The economic downturn is causing some Baby Boomers to downsize or postpone retirement, but they still are in no hurry to pay off their mortgages, according to the annual “Affluent Boomers at 60″ survey from Oakland-based Bell Investment Advisors.  Historically, most seniors paid off their mortgage before retiring.  Not so today.  More than 55 percent of those surveyed who currently hold a mortgage don’t intend to pay off their loan until their 70s, if then. That could change if the economy worsens or the slowdown is prolonged.  One in four Baby boomers already are changing their retirement plans and 40 percent are “downsizing” their lifestyles.  More than one quarter (28 percent) have lost a job in recent months or know someone over age 60 who has.  As a result, 22 percent say they are cutting down on charitable contributions, 21 percent are changing vacation plans, 18 percent are reducing the amount they are saving, and 11 percent are postponing retirement entirely.  Sixty-nine percent say the economy is causing them to change to a more conservative investment strategy.  The survey included equal numbers of men and women born in 1948, all of whom reported investable assets of $1 million or more.

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I’ve long been fascinated with the idea of owning a condo in San Francisco and renting it as a short-term vacation rental. It’s a great way to get a real cash-on-cash return for condo and apartment investments. It would also allow me a way to retain control of my property if its subject to rent control.

The only thing that’s stopped me is how labor-intensive such an investment is. You’re essentially running a hotel room and  I’m a real estate investor– not an inn keeper.

I’ve been waiting a long time for a San Francisco new outlet to pick up on the story of investors leasing out vacation rentals in San Francisco. I know a number of landlords who have been doing it for years, so I’m happy to see  super-sharp Carol Lloyd of the SF Chronicle take the time to report on it.  Here’s her story, dated May 23, 2008.

The Urban Vacation Rental Offers Potential Profit and Control

“Charming garden apartment” in the Castro for $3,500 a month. Three-bedroom flat in Ashbury Heights — $7,000 a month. “Large one-bedroom apartment” with Golden Gate views — $6,000 a month. “Beautiful New Edwardian Victorian” in the Castro — $16,000 a month.

Say what?

These are the kind of rental listings that make you question your eyesight. But even if you blink and read again, the improbable numbers remain the same. It’s true, some basement flats are going for the price of three-bedroom, two-bath single family homes in the same neighborhood. And some three-bedroom, two-bath single family homes in modest neighborhoods are renting for the price of mansions in Pacific Heights.

And here’s the kicker. They are actually good deals in relation to comparable accommodations.

Welcome to one of the city’s little-noticed but booming surreal estate markets: the urban vacation home.

San Francisco has been a mecca for tourists and business travelers for more than a century, and to meet the demand a vital hospitality industry has sprung up. Scores of high-end hotels and corporate apartments, hostels and bed and breakfasts all compete to attract the city’s yearly 16 million visitors and get a portion of the over $7 billion they spend. But in the past few years, with the rise of the Internet’s free market enterprise, the city has seen another sort of accommodation crop up: the individually owned vacation property.

“There’s a huge demand,” says Justin Halloran, vice president for HomeAway, a company that owns VRBO.com (Vacation Rentals By Owner), VacationRentals.com and its namesake HomeAway.com, along with a number of other domestic and international vacation home Web sites. “The areas where we see the most demand are urban areas like San Francisco, New York and Las Vegas, where hotel prices are high and there’s a relative lack of supply,” said Halloran.

Indeed, such vacation Web sites have traditionally attracted listings from second homeowners in traditional resort areas such as Lake Tahoe — currently on VRBO.com there are 695 listings for the California side of Tahoe, while there are only 200 in San Francisco. But according to Halloran, that seems to be changing with both the supply and the demand for San Francisco vacation rentals increasing rapidly. In the past 90 days, HomeAway.com’s San Francisco properties were up 41 percent and inquiries for those properties had increased 80 percent compared to the same quarter a year ago.

Indeed, according to a quick and dirty survey of a dozen Web sites which list San Francisco vacation homes, more than 700 houses, flats or apartments in San Francisco are being primarily rented as temporary crash pads. That doesn’t count those properties that exclusively use Craigslist.org as their sales portal.

For visitors this is great news — especially as hotel rates escalate through the roof. Renting an individual apartment or house can mean a lot more space and luxury for a fraction of the price. “We found that, priced per square foot, hotels were 50 percent more expensive than vacation homes listed on our sites,” Halloran said.

