August 15, 2008

San Francisco Landlord Foreclosures: Tenant PSA And Growing Trend

"State and local laws prohibit landlords from evicting tenants or shutting off utilities [due to a foreclosure], but not all renters are aware of the rules, and not all of the entities that take control of properties try to learn them."

"The issue was virtually unheard of a year ago. The San Francisco Tenants Union had to circulate a memo to its counselors earlier this year because few had ever encountered it before.

The exact number of tenants dealing with the aftermath of a landlord foreclosure is difficult to ascertain. Three tenants groups contacted by The Chronicle reported around 130 cases this year, but most counselors believe that many more tenants aren't contacting the organizations. What is known is that lenders foreclosed on 492 homes in San Francisco during the last year and a half, according to DataQuick Information Systems."

Foreclosure's hidden victims [SFGate]

First Published: August 15, 2008 6:00 AM

Comments from "Plugged In" Readers

the rental law in the city , in essence, is forcing the lenders to charge highter interest rates for people who buy for investment purpose, thus reducing the number of landlord, which translate into reduced supply of rental units, which resulted in..............................

Government interference with free market is a bad thing.

Posted by: 11223 at August 15, 2008 9:14 AM

492 irresponsible buyers in San Francisco who outbid everyone else are flushed out of the system but yet the prices those 492 buyers paid are considered legitimate comps by appraisers and agents while any resales for less are dismissed because a rational bank is motivated to sell for current market value? Yeah, that makes sense...

Posted by: toni at August 15, 2008 9:20 AM

People get foreclosed upon year in and year out. They always have and they always will. You have no idea about these 492 various backstories. "Prices those 492 buyers paid" -- that was written as if they all bought with sub prime or something.

Posted by: fluj at August 15, 2008 9:42 AM

Yes, but the number of foreclosures in San Francisco is up by 182% in the last year and up by a factor of 15 compared to two years ago. You can't seriously contend this is just a case of "People get foreclosed upon year in and year out. They always have and they always will." Come on. Don't completely blow your credibility, fluj.

Posted by: anon at August 15, 2008 10:06 AM

11223 - I've not seen a study that correlates SF's (or other municipality's) rent control ordinances with lender risk and therefore higher interest rates. That's interesting though. Do you have any good articles or studies to recommend?

Posted by: hmmm at August 15, 2008 10:14 AM

"People get foreclosed upon year in and year out. They always have and they always will."

That's a total red herring. It's the magnitude of the problem that's different now. From a problem that was "virtually unheard of a year ago" to at least 130 reported cases this year alone? Wonder how many of those landlords fell [prey] to the "buy, sell, repeat, retire" realtor billboards and sales pitch.

Posted by: Michael at August 15, 2008 10:23 AM

No. Before you guys say another word look what I was responding to.

The guy essentially said, "492 people overbid properties and cry me a river. Now the banks will set the real values."

Red herring eh? No. How about you read what you're quoting there instead?

"Virtually unheard of a year ago" is speaking to something else entirely, OK? That is speaking to landlords shutting off utilities and bullying tenants.

492 Homes. Landlords losing rental properties to banks. The twain shall meet? Rarely.

Too many haters on here.

Posted by: fluj at August 15, 2008 10:32 AM

hmmm,

no, I don't have anything good enough to recommend here. I was just talking intuitively. Full disclosure - I live in South Bay and work for "not Google". Purchased 2 units as investment properties in SF. When I compared the south bay and Sf rent levels on similar properties, it was a very easy decision.

I think the rent control is doing everything the exact opposite of what it was supposed to do. But that is what happens with most of government interference, don't you agree??

Posted by: 11223 at August 15, 2008 10:35 AM

11223 - I would like to keep as much "interference" off my real property. I would rather pay higher taxes than subsidize units directly. Although, to your broader question, there would eventually be some "intereference" if the government then used those taxes to run housing directly (and some agencies have been rather inept over the years). Note: just "talking intuitively," not with any data or agency in mind.

Posted by: hmmm at August 15, 2008 11:01 AM

11223 - How many multi-unit properties could you have possibly looked at in the South Bay? Were you comparing rents on a TIC versus rent on a house down there?

And yes, government interference is generally bad, especially things like prop 13 and the mortgage tax deduction. At the same time, it can certainly be argued that the lack of good government regulation is what caused all of the current mess we're in with regard to subprime, etc.

