Keep & Rent, or sell into a strong San Francisco market?

[Jamie M.]

New to this group, thought I'd post my current situation and see if others have opinions on it...  

My wife and I bought our first "starter" home in San Francisco (Eureka Valley - in between Castro and Noe Valley) 4 years ago.  It is on the smaller side - 3BR, 2BA, 1,600 sq ft.  It also has a lot of history: the original structure was an earthquake shelter built in 1906.  There is also a small in-law cottage in the backyard and the far edge of the property.  This was a great unintended and unexpected house hack that we fell into (more on that in a minute).  The house was completely renovated in 2011 and has nice, high-end finishes.  Not the best, but very good for sure.  There are flaws: no garage (although surprisingly easy street parking for SF - we park 2 cars in front of the house daily), small for the price point, busy street but very quiet backyard and deep lot.

A growing family led us to purchase a larger home about a mile away recently.  So now I'm going back-and-forth between keeping the current house and renting it, or selling into a VERY hot market, both in San Francisco, as well as our specific neighborhood.

More on the house hack that I fell into: I didn't think much of the in-law unit when we bought the house, but decided to list it for short-term rental.  I grossed ~$60k per year on the short-term rental unit, which was a complete surprise to me, which over 4 years put us in a better position to upgrade our primary home.  This may factor into a buyers willingness to pay...

So a bit of the numbers: we bought the house for ~$1.5mm, currently have ~$1.15mm mortgage.  Appreciation has been very strong, and based on recent comps I think we could see as much as $2.3mm.  Note there were 10 offers on the house when we bought it, and it sold for almost 20% above asking, neither the 10 offers nor the 20% above ask is unusual for San Francisco (the house we just bought had almost exact dynamic).

Rental comps are hard to come by for our neighborhood, but I think I could rent it for ~7.5k, maybe  up to $8.5k per month.  The short-term in-law cottage rental goes away of course, and I'd likely exclude this from the rental anyway and keep it vacant (could be used as a stop-gap between renters).  The net result is a strong cash-flow profile.  

The pro-case for selling would be to roll the equity from this house into our new house and reduce the monthly mortgage and rebuild our savings and investments (which we depleted to make this move).  Keeping the house would put the majority of our net worth into real estate.  But I'm eager to maintain, and build, my second revenue stream.  Selling the house takes that stream away entirely, for now.  But a sale would be into a super strong SF housing market, with far more demand than supply.  At least right now...  SF rental laws are extremely tenant friendly - something to consider as I have zero experience being a landlord to long-term tenants.

The con-case for selling is that they aren't making more land in one of the most desired neighborhoods.  Despite the house's few flaws, it would be snapped up in a matter of days in the current frothy market.  I don't really see that changing - maybe leveling off (famous last words!).  I do not expect anywhere near the level of appreciation we have seen in the last 4 years.  My expectation is it would stay flat for a while.  2008-2010 in SF was flat, for comparison.

Without experience as a landlord, I suspect that there are nuances of renting homes vs. apartments and at this price point that I don't know what I don't know, and I'd be open to hearing any feedback...

[David Faulkner]

If you are not forced to sell now or in the foreseeable future and you plan to stay in the bay area long term (at least the next 10 years), then I would not sell. One thing to consider is that if you do decide to sell, make that decision within the next 3 years. If you lived in the home as your primary residence for 2 of the last 5 years and sell, then up to $500k capital gains for married couples is tax free. There are still transaction costs, but that is a huge bonus. So, I'm not saying you should sell (I wouldn't), only that if you do decide to sell, don't wait 4 years and then sell because you will miss out on the capital gains tax exclusion described above. BTW, I would expect that this landlording experience would be about as easy as they come ... of course you still need to screen your tenants and respond to occasional repair requests, but you are not likely to find a higher quality, lower maintenance tenant base anywhere. Also, I agree with you that the most likely scenario is a flattening of prices and rents in the short term, or maybe even a very slight dip, but in the long run the historical record speaks for itself and I don't see those long term pricing trends changing in the future.

The in-law cottage is interesting ... I would get some local expert investor and/or realtor (that deals in rentals/leased properties) eyes on that to get some opinions. How is access to that? Is there an alley running behind the property or is the only access through or around the main house? If alley access, you may be able to convert to a detatched garage or keep renting it as a separate unit, either long or short term ... I do not know your local laws, though, but definitely worth looking into. If none of those are a possibility, I see no reason why you would keep it vacant rather than including it with the main house rental and upping the rent charged because it is included. Talk to some pros about it ... I'd bet there is a way to bump your income from it and you may do even better than you are thinking as a result.