The availability of these temporary rentals allows visitors to come to the city and stay in residential neighborhoods that don’t have tourist accommodations. They also attract families with children who don’t want to eat every meal in a hotel. “Our biggest customers are married women between the ages of 35 and 55 with two-ish children, who are planning a vacation for their families,” said Halloran.

Although there have always been a handful of individually managed residential apartments available for vacation or short-term rental — I recall finding one for my parents a decade ago through the Noe Valley Voice — and there have always been property managers or corporate apartment agencies that offer short term housing to business travelers, the advent of by-owner vacation home Web sites has allowed a new accommodation category to blossom. According to Henry Harteveldt, a travel industry analyst, vacation homes make up a growing sector of travel accommodations, with more travelers renting vacation homes every year.

But looking at the listings for San Francisco’s VRBO, another thing becomes clear. It’s also a boon for property owners who want to maximize their earning power and avoid the complications of rent control.

For the property owner, running a one-unit hotel definitely has its ups and downs. Although rents have skyrocketed in the past two years, they haven’t nearly caught up with real estate prices. Even with a 20 percent down payment, the mortgage payments on $1 million home will run more than $5,000 a month for a 30-year fixed-rate loan. But can you rent out that $1 million house for $5,000? Not likely. So, for recent buyers who find themselves in a tight spot or who plan on being away from their primary residence for a portion of the year, the vacation market offers higher risks but (as they say in the biz) higher upside potential. Many of these homes can fetch as much weekly on the vacation market as monthly on the regular rental market.

But even if the rates are higher than long-term rentals, so are the costs, the labor and the risks. First of all, the homes are turn-key and need to be maintained at a high standard. If an espresso maker or television breaks the homeowner will probably end up replacing it. Secondly, the homeowner pays for all the utilities, Internet connection, cable and gardening maintenance — costs that may rise or fall steeply depending on the guests’ vacation habits. There is also the unpredictable workload of booking guests, managing their complaints or requests, and managing a cleaning crew after each booking, along with the bureaucracy of small business taxes. Most importantly, homes that don’t rent enough weeks out of the year can quickly trigger a financial nightmare.

Still for some homeowners, the potential earning power coupled with retaining control of one’s property far outweigh the risks — especially if the home is located in a destination neighborhood in San Francisco. One homeowner I know who bought a house with an extra rental property near North Beach claims to have discovered a proverbial gold mine in his basement flat. When previous tenants moved out, he turned the place into a vacation home. The upshot is that he’s renting out the flat almost year-round and earning double what he might otherwise earn with a long-term tenant. Plus, he still has the place available for visiting friends and family. In this land of Surreal Estate, where access to property often determines our destiny, the vacation home option is more than a micro business, it’s a strategy for retaining control of property.

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This week at our sales meeting we had our ace rental agent, Laura Gray give us an overview of the rental market. Here are her observations:

Rents are up 10-15% from a year ago. According to Craigslist, most one-bedrooms rent in the $1500-3000 range, ( some can go up to $4,000), with the average being around $2500.    Two-bedroom go up to $6,000, with many  right in the $3200 range.

A CraigsList snapshot for the day offered this much in inventory:  206 units  for rent in Pacific Heights,  308 in SOMA/South Beach and 31 in the Hayes Valley.

Units on the North side of town (PacHeights, Marina, Telegraph/Russian/Nob Hill, North Beach) command the highest rents. They also go faster and attract the highest quality tenants.

SOMA/South Beach takes a little longer to rent.

Hayes Valley is hot. Laura has a good sense of the market in this neighborhood because she handles a number of rentals in larger buildings there.

Competition is fierce for units offered below $2500/month. Units at this price point usually go quickly and easily, with multiple applications.

In the $2500-3500 range renters are expecting a better location and/or luxury building. Units renting in this range will sit a little longer before renting.

Above $3500 requires some patience– if your place is worth that much, it will eventually rent, but it may take some time.  

Premiums are paid if your rental is the ‘quintessential San Francisco home’– and has updates. I.E. period architecture with remodeled baths and kitchens. Laura used 1839 Filbert as an example.

Lofts go fast– especially if they’re in North of Market locations (this is a rare commodity).

The relo market isn’t nearly as hot as it used to be. In previous years, transferees were a big segment of the rental market. Now, not so much.

