister I would, but 50% ownership, if we are agreeing on what to do with the RE, is fine. I would convert it to STR with professional PM after the lease is up. I would keep it STR until regulations make it illegal. By then the LTR rent is very likely to be higher than it is today and there is likely to have been some appreciation. Your return on investment is likely to be good. I would never sell it. It is too rare an asset. I also see that you have a very favorable property tax situation. Your accessed value is less than 25% of value. If you sell, you loose this valuable benefit. As long as prop 13 is in place, you have a great investment property. You are not a charity. You should not be renting $2K/month (or anywhere close to that) below market rent. If they are a good tenant, maybe $300 to $400/month below market can be justified (at best case). You have an A grade property (both location and quality). A grade properties typically get the best tenant pool and it is not hard, in that grade of property, to obtain good tenants. Good luck

Bryan O. · Answer

@Flash Alexander it looks like you have better clarity there. Keep in mind as well that STR is active income, taxed like regular W2 wages. Long term rental is passive income. Make sure if you STR it you are aware of that difference. If your reserves are that low, I would probably recommend item 1. You can reinvest into higher cash flow and ROI and hold some cash back to ensure your reserve fund is sufficient. Best of luck!

Larry Alexander · Answer

Cash flow. Reading the answers I've concluded two options:1.) Sell and reinvest in a better market - Midwest (Kansas, Cincinnati, Michigan)2.) Keep it, buy out my sister and convert to STR. Higher risk but potentially higher reward. I'd only be able to miss a couple payments if things didn't pan out.

Bryan O. · Answer

@Flash Alexander you don't mention what your actual goals are. Is this property there as a store of value and appreciation play? Are you trying to get good returns on an investment? Are you so busy you want a single A+ property and A tenants? There is some advice here to consider, but without telling where you are going you can't really ask how to get there.

Bjorn Ahlblad · Answer

@Flash Alexander This scenario works with you as sole owner or as co-owner; but it does not cash flow-it is an appreciation play like all of California. If you become the sole owner your property taxes will increase considerably I believe. Very nice looking property I am surprised it is not worth more. Raise the rent and enjoy the ride!

Calvin Ozanick · Answer

Well first of all, I would look to raise the tenant rent to market rate. This would be your first course of action whether you are a co-owner or the sole owner. The tenant should know that they are getting a deal, and if they are not willing to pay the rent raise then you should not feel as badly about removing them from the unit. Also, look at it just like a purchase. If financing makes sense and numbers work out, then it is a good deal. If it is too much to finance, and the numbers do not make you money, then you shouldn't do it.