San Francisco Conversion to Multi-Family: What Works?

Question

Hello SF BP'ers -

What are the best value-add options for a single-family home in San Francisco zoned as an R3? (triplex).  I own a property like this which is currently renting at market rate and would LOVE some guidance and ideas.

Account Closed

I am considering the following OPTIONS. Which of these are doable and likely to yield a high return over 5-7 years?

A. Convert to a 3-unit building and rent them out (with rent control). Great short-term return, likely less long-term return.

B. Convert to a 3-unit Tenants in Common (TIC) and sell the building to 3 buyers. What kind of time and money would this require?

C. Convert to a 2-unit condo building. Can I do this as a sole owner? Or do two buyers have to partner on a duplex purchase in San Francisco to then convert it to condos?

D. Add an in-law unit for additional income from short-term rentals (e.g. AirBnB).

E. Keep it as a single family home and continue to rent it out with no rent control

Thanks in advance for your ideas!

Amit M. · Answer

not sure about the lender, maybe a limit on cash out refi on rental homes?  I'd check other banks. Ive had good luck with us bank, so give them a call.

Your formula can work. You/them need to compare it to traditional hard money, which I'm guessing is 10-13% these days. So -/+8% plus an upside could work. There is also the issue of securing their loan, by another property of yours would be common, or the existing if you have a lot of equity in it. Friends and family may be more flexible, but be careful as it can lead to unanticipated conflict. Personally I'd prefer to work with outside peeps. If things go south it isn't personal.

Amit M. · Answer

you can't legalize the inlaw w/o a kitchen. Your options are to legalize the inlaw (making it a legal 2 unit bldg and subject to RC) or incorporate the downstairs into the main house, increasing its size, while keeping it a true SFH. It's all about trade offs, but either adds legal sq ft to the home, thus increasing to value in a tangible way. If you really want to Airbnb, you can try option 2 by having a second street entrance to downstairs and a wet bar. Also add an interior door (after inspections) to separate the main hose from downstairs. But Oceanview, I'm not sure it's worth the effort for an Airbnb play.

To make a decision on the 3 unit option you really need to get a lot more info about year specific property. I'd start by placing a call to sf planning. They will look up your home online and give you basic info about expansion potential. Next you probably need to engage your architect and contractor, to get rough cost, and what is practicable to build. That will determine if this project makes sense or not. Once you have that info, post it here, and I'll give you my POV. If you keep this dialog online others can chime in too.

As for partners for $$, it's basically a hard money type loan if you don't want to give up equity. Or if you can get a heloc or second loan on another property of yours, that's a much way better and cheaper way to go.

Amit M. · Answer

for long term value, making it 3 units = gold medal. Adding inlaw = silver. Leaving as is = bronze. BUT, you first need to talk with SF planning dept to see if it's even possible to expand on your parcel, by how high, etc.- this partially depends on height and bulk of neighboring buildings.  Is bldg considered a historical resource? (Good luck changing the facade then.). This is all quite involved. You can put the time in yourself, or hire an architect to analayze expansion options (which won't be cheap at ~ $150/hr.) If you can realistically expand, you'll need to budget minimum $250 PSF for construction, probably more. So you'll need access to cash or be able to obtain  construction loan. Silver lining is, if you can expand/change the building enough, planning may let you map them out as condos, so you end up with 3 condos, which would be the cherry on top.

Inlaw option will cost a lot less, especially if you already have a decent basement area that can be reconfigured. Keep in mind that you can't (legally) Airbnb the inlaw I believe more than 90 days, and the law on this may get worse. And then both units are under RC too. But you will get more income of course, and if you select tenants carefully they will hopefully not become lifers.

Easiest of course is do nothing and keep as SFH. Rents are flat/slightly down now, but remember they shot up a tremendous amount over last 5 years. And they will go up again. Your rental income will grow as is, you just need to be patient. The options above all require a sh!t ton of work and effort, as it's very hard to develop/expand in SF.

Chris Mason · Answer

Hi Ethan,

a) Not crazy, if you can navigate all the regulatory stuff.

b) Honestly I do not know a lot about this one.

c) It's relatively rare for a condo conversion to be sufficiently successful on paper that folks can get Agency 30YF loans on it, which dings value significantly.

d) What folks have been doing with short term rentals in the bay area has knocked my socks off.

Account Closed · Answer

I'd either rent it out as a 3 unit or attempt to subdivide into condos and sell individually. Usually the sum of the parts is more than the whole.

