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taddyangle

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Reply with quote  #1 
Hello,

A friend of mine is over seeing his fathers estate and he is trying to see what options he has as it relates to rent control in the city of San Francisco.

His parents purchased a 7 unit building in the 1960s, and rents are currently about $800 per door.  The father has the property in a trust and does not need the income, nor does my friend, and consequently they have ignored dealing with properly managing the units for who knows how long.  There are no leases on record and pretty much all my friend has are the cancelled checks from each months rent. 

He knows he has to deal with this at some point, and any benefits would be for the grand kids.  

He asked me to post here to see if you guys had any thoughts on how he should handle this situation.  They have no intention to sell and my advise was to get the property inspected to assess the condition, as they have done absolutely nothing in regards to maintenance for many many years. 

Thanks

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mlreits

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Reply with quote  #2 
I would suggest he hires a professional property manager to manage the building. Sounds like the tenants are due for a banked rent increase. I believe banked rent can go back 5 years in SF so up 15% rent increase. If he has to spend money to fix, upgrade or remodel, he can also apply for capital improvement pass through, which is another increase on top of the rent increase. A good property manager who knows SF rent control is worth his weight in gold IMO. They have been penny wise pound foolish to let the situation slid this long IMO. Now, they will always be behind the 8 ball and likely never going to catch up with fair market rent.

Good luck.

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Minh

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Reply with quote  #3 
Quote:
Originally Posted by taddyangle
Hello,

A friend of mine is over seeing his fathers estate and he is trying to see what options he has as it relates to rent control in the city of San Francisco.

His parents purchased a 7 unit building in the 1960s, and rents are currently about $800 per door.  The father has the property in a trust and does not need the income, nor does my friend, and consequently they have ignored dealing with properly managing the units for who knows how long.  There are no leases on record and pretty much all my friend has are the cancelled checks from each months rent. 

He knows he has to deal with this at some point, and any benefits would be for the grand kids.  

He asked me to post here to see if you guys had any thoughts on how he should handle this situation.  They have no intention to sell and my advise was to get the property inspected to assess the condition, as they have done absolutely nothing in regards to maintenance for many many years. 

Thanks


The San Francisco Rent Board's web site should answer most of the relevant questions, but if further clarification is necessary it is possible to visit the SFRB and talk to someone face-to-face. 

https://sfrb.org/

Minh correctly mentions that dealing with "banked rent increases" should be on the agenda.  My reading of the below-linked document is that the rent increases permitted for the most recent five-year period only total around 8.3%.  I did not at first reading notice any 5-year limitation, but it is possible that I missed it.  It would certainly be worth checking with the SFRB to make sure that the right to take every allowable rent increase is either exercised or preserved.  

https://sfrb.org/sites/default/files/Document/Form/571%20Allowable%20Annual%20Increases%2018-19.pdf

A disadvantage of banking rent increases rather than implementing them annually seems to be that you lose the compounding effect - you only seem to be permitted to add the percentage increases together, rather than compounding them as you would if you were to increase rents as permitted every year.  

All of this has to be done precisely correctly.  No winging it; no assuming that common sense applies.  You have to know the rules and follow them to the letter.  Unless you enjoy dealing with these guys:

https://www.sftu.org/

One of the most onerous parts of San Francisco rent control is that they don't even allow you to increase rents on existing tenants in accordance with CPI.  Note the following blurb from the earlier-referenced pdf:

"Effective March 1, 2018 through February 28, 2019, the allowable annual increase amount is 1.6%. This amount is based on 60% of the increase in the Consumer Price Index for All Urban Consumers in the Bay Area, which was 2.7% as posted in November 2017 by the Bureau of Labor Statistics."

Thus, it appears that you only can raise rents on existing tenants by 60% of the CPI increase.  So in real terms, if tenant turnover is zero, you are collecting less and less rent every year even as your expenses increase.  These are not economics which I would find even remotely attractive.

