the property management shop
How Rent Control Leads to the Loss of Rental Stock
By Marc Wilson
Q. My wife and I own a 12-unit apartment building in the Marina. I have heard about some unbelievable sales prices lately. I don’t know who is paying these prices or why, but it might be time for us to consider selling sometime in the near future. Should we keep our units vacant as the tenants move out? It might be a year or two before we sell and I would sure miss the income.
A. A sales flyer for a 15-unit Marina District apartment building just came through my mail slot. The asking price is close to $7 million, a whopping 18.3 times the current gross income. The realtor is expecting multiple offers and thinks that the price might get bid up. You know what that means, don’t you? It means that San Francisco’s rental housing stock is in serious, serious trouble. I think it’s safe to assume that the buyer of this property (and many, many others just like him) is not planning on being a property manager/owner of rental housing in the great city of San Francisco. Something tells me that tendering a $4 million down payment to a new loan of $3 million, just so he can pray to break even every month, is not exactly this investor’s dream come true. Something tells me that the new owner of this property will not be joining the San Francisco Apartment Association. No, this buyer is in the business of owning this property for the least amount of time possible. This is just another tenancy-in-common (TIC) conversion sale and the buyer is a TIC developer. Even the sales flyer touts that, “This offering is most suitable for the owner/occupier, TIC/condo investor. Units in the area are reported to be selling for $800,000 to $1,000,000 per unit.”
The subject building was built, like most of San Francisco’s rental stock, between 1925 and 1935. Generations of young people have gotten their start in San Francisco by living in apartment buildings just like this one. This building has provided safe, habitable housing for San Francisco tenants for over 70 years and now the party is over because of rent control.
What percentage of San Francisco’s rent control-exempt apartment buildings get converted to TIC-for-sale units every year? Zero. Why? Because these owners are perfectly content to receive market rents for their apartments and to have absolutely no dealings with the San Francisco Rent Board. Only rent controlled properties are being converted to TIC for-sale housing and, in the process, being emptied of their tenants. This is what rent control advocates have reaped. This is their legacy. Only one thing will stop the clear cutting of San Francisco’s rental stock, and our leaders simply do not have the brains or the nerve to see it. The only thing that will stop this slaughter is the end of rent control.
Tenants aren’t the only ones eating the golden goose. This trend is definitely not good for the average San Francisco apartment building broker. Sure, things have been easy the last five years. Short marketing stints, multiple offers, double-ended transactions, big prices and sweet paydays have been the norm for many local brokers. But TIC conversions will continue to reduce the total stock of rental housing in San Francisco. This drop of available properties coupled with more and more properties being concentrated in fewer and fewer portfolios will result in decreasing sales volume and less commissions. Specializing in the sale of San Francisco apartment building sales, though risky, used to be considered a reasonable bet.
But I feel sorry for the younger apartment building agents today. How in the world are they going to purchase their first small apartment building in this market? Broker some deals, live frugally, save some money and then make a $1 million down payment on a 6-unit apartment building? These pricing structures take all the fun out of long-term investing. We are all plying our trade in a shrinking market, a market that has a pricing structure that is simply not conducive to long-term investing. The average broker has a couple of tough choices: hang in there and hope for the absolute mother of all recessions, something that takes rents down 20% and prices down 25% (this scenario would, in all likelihood, provide brokers with abundant purchase opportunities with little or no down payment); or stop complaining and jump on the TIC band wagon.
Rent controlled tenants don’t care about the devastation of San Francisco’s rental stock because they are too busy hugging their entitlements. Obviously San Francisco’s tenants need to be saved from themselves, and fortunately for them, help might be on the way. The Howard Jarvis Taxpayers Association has sponsored and gathered signatures for the California Property Owners and Farmland Protection Act. This initiative would disallow eminent domain and would authorize regulatory takings compensation to property owners for damage done to their properties due to almost any governmental regulations. If it passes, this act would nullify rent control in California. This act is riding a wave of strong voter discontent with eminent domain and regulatory takings of any kind by any city, state or federal authority.
A similar act, Proposition 90, came darn close to passing in 2006; 47.5% voted in favor of it with a very light campaign. This time around, the kinks have been worked out and the money for a strong campaign has been procured. I’ve got a good feeling about this one. Most California property owners say a silent thank you to Howard Jarvis every time they pay their property taxes. You remember Howard Jarvis, don’t you? He brought you Proposition 13 and the association he founded is bringing you the end of rent control; it’s just beautiful.
Back to your question, if you are serious about selling the property in the short term, you should leave your empty units vacant. I think the increased value related to apartments delivered vacant at the close of escrow will outweigh any lost cash flow. If your buyer is a TIC developer, her main concern will be how long it will take and how much money it will cost to get the units vacant. Any units that you can deliver vacant are a bonus to the buyer and will enhance the value of the property. I don’t think that any one thing more clearly demonstrates the sick and deprived nature of the San Francisco rental housing market than the simple fact that rental units here are worth more vacant than occupied. This is a truly homegrown phenomenon and is the reason that San Francisco’s rental housing stock is in such serious trouble.
The opinions expressed in this article are those of the authors and do not necessarily reflect the viewpoint of SFAA or SF Apartment Magazine. Marc Wilson has specialized in the brokerage of San Francisco apartment buildings for 20 years. He can be reached at 415-229-1275. Copyright © 2008 by SF Apartment Magazine. All rights reserved.