We get it. You think rent control is horrible, but there are so many other "government interferences" that I bet you like or support, so this talk of "free markets" is absolute BS.

Posted by: Brutus at August 15, 2008 11:07 AM

Brutus,

I don't think rent control is horrible, like you predicted. Rent control is, instead, why I picked SF to buy my investment properties.

Speaking of comps, let me tell you this: I bought a TIC unit a few years ago for $625K, 2bd/2bath, with parking, for about 1200 sq feet. Due to rent control, I can only increase 2% a year, so it is now renting $2850, where the market rate would be $3300 i think.

In Palo Alto, that same $625K can buy you a 2/2 apt, with a slightly less space. You woule be lucky to rent $2200 TODAY.

So, to me, that is how rent control helped me.

Posted by: 11223 at August 15, 2008 11:17 AM

^^^Why are you convinced that it is solely rent control that has caused that price variance? Couldn't it simply be a higher demand for rental units in SF? Or more people willing to pay a premium to buy in Palo Alto? I think you're being incredibly simplistic in your causation/correlation analysis.

Posted by: Brutus at August 15, 2008 11:20 AM

Brutus,

this is my logic, it sounds simple but I do think that is some truth to it.


In two cities that are so close to each other, SF and Palo Alto, if two properties are at the same price, their rent should be comparable too, at least in a fully functional free marekt. (Sorry, I had some ecomomy class in my MBA program, but I hardly remember anything from those classes now).

The only reason why SF's rent level is so much higher than south bay is rent control - an artificial forec in the whole supply and demand equation, still total BS to you???

Posted by: 11223 at August 15, 2008 11:27 AM

You call someone simplistic after missing his or her initial point?

Posted by: fluj at August 15, 2008 11:29 AM

fluj, I saw 11223's "initial point", but ignored it because of numerous other posts in other threads.

11223 - I could agree that rents should be the same if all other demographic factors between the two cities are equal, which they are not.

Demographic factors can account for a lot of the difference in why a two bedroom apartment in a city would rent for more than a two bedroom house in a suburban area.

Posted by: Brutus at August 15, 2008 12:03 PM

In two cities that are so close to each other, SF and Palo Alto, if two properties are at the same price, their rent should be comparable too, at least in a fully functional free marekt.

In a "fully functional free market" the rent in both cities would be significantly more, or the prices would be significantly less. My "BS" comment was about your talk of free markets, when discussing real estate in the US or California, in particular. Rent control is but one government influence on the market, which is not even remotely free, anywhere in the country.

Posted by: Brutus at August 15, 2008 12:10 PM

Brutus,

i think you missed my point again.

My arguement is that if two properties (whether it is SFH or condo, or anything) are selling for the same price, they should be renting for the same rent too. Your focus is on apt vs house.

Posted by: 11223 at August 15, 2008 2:27 PM

^^^My point is that other factors affect the price of sale versus price of rent, which you seem to think is based entirely on rent control.

Consider this - if a "fixer" house in Palo Alto is selling for $650k and a nice condo is selling for $650k in SF, of course the condo is going to command more rent, because while both are the same price, one can rent for more because the value to the renter is higher. The value to the owner could be exactly the same.

Also, demographics do matter. More people rent in SF. It's much more "socially acceptable" to rent in SF while making good money than it is to do the same in Palo Alto, meaning that the rental market in SF is probably more competitive, yet the for-sale market might be equally competitive in both cities. The two cities are NOT close enough together to disregard demographics.

More families with kids live in Palo Alto - it's more "socially unacceptable" to rent when you're settling down with kids, so it's quite likely that more people moving to areas like Palo Alto will disregard rent vs buy equations than singles and DINKs living in SF.

The no-car or car-light factor. Housing and transportation costs should be looked at together. Many people are willing to spend more on rent if they can save on transport (cost or time) and thus bid up rental prices on places that can cut transport costs or time. This is where it's important to compare SFH vs SFH in the two areas - transport costs would be figured into properties that are primarily looked at as owner-occupied (even if the owner wasn't occupying it), but aren't as likely to be priced in on multi-unit places that are not owner-occupied typically.

Just my thoughts.