It comes down to your long term plans. If you think that properties in SF will be worth much more in the future, keep it and rent it out (3 unit will yield much more in rent).

If you are bearish on SF and think we are at a peak, sell it. I'd stay away from TIC as you are seriously limiting your buyer pool.

Ethan Cooke · Answer

Account Closed Thank you for your thorough response! Two follow-up questions:

- In-law/AirBnB option: If I lived in the main unit, would the 90-day AirBnB limit still apply?

- 3-unit expansion: If I find 1-3 partners to help finance the construction for buy and hold, what are good ways to structure the deal? I would want to give my investor(s) a fair return while keeping the asset long-term.

I have an awesome SF architect and contractor/partner, so I have the right team for the 3-unit play. Thanks.

Sean Walton · Answer

@Ethan Cooke I'm in SOMA near Moscone Center so it is easy to keep high occupancy the challenge with 30 day minimums is getting departures and arrival to line up right. It would be nice if I could accept shorter rentals to fill the gaps. I bought a short sale in October 2011 for $300k purchase. Gross rents between $3600 to $4200/mo. It was built in 2004 so maintenance has been minimal and mostly handled by me. You do have to pay more expenses like internet, electricity but it still makes sense for now.

A lot of people new to the city like the idea of being central to wherever they are working so they don't have to figure out MUNI or BART. I think that is what attracts them to my place. I'm not sure about mid-term rentals in other areas of the city but with Lyft, Uber and Chariot being farther from downtown is less of an issue. In airbnb you can put together a personal neighborhood guide to help people realize there are cool bars, restaurants etc in your area.

Ethan Cooke · Answer

You guys rock!

@Amit M.  Thanks for more great feedback. Glad the financing idea for base return plus upside sounds feasible. I like your idea of using a property as collateral for a private loan especially if I can't find a bank loan after trying several. I'll also be sure to use explicit contracts so that any partner (friend or straight business associate) knows exactly what to expect.

@Johnson H. Thanks, you have a lot of good financing ideas. I will probably hit you up for another phone call once I get into this!  My key takeaway after just two years of investing in San  Francisco is buy and HOLD. While it would probably be easier to find a financing partner for a flip a deal, my goal is to find a partner for a BRRR deal and pay them back over time through rehab plus appreciation.

Johnson H. · Answer

Hi Ethan,

Looks like you've gotten some great replies so far. I am always interested to hear the SF guru @Amit M. has to say. Interesting that he would rather go with the three unit if location wasn't a factor. But like I mentioned on the phone, if your plans are short term for the property then adding sq footage and adding the in law without calling it an in law in the SFH to flip would be a good option. Also, people are right that even with AirBnB, both units will be subject to rent control.

As for the loan, it sounds like the lender is quoting the conventional loan limit for one unit/SFH in SF which is currently $625.5k. You'll probably want to speak to a different lender for your jumbo loan options on investment property.

Finally, for structuring with partners there are a lot of methods. You can offer a preferred return and depending on how high/low the preferred return is, you can then have your equity split based high/low off of that. In addition, some sponsors would rather take equity than an hourly management project fee to keep skin in the game for the sponsor or the upside is higher for the sponsor, some sponsors want to take fees during the project to get paid and some are only fee based and have very little equity in the deal. If you do go with a jv, spell out in the operating agreement if things go south, what would happen, how will people contribute money for additional expenses, etc. If you don't, the jv can destroy your relationships. Good luck!

Ethan Cooke · Answer

@Sean Walton Yes, I agree that AirBnB can be really lucrative. It looks like STR's in SF's Oceanview neighborhood where my place is go for about $75 per night per bedroom, which adds up if you have high occupancy.

How well has it worked for you to do 30+ day San Fran rentals? In which neighborhoods? This might be a good option.

Thanks @Amit M.--you're on! Re: 3-unit option, I will do some research in the coming weeks/months with SF Planning Dept, my architect and contractor and post my findings here.

Thanks also for your insight about financing options. Two questions for your and others who know about creative financing:

- A lender told me that to re-finance this investment home with cash out, the max loan is $600K even if the assessed value is $1M+. Is this typical? Or just what that lender is willing to do for me based on my borrower profile?

- Re: financing with partners, what do you think about my setting up a deal like the following?

- I offer a minimum return to family/friends (e.g. 8%)

- claim a small project management fee for overseeing construction (whatever is reasonable)

- offer a percentage of added/assessed value or a % of future rent for a period

Thanks!

San Francisco Conversion to Multi-Family: What Works?

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