What are some good value-add strategies in San Francisco?

[Chris Larsson]

Hi Everyone,

I'm looking to buy somewhere within the city of San Francisco as an owner occupier. 

It seems that in many markets, the biggerpockets game plan is to buy a somewhat distressed multiplex, add value through improving/remodeling the property, and increase rents because of that added value. However, in San Francisco, most mulitplex buildings are rent controlled and have a web of regulation surrounding evictions, rent increases and therefore limit how much value you can add by improving the building or running it better.

What are some good value-add strategies to use within the city? Let's keep discussion to the SF municipality only, since laws vary drastically around the bay. Here are some ideas I've seen: 

-Take advantage of the duplex expedited condo conversion program. This allows two owners, working together, to subdivide a duplex into condos after 1 year of owner occupation, which removes the building from rent control and adds substantial resale value. Fix up building in process.

-Buy weak cash flows. A lot of the cheapest buildings (by square footage) have deeply below market rate units and very low CAP rates. In this case, you need to play the waiting game because at some point, those units will clear, you can rehab the unit to bring up the going rental rate and refill the unit at a rent level potentially many times the current rate (and a corresponding increase in equity). This will give you bad cash flows (at least to start) but periodic 'bumps' in value as people cycle out of apartments. Problem is that this is really hard to forecast so your IRR has a very wide confidence band and your cashflows are likely negative for a long time.

-TIC conversion? I don't know much about this but there might be something here. I'd love to hear more.

-Capital Improvement passthroughs? Again, I don't know much here, but there may be positive ROI in this program.

Anyway, I'd love to hear what everyone else thinks and find out what's working for others. Feel free to correct me if I'm wrong anywhere. It's a tricky market we have here, but there's got to be some value somewhere.

Thanks for responses in advance.

[Johnson H.]

Besides what others have said, another way to add value in San Francisco is to add square footage because the price of construction per sq ft is lower than the resale price per sq ft depending on the area. Either with buying a two story house with an unfinished first floor and finishing and the first floor with extra bedrooms or inlaw unit, extending a building out if the property lot is long or adding a third floor.