Many of Laura’s tenants can afford to buy but are choosing not to.  To them, it still seems more reasonable to rent a great place for $3500/month instead of shelling out $5000/month to own it. I’m sure they understand that the after-tax costs are much lower, but we won’t go there in this post.  

 I’ve been working with investor clients lately, and have called Laura a few times to get estimates of rental values for specific units. Generally she’s quoted me premium rents for the properties I inquire about, probably because they’re high quality condominiums.

An executive studio at The Montgomery, for instance should rent for $1800-2000. A two-bedroom in the same building should go for $3400-3600. 

I also asked her about rental values for a couple of large  two-bedroom condominiums in prime Pacific Heights.  These were both in period buildings and had a lot of charm.  She estimated that they could command upwards of $4,000– and maybe go as high as $5,000. Both of these places had parking.

Two great links to learn more about the rental market in San Francisco:

Laura’s Rental Listings on the Paragon website - fun eye candy and a great way to get a sense of what nicer places rent for.

CraigsList Rental Stats - God bless the guy that runs this site. It slices and dices CraigsList rental data for San Francisco in a bunch of different ways.  It’s a great way to see how much you’ll get where in the City at different price points.  

An article from Investment News analyzes how the strength of the rental market is related to the housing crisis.

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The following is critical information for landlords and TIC owners. I came to me by email courtesy of Sharone Malone. It interprets (to some degree) the difference between Props 98 and 99, coming on the June ballot.

I am printing Sharon’s email word-for-word. I avoid the snake pit of politics whenever possible on this blog. But this stuff is important to anyone owning real estate in San Francisco, and anyone considering a purchase here:

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On the June ballot there will be two competing State Propositions dealing with property rights–Proposition 98, and Proposition 99.

One of the key differences is the issue of RENT CONTROL.  Proposition 98 gives Californians the opportunity to END RENT CONTROL, while the competing Proposition 99 does not.

Poison pill:  In the event both propositions get a majority vote, Proposition 99 is written with a “poison pill” - if it receives more votes than its rival Proposition 98, )roposition 99 would be come law, and Proposition 98 would not.

Therefore I urge you to VOTE YES on Proposition 98 and NO on Proposition 99.

Please note an important feature of prop 98 - tenants currently protected under rent control, would continue to be protected.  It is ONLY when the tenant voluntarily leaves, or is evicted for just cause, that the unit is relieved of rent control. 

RENT CONTROL hurts tenants, owners and the city of San Francisco.  For an in-depth case against rent control read “The Case for Ending Rent Control” by Peter Byrne in the SFWeekly. Here is a synopsis for Byrne’s argument:

Some of the reasons rent control hurts the people it was intended to help (”the law of unintended consequences”):

1.  Poor financial planning for the tenant.     Example- Ms. Tenant rented an apartment out of college for $700/month.  Although her income increased over the years, and she could have purchased a condo for herself, she didn’t
because her rent was so low she lacked incentive to own.  Now, 15 years later- the condo she could have purchased for $175,000 is worth $750,000. She may have saved on rent, but if she had purchased she’d now have $575,000
of equity, instead she has none.

 2.  High, unaffordable rents: Rent control discourages tenants from moving, effectively removing these units from the market and the number of available rental properties.  With low inventory and high demand, rents stay high.

3.  Owners reluctant to negotiate on rental price: If an owner knows they will be severely limited to rent increases (the average allowable rent increase over the last 15 years has been 1.68%) they will hold out for a high rent even if it means several months of vacancy.

4.  Incentive to reduce the inventory of rental property:  Owners choosing to sell rental units as TIC’s because rents are not adequate to pay property expenses.  Developers fearing rent control, reluctant to build rental properties, keeping inventory low while demand continues to grow. 

5.  Owners reluctant and/or unable to afford to keep rent control properties in good repair: The tenants live with thread bare carpets, chipped and pealing paint, broken cabinets.  The exteriors of the properties are often dirty, dingy and in general poor repair.

6.  Low income, elderly tenants severely disadvantaged: An owner with a vacant unit is going to favor high income young tenants who are likely to move in a couple years than lower income and/or older tenant, because it is
only when the tenant voluntarily vacates that he can re-set the rent.  With long term tenancy building expenses increase faster than the rental income increases, annually reducing the owner’s income.

Economists predict, and other decontrolled cities have proven,  that if San Francisco decontrolled rental units, the price of formerly controlled units would rise, but to a level nowhere near as high as current rents.  In effect, it would result in an overall rent reduction.