There are people who specialize in San Francisco real estate and who have navigated the pitfalls well (so far).  Many of these people specialize in rental units which attract people who are likely to "move on" in a couple of years, at which time rents can be marked to market.  It could be financially disastrous to rent to a 50-year old who never moves, and who still is there 40 years later paying a trivial rent.  And that happens, a lot.  It probably goes without saying that it is unlikely to be legal for landlords to discriminate against prospective renters who are likely to stay put.

If we run into an inflationary period (quite likely at some point), the problems posed by inadequate CPI adjustment would be further exacerbated.  

There are some provisions whereby rental arrangements can be terminated by the landlord under certain circumstances, but there is nothing simple about this.  You have to know what you're doing, and obviously there will be stiff and loud resistance from the tenants whose low rents and long-time homes you would be threatening.  

If I were speaking with the heirs, I would have the following questions:

1)  Why  do they want to keep the building?  Is there a good reason? 
One good reason could be that the building and/or the underlying land is worth way, way more than the rents can justify and that much better net proceeds could be realized when desired; but any such argument must be based on demonstrable facts and not on wishful thinking. 

2)  What kind of a trust is the building in, and was there a step-up in tax basis at the death of the father?  If there was a step-up in basis and if the building could be sold at a good price without resulting in any capital gains taxes and the money could be transmitted to the heirs, then I would seriously consider taking that option.  

You mentioned that the previous generation neglected increasing rents and that there is likely to be quite a bit of deferred maintenance that at some point needs to be done.  Is the current generation up to the task?  Do they wish to be landlords?  If so, why did they fail to get involved earlier and not even take the basic step of annually increasing rents? 

I can't think of any successful generational transition of a family business in which the younger generation wasn't actively involved well before the passing of the older generation.  And in any case, very few family businesses are successfully passed on.  Every generation has differing skills, interests, and motivations.  

Few people are cut out to be landlords.  Maybe it is 1% of the population, maybe it is 5%.  Odds are not high that the current generation should be spending their lives being landlords, particularly in a complex legal climate like that of San Francisco.

Just because someone inherits an asset or business doesn't mean that they are obligated to spend their own lives owning the same assets or running the same business that their parents did.  For most people, especially if they can get a good price for the assets/business and there are no negative tax consequences, it often makes more sense to cash out and to use the money doing whatever it is that they want to be doing with their own lives and careers.
mlreits

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Reply with quote  #4 
After I posted yesterday, a SF investor buddy came across my post and reached out. He said “Minh, banked rents can go further than 5 years in SF. There isn’t a time limit.” He also sent me a link relisto.com to help calculate for banked rent. That’s huge.

To add to what SFL said above, investors who can navigate the rent control land mines in the Bay Area are getting handsomely rewarded. I know an investor who buy small multi-units and condotize them to get them out of rent control. He’s patient and has amassed 18 units in SF over the years. Another investor friend bought a 4plex and decided to Ellis Act to get rid of all in-place tenants. He’s leaving all the units vacant for 5 years to satisfy the Ellis Act requirements. The last time I talked to him, he said if I ever need a place to stay overnight in SF, let him know.

It boils down to your friend’s end goal. What does he want to do with the asset or get out of it? There are various options. All come at a cost. If he knows his end goal, then he can work it backward.

Best of luck.

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Minh

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taddyangle

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Reply with quote  #5 
Guys, thanks for the thoughtful responses.  I will keep you posted.  



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JohnsonH

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Reply with quote  #6 
Hi, I am Minh's SF friend regarding the banked rents. Please let your friend know that there is a mandatory soft story retrofit for many multifamily buildings three story's tall and above. He can check if the building is on the list https://sfdbi.org/soft-story-properties-list

If the building does not have a commercial/retail unit on the first floor and it is on the list, he is over due to complete the retrofit. Last bid I saw was for roughly $12k a unit. His mileage may vary depending on the work being done and prices continue to increase. The positive is that the costs of this retrofit can be passed through tenants though a soft story capital improvement pass through. It is special for soft story as 100% of costs can be pass through over a 20 year period with some limitations. This will help with the low rent.

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