Posted by: Brutus at August 15, 2008 5:20 PM

Satchel has also posted numerous anecdotal stories about cheap rents to be had in Marin. Is it possible that the local market distortion (rent control) shielded SF from some of the massive nationwide distortions that were introduced over the past few years? That could explain why prices to buy seem so much more out of whack in Marin and the South Bay compared to SF.

Posted by: Brutus at August 15, 2008 5:47 PM

Brutus,

You see the (relatively) cheap rents in SF proper, as well, on SFHs. However, it does seem like Marin has even better deals as far as renting goes (relative to buying of course).

I do think that the low rents are largely an artifact of prop 13. However, we should entertain the possibility that the high purchase prices of SFHs in most - if not all - Bay Area neighborhoods is the *true* distortion. Rent on SFHs is completely unregulated. If the income/wealth of the area supported the pricing, rents on these would be driven up to approximately the cost of buying. (Of course, for nice properties, there will be a premium for ownership, largely associated with the stability that owning a property provides. But not this much of a premium!)

What you say about demographics driving decisions has some merit, but these demographic considerations would also apply in places like the suburbs of NYC or Chicago, for instance, and we definitely do NOT see the sorts of disparities we wee here in the rent vs. buy "arbitrage". There's no mystery here - it's pretty obvious. Prop 13 has led to "costless" ownership of homes by long term owners, which both encourages holding the asset (leading to diminished supply for purcchase) as well as increased willingness to rent them out at low or even negative economic returns to the asset (at least in real terms).

In fairness, most of the deals seem to be in the non- "glamour" nabes. I have some theories as to why this is, but who really cares?

Here is an example of a ridiculous rent/buy: a 4/2.5 in a very nice street in Ingleside Terraces. It is almost impossible to buy a house of this size for less than $1.2M, and many of the houses even now sell for more there. I have a friend who bought a house almost identical to this one in 2000 for $950K!!
http://sfbay.craigslist.org/sfc/apa/796471222.html

They have literally been trying to rent that house for 6 months already. So, obviously $4500/mo is a pipe dream. Maybe $3500/mo is realistic now. They actually pay a fair amount of tax on this property - almost $4,800 per year (assessed value is $415K). Maybe that's why they don't lower it to it's proper market clearing rate in light of the relatively low salaries in SF :)

That's just one example, but there are dozens of others of course.

I can't emphasize enough that in my experience, craigslist asking rents on SFHs can be knocked down 15-25% by a solvent renter.

Posted by: Satchel at August 15, 2008 6:35 PM

Satchel,

So I guess the question is this - does rent control in San Francisco help offset the affects that prop 13 would have (and does have everywhere else)?

Using 11223's case - it isn't just that the distortion of rent control is raising prices in SF, but rather that the distortion caused by prop 13 has lowered prices everywhere else, and rent control has had some effect in raising them slightly back up in SF proper.

My only question then is this - wouldn't there be a very large difference in selling price between rent-controlled units and non-rent controlled units? For example, a unit in a new building should sell for significantly more than a similar unit in a condoized 1930's building, if the economic theories hold true, since the effect of rent control raising the prices of rents in the area should raise the asking price, but would not tack on the risk discount that a unit subject to rent control would have.

My demographic theories don't work in Chicago and NYC, true. But couldn't that at least partially be explained by relative size of the cities? The urban areas of Chicago and NYC (and even the urban areas of their suburbs) occupy a much higher percentage of the metro area. I'd be curious to look at Seattle for comparison, as it seems to be closer to the Bay Area in development pattern to determine how much is caused by prop 13 and how much is caused by development and demographic patterns and trends.

Posted by: Brutus at August 15, 2008 7:14 PM

Brutus,

There's lots to chew over when thinking about distortions like Prop 13 and rent control, and of course we can never run a controlled experiment to tease out exactly what the effects are, and how they interact, etc.

I think the key aspect of rent control is that over time it leads to higher than "equilibrium" rents. This is because supply is artifically constricted in at least two important ways: 1) new building is discouraged because investors will naturally target that part of the market where returns are likely to be highest (in particular, the luxury condo market, and "corporate apartment" market: and 2) existing occupants of rent controlled units are at the margins much less likely to vacate because leaving means both foregoing the "subsidy" as well as facing the limited supply market created by the rent controls. Another (more limited) effect is that units are purposely kept vacant in order to avoid problems associated with the rent regulations, again exacerbating the supply/demand imbalance.