The two propositions are complex and somewhat confusing.   If you would like a three page comparison of Prop 98 - “California Property Owners and Farmland Protection Act” and Prop 99 “Homeowners and Private Property
Protection Act.”  please let me know and I will email you a copy.

Remember, if Prop 98 passes, no tenant will be displaced or have their rent raised in excess of the current rent control maindates.  Decontrol takes effect ONLY after the tenant voluntarily leaves, or is evicted for just cause. 

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To be honest, I kind of forget sometimes that we have things to vote on in June. My mental bandwidth has pretty much been taken up by the current primaries and upcoming November general election. take up pretty up all of my mental bandwidth. Props 98/99 are important to consider, especially if you are a San Francisco landlord or TIC owner–

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Here we see that lower priced homes, by far the largest segment of our real estate market by quantity of sales, have been the most negatively affected by market changes: year to year, house and condo sales under $1,000,000 declined by 28% and 40% respectively. Conversely, at the highest end, house and condo sales increased by 34% and 100%, though the actual number of sales is small. (Due to the small number of sales and the huge range in sales prices, changes in median price at the high end are not particularly meaningful.) The middle range declined by 12 – 16% in unit sales, with mixed results in median sales prices.

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Comparing 1st Qtr 08 to 1st Qtr 07, the number of home sold in San Francisco decreased about 27%, with properties below $1,000,000—condos in particular—showing the largest drop. The lower end of the SF housing market—to a large degree fueled by first-time buyers—has been the most affected by market upheaval and new financing conditions. The middle price range, $1,000,000 to $1,999,999, showed a much smaller decrease, while sales of $2,000,000 and above actually increased.

Median days-on-market for all houses and condos sold barely changed (37 days in 07 vs. 36 in 08), but for homes on the market that didn’t sell stayed on the market longer (60 - 69 days in 07 vs. 80 - 89 in 08)—i.e., the homes selling are generally selling relatively quickly, but those not selling are staying on the market for longer periods of time (and so price reductions are increasing too). The quicker a home sells, the higher the sales price as a percentage of list price: those selling within 30 days average 4 - 7% more than those which do not. The below graph does not adjust for price reductions—which would significantly increase the difference.

Sale Price to List Price (SP/LP) by Days-on-Market, First Quarter 2008

The number of homes for sale has gone up about 20%, and the months-supply-of-inventory has increased by 1 month (3.2 vs. 2.2 months). The median sales price of all homes sold increased by about 3%. Though down from its peak in May 07, San Francisco is the only Bay Area County still showing median price increases year over year. (Some counties have shown declines in excess of 40 %.)

City-wide averages and median numbers mask dramatic differences between different SF neighborhoods. Some areas still feature low inventory, high demand, multiple offers and quick sales; others—generally the less affluent—are on the opposite end of the spectrum.

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Home ownership in “the best place on earth” is a solid investment even in shaky economic times. The median price for single family homes and condos in San Francisco jumped from $780,000 to $810,000 between March 2006 and March 2008.  

Like any real estate market, we have month-to-month fluctuations. But compared to other markets across the country, we clearly have a continued historical strength and resilience in our local market.  And San Francisco continues to be one of the most coveted real estate markets in the country.

There’s lots to choose from, interest rates are low and San Francisco continues to be one of the best performing areas in the entire country. If you can afford it and are ready for the ‘five year hold rule’ it’s a great time to buy.
 

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As ARMs reset, little of the expected chaos is coming to fruition.  Worries that subprime mortgages would sideswipe borrowers with giant monthly payment increases have been reduced by Federal Reserve rate cuts and other steps to stimulate the nation’s credit markets.  In fact, some borrowers with resets occurring today are finding their monthly payments staying much the same.

A little background for first-timers or those just sticking their baby toe into the real estate market:  Back in the day when real estate prices skyrocketed and money grew on trees, many Adjustable Rate Mortgages (ARMs) started with absurdly low introductory rates that were scheduled to jump at the end of a one-or-two year introductory period. The new rates were generally tied to a  Treasury or London Interbank (Libor) index, with the mortgage rate typically set at 2 to 6 percentage points above that index rate.  Thereafter, the rate is scheduled to adjust annually.

