April 27, 2012

To Rent, Buy, Or Invest At The Palms By The Numbers (Not The Heart)

Purchased for $760,000 in late 2006, the two-bedroom number 606 at 555 4th Street (The Palms) is currently rented for $3,200 a month, a rent which will increase to $3,500 on Tuesday according to the owner.

On the market listed for $699,000, monthly HOA dues are $544 and the property tax rate is currently 1.17%. We’ll let you run the numbers in terms of rent versus buy or as an investment (for which we calculate a CAP Rate under 4 percent).

∙ Listing: 555 4th Street #606 (2/2) 1,031 sqft - $699,000 [Redfin]
San Francisco Property Tax Rate Set To Increase 0.67 Percent [SocketSite]
To Rent Or To Buy, That Is The Question (That Only You Can Answer) [SocketSite]

First Published: April 27, 2012 8:00 AM

Comments from "Plugged In" Readers

(d) None of the above.

Posted by: Tweety at April 27, 2012 8:46 AM

Nice wishing price.

Posted by: J at April 27, 2012 10:00 AM

Looks like a student dorm room.

Posted by: Oceangoer at April 27, 2012 10:33 AM

I wish I went to your school. That don't look like my old dorm room.

Posted by: R at April 27, 2012 10:53 AM

It's certainly nicer than a dorm room, but still a generic floorplan and not much else besides neighbor-visibility.

Posted by: EH at April 27, 2012 11:11 AM

Would have to live there for 7+ years before buying was better than renting at ask assuming no downturn.

Posted by: CH at April 27, 2012 11:42 AM

I get break-even at 6 years but the difference may be because I get hit with the top marginal income tax rate. And that's assuming 2% increases for both home and rent prices/rates, which is probably wrong in one or more ways.

Posted by: shza at April 27, 2012 1:02 PM

What J said. A sale at asking would represent a nominal loss of value of only 8% from the previous sale, which was the year before bubble peak, ignoring transaction costs.

I think that the seller is going to have to take a larger haircut than that or they are going to be in the landlording business for a lot longer.

Posted by: Brahma (incensed renter) at April 27, 2012 1:14 PM

Why this does not work as an Investment at $699?

Rental Income $42,000 (3500 *12)
Interest (4.5% Mtge) $24,980
RE Taxes (1.17%) $7,900
Condo Fees $6,500 (rounded)
Insurance (estimte) $1,500
Depreciation $18,900 (699 X 0.9 x 3.33%)

This gets you a "tax loss" from rental of around $17,000 to $18,000. But at over $150k in AGI, rental losses are disallowed (but carried forward). So you get no tax-write off other than the expenses. If you back out the non-cash depreciation, you have positive CF of around $1,000, but you also paid (assume you don't have an IO mortgage) around $9,000 in principal - so you are running $8,000 negative CF.

What if you paid all Cash? You can get a pre-tax CF yield of around 3.7%. Not bad. But that is taxed at ordinary rates. If you look after tax, it is around 1.7% (including the tax benefit of depreciation). This is roughly the same as what I can get from a REIT fund without the liquidity and concentration risk.

So. As an investment, you are betting on several things:

A. Earnings Growth. Rental income increases over time such that the IRR is positive.

B. P/E expansion. This is the "greater fool" theory used in the last SF real estate bubble. It assumes that someone else will pay a lot more for the property when I want to sell. This often requires wage growth (people can afford more) and/or a decline in the housing unit to population ratio. If popultation growth out strips the growth in housing units, demand (and prices) will rise - all else equal.

This is a tough deal to do. There is almost no margin for error (HOA assessments, vacancy, etc.).

The buy to live-in scenario seems to work (about $3k in after tax CF per year over renting), but this could decline if you are in AMT. Still takes 5-6 years to get a low (3-5%) return on capital.

Posted by: JustLooking at April 27, 2012 3:58 PM

What if you buy with 10% down and then whore it out on airbnb? :)

Posted by: Mikel at April 27, 2012 5:06 PM

JustLooking, that is a solid analysis. All I can say is that since this unit was built within the last 30 years it is not subject to rent control.

And currently there are headwinds all around the global economy. But one day, less than 10 years from now, the global economy is going to be firing on all cylinders, and at that point (combined with high comoddity prices and higher interest rates) there will be significant inflationary pressure. So not only will rents be way higher but so will asset values.

That being said if I had $700k to invest I think you would get much better short to mid-term yields elsewhere (not further exposure to SF RE).

Posted by: anon at April 27, 2012 5:18 PM

Just looking....$200,000 to invest today. Where are you investing it???? Thx

Posted by: Linda at April 27, 2012 5:48 PM

Why bother when #915 is available for $619k? It's cheaper and has a better view. $3500/mo is a wish price for this cooped in unit in a more normal market, if you are counting on the higher rental income.

Posted by: sfcommie at April 27, 2012 6:44 PM

what kind of idiot would pay $3500 to rent this place? Better yet, what kind of idiot has been paying $3200 to rent it? Despite the fact that rents have gone up by 20% for 2 yrs, they will level out and possibly drop again. It is not a straight line up, as many homeowners have discovered. As soon as housing process begin to go up, again the rental trend will change.

Not being rent controlled may be good for long long term, but it doesn't always carry an advantage for medium term for owners.

Too many people tend to believe that prices always go up once on that path. History is not so kind to those beliefs.

Posted by: spencer at April 28, 2012 8:42 AM

Linda:
$200k. Assuming that this is not my full portfolio, 3-5 year as a minimum investment horizon.
A. Avoid Developed Europe with the exception of Germany. Until I see stability in the other countries (Spain, France, Italy, etc.), I am keeping my own portfolio light on Non-US developed and even the managers I have are underweight DM-Europe.
B. 40% Emerging Market Equites. If you like ETFs, the low cost route is VWO (Vanguards EM ETF with a very low expense ratio. If you like active, look at DFA.
C. 40% US equities with a bias to mid & small cap. US will likely lead ROW (rest of world) out of the recession and in a recovery phase, small & mid tend to benefit the most. I would go with active management & not EFTs in this area. I have help Fidelity Low Priced Stock (FLPSX) for years.
D. 20% EM debt. The US & EM markets are where we will see growth. Again, I would go the ETF route (EMB).

Caveat: This is a non-diversified portfolio and should not be your full investment portfolio.

Regards,

Posted by: Justooking at April 28, 2012 9:02 AM

Spencer, $3200 is actually a pretty good deal for 1031 square foot 2BD, 2BA unit in this area, particularly if it comes with parking (I imagine it would).

Lofts around the corner on the Brannan corridor are going for $3300-$3500 for the same size, and then you'll have to tack on $200 for a parking spot if you want one.

Posted by: Fishchum at April 28, 2012 12:51 PM

Just looking....$200,000 to invest today. Where are you investing it????

It really depends on lots of things: your goals, your age, your tolerance for risk, how much in other assets do you have.

Don't put all your eggs in one basket.

Posted by: NoeValleyJim at April 28, 2012 2:25 PM

The SF Condo market is nothing more than speculators selling to other speculators. Most of the units I looked at have less than %50 owner occupancy

Posted by: jkljkljlkj at April 29, 2012 1:04 PM

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