Again, no way to run a historical experiment, but it is no surprise to me that the cities with the highest rents on apartment-like units are also those with long histories of rent controls: NYC, Boston and SF, to name the most glaring ones.

Although Prop 13 lowers the burden on apartment owners, there is no reason to believe that they would pass any of these savings on to the renters: why should they? They will charge the max allowed by law, and it will be easy to get because the controls and effects of the controls ensure a shortage. Again, over time, this conditions the population to expect higher rents, which leads to an increased willingness to pay high prices for condos, etc.

(Although there is no reason to pass Prop 13 savings on to apartment renters in light of the artificial shortage, Prop 13 does act to save landlords' bacon at times I'm sure! For instance, in SF, the controls came in largely AFTER the worst of the inflationary 1970s. In NYC, they existed since WWII - with revisions in the 1950s - and so when the inflation of the 1970s hit, landlords were not able to stay in business. Their bacon was cooked - LITERALLY - and that is why tens of thousands of units were intentionally burned down in the Bronx, Manhattan (less so) and parts of Brooklyn from 1973 or so through 1982 or so. Had SF instituted controls in the 1940s, much of SF would have been torched as well, I'm sure.)

Prop 13 works differently. It acts as an insurance policy against rising taxes. As such, the value of this insurance is capitalized in the value of the asset, leading to higher than equilibrium purchase prices. The "value" of this insurance increases as people perceive the "natural" rate of appreciation to be higher than the 2% maximum tax assessment increase, so you can see how this capitalization effect goes into "overdrive" in the nicest neighborhoods (and those regions of California that are most desirable) over time.

Because the protections of Prop 13 can be passed down to subsequent generations, property owners are incented to retain the properties. The idea that this was intended to keep old people in their homes was of course always a smokescreen. There is no limit to how many properties can be sheltered, no requirement that the property be residential, no requirement that it be owner occupied or that the owner even reside within California, etc. Whatever the true intentions were, "keeping old people in their homes" was just for consumption by economic illiterates (i.e., 99% of the voting public).

When it comes to renting out these SFHs being held, long term owners charge what they can - there is no artificial price control. However, there is the economic constraint that people here cannot afford to pay very much in rent - at least relative to what they can "afford" to buy. Similar to the way rent control conditions the population to accept high rents on apartment-like units, the "glut" of low tax base SFHs conditions people to expect that it is MUCH cheaper to rent an SFH than to buy it. This is of course another distortion, and IMO is primarily what separates the SFH rental market here from the SFH rental market in places like NYC and Chicago (and just about ANYWHERE outside of California I have ever seen).

I hope that helps to give people some ideas to chew over!

Posted by: Satchel at August 15, 2008 7:51 PM

Re: Palo Alto "it's more "socially unacceptable" to rent when you're settling down with kids,"

No it's not. People want to get into PA schools anyway they can -- renting is a perfectly fine way of doing it. You certainly don't see people renting in SF for the schools...

As for "fixer in Palo Alto" for $650K -- someone hasn't looked at the market recently. PA fixers in the better neighborhoods are going for more than $1.4M.

Posted by: Usually Named at August 17, 2008 8:17 PM

^^^I was using the numbers that 11223 provided. $650k for anything in PA does seem remarkably low.

When I made the statements that I did, I was more using PA just because the original poster did, but I wasn't really being specific to PA. Any area down there is going to have low end rents (like that on a $650k property) more impacted by the large apartment complexes and what they charge, than what you would see in SF. High end rents are going to be more impacted by the effects of prop 13, as Satchel has mentioned.

Posted by: Brutus at August 17, 2008 9:04 PM

If Prop 13 causes rents to permanently stay lower, why doesn't it have that effect in the rest of California? Your theory breaks down in Bakersfield.

And that $4500/mo place that would sell for $1.2M is not really that much lower than owner occupancy would be.

$1.2M @ 7.5% = 7200/mo PI
$1.2M @ 1.1% taxes = 1100 property tax
300/mo insurance
----
8600

Subtract out the mortgage interest and property tax deduction (7400 * 40% marginal tax rate) and the $900/mo you are paying down the principle and you are paying $4740/mo in ownership costs. Add in, say, $800/mo in maintenance and you talking an extra $1040 or 20-25% to buy over rent.