The good news is that Libor rates have been stable, thanks in part to the actions of the Federal Reserve to lower interest rates.   For example:  Let’s say a borrower in Spring 2006 obtained a mortgage indexed at five points above Libor (then at around 5 percent).  That would have meant an indexed rate at that time of 10 percent.  However, a two-year introductory rate capped the payment at 8 percent.  As of last week, Libor was at 3.08 percent, which means this fictional mortgage would reset at 8.08 today – only a slight change for the borrower.

You can read the full story in SFGate.

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With prices falling in many parts of the country and the number of foreclosures rising, a small yet growing number of bargain-hunting buyers are seeing an upside to the real estate market. Here are three categories of buyers who see silver linings in all these thick clouds of foreclosures.

First Time Buyers - Beyond the Bay Area and California’s borders there are happy stories about first-time homebuyers who used to be frustrated by the pricey market of yesteryear. Today, they are among those most attracted to real estate today.  In November 2007, 39 percent of buyers nationwide were first-timers, up from 36 percent in 2006, according to NAR. 

In San Francisco, first-timers on a budget head to neighborhoods in what we call “District 10″ — places like the Bayview, Portola and Silver Terrace neighborhoods. (See my sale in the Bayview for an example of the kind of deal you can get in these neighborhoods today).  Within San Francisco, these neighborhoods have the highest foreclosure rates (although they are not nearly as bad as other parts of the country).

International buyers are also jumping into the market. In San Francisco, we hear all the time about Pacific Rim buyers snapping up the high-end units in luxury buildings like the Infinity or the Millennium.  Foreign investors also looking at opportunities in the U.S. real estate market because their Euro goes so much further– declines in the value of the dollar against other currencies and lower prices translate into a discount of up to 30 percent for some foreign buyers.

Investors also cross state borders, seeking bargains in those markets hardest hit by the real estate downturn.  Some even buying properties sight-unseen for conversion to rentals until the market heats up again – a risky proposition, according to some observers.

You can read the full story in USA Today–

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Retail condos, according to a recent article in the San Francisco Business Times, are becoming a popular alternative for small businesses. Owning your own space instead of renting it is a great way to for shop owners to eliminate ugly rent increases when it’s time to renegotiate the lease. It also eliminates the threat of a landlord easing you out when more favorable tenants come a courting. .

Many developers also see a benefit to retail condos.  With hundreds of living spaces stacked on top of one another in neighborhoods like Mission Bay or SOMA, retail goods and services that can serve the residents is a big draw. Usually the market for a retailer lives within 1/2 a block,  so these larger new building off an immediate customer base. Whole Foods Market, which occupies two contiguous commercial condos on the ground floor at The Potrero, is a perfect example. The store is one of the project’s biggest draws for prospective buyers who love the idea of running downstairs for a cup of Peet’s or healthy grab-and-go food.

To buy their condos, many small businesses are turning to the SBA’s 504 loan program. These loans are designed specifically for property acquisition and only require 10% down. That’s far less than the 25-30% a traditional lender requires for a commercial investment.

(Caveat– last I heard, the SBA loan process is onerous and requires copious amounts of paperwork– so look carefully before you leap at this option).

Purchase prices for new retail condos run about $500/square foot.  but you can occasionally find a retail space in an older mixed-use building. Right now there’s a storefront office on Divisadero at Pine– approximately 750 square feet listed for $429,000, and a tiny storefront at the corner of  Larkin and Jackson that used to be a nail salon listed for $155,000. Keep in mind that both of these listings are TIC units and will not qualify for the SBA financing.

At Paragon we have a handful of commercial condos for sale and/or lease along the Van Ness corridor.  Please call me if you would like more information.

Purchase prices for retail condos in the city are running around $500 per square foot, she said. The demographics for the buyers of the new residential condos are also attractive — lots of young couples without kids and downsized baby boomers who are clearly not living on fixed incomes.

Retail condo buyers, House said, represent a varied landscape — restaurants, home decor, wine bars, coffee cafes and service business that include optometrists, dentists and spas.

Things to ponder
Business condos certainly come with their own set of potential problems — just as with residential condos, retail condo owners are part of an owners association and must agree on marketing decisions, which might include who they allow to buy in the building and other provisions. But there are no lawns for a neighbor’s dog to soil and no one will complain about late night piano practicing.

Some developers and management companies are being as cautious as little old ladies crossing a busy street — building in soundproofing, extra ventilation and thicker walls and flooring to buffer upstairs tenants from restaurants. One Florida mixed-use project, next to a busy port, is requiring that residents to agree not to sue over noise.

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