And this locks in not only your mortgage rate, but also your tax rate. Seems like a pretty good deal to me, over the uncertainty of renting.

Posted by: NoeValleyJim at August 17, 2008 9:29 PM

NVJ,

I sgree with you to some degree. And I don't think that you can compare California to the NYC or Chicago areas or wherever else because only California has had the consistent level of population growth over the past century. The only other comparable place (in terms of consistent population gains year in year out) is Texas, which has far fewer other regulations and far fewer natural geographic boundaries surrounding metro areas.

Posted by: Brutus at August 17, 2008 10:07 PM

NVJ,

The effects of prop 13 DO have an effect all over California, of course, and rent anywhere in the state for SFHs will be a bit lower than equilibrium. However, of course, this is most evident in areas with high percentages of older housing stock (where the disparities in tax rates are consequently greatest between long term owners and more recent buyers).

I'm not an expert on Bakersfried, but I do have a foolish acquaintance (used to report to my wife) who bought a place out there in 2005 or 06 as an investment. The blogs are also full of stories about how much less it is to rent in Bakersfried than to buy, etc. In addition, the relative percentages of new housing (say, after 2000) versus pre-1979 housing in Bakersfried is MUCH higher than in SF or west side of LA, to just name a few places where rent/buy disparities are enormous.

About after tax costs of owning, you need to revisit your numbers. First, and I point this out every time but people don't seem to want to accept it, you CANNOT deflate your deductible housing cost expense (property tax + interest component of loan cost) by your marginal rate. You need to go through the brackets and do the return. You will find that it is almost impossible to achieve a greater than 33 or 34% reduction in real cash outlay, and certainly not 40%.

Second, you don't seem to understand that interest on only up to $1MM of acquisition debt (+ up to $100K of home equity loan) is deductible for individual filers. In SF, as you know, $1M doesn't get you too much.

Third, you don't ascribe any cost to the downpayment that is tied up in the home asset.

Last, $4500 per month on a $1.2M place is a straw man argument in most of the parts of the Bay Area. I just rented a $1.2M (approx) place in Tiburon for $2800, after living in a $1.4M (approx) place in Monterey Heights in SF for $3100.

There are tremendous distortions in the California market. That is why CA cities always show up near the top of any charts on rent/buy disparities. Certain cities in Florida as well show up high on those charts. Florida also has some tax distortions built in (the "SOH" initiative) as well as the "homestead" exemption that, among other things reduced tax rates a bit and more importantly shelters home equity from legal judgments of creditors. That is why OJ Simpson owns a nice spread down there :)

Posted by: Satchel at August 18, 2008 7:25 AM

Wow, a lot of interesting posting since i last checked in here.

My guess is that Brutus, don't take it offensively please, never lived in South Bay, or ever looked the South Bay market.

For anyone has lived/worked/watched the south bay market, it is a no brainer that rent level here is way below Sf. And while there could be multiple contributors to that, rent control has a major role in this, even if not the sole factor.

Posted by: 11223 at August 18, 2008 11:42 AM

Satchel - good points about rent v buy and the need to consider the brackets and actual full return in determining the mortgage tax impact. FL's homestead exemption can be claimed only be owners who live in the property - so absentee landlords and investors and commercial property doesn't get protected. Wouldn't that make sense for Prop 13 - protect only owners who are actually living in their houses?

Posted by: FSBO at August 18, 2008 11:59 AM

11223 - Actually I did live in Sunnyvale for two years - hated it and was paying as much as I would to rent a slightly smaller place in SF, so I moved.

I have no doubt that rents on a per square foot basis are lower in the South Bay, but to me many other factors seem to play a much larger role than rent control (one thing I didn't mention before was the presence of more large corporate suburban rental developments, which probably play a role and affect prices across the rental spectrum - especially older places that are paying beans for property taxes).

That was primarily my beef with your assertions, which seemed to place all blame for any difference solely at the foot of rent control. I also was pointing out that there were many other distortions to the "free market" that played a much larger role in rents than rent control does. I took issue with your statement that somehow the "free market" was not being followed in SF, but somehow was being followed in the South Bay (which is an absolutely ridiculous statement).

Rent control certainly does have an affect, though I think its affect is very much overstated in many cases.

Posted by: Brutus at August 18, 2008 12:03 PM

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