Today, I got a question from my clients asking for advice on buying a two-unit building with another couple. Here’s my adapted response. Remember, you should investigate the circumstances of your transaction as your situation will be different.
Question: Another couple wants to buy a building with with me and my partner. We want to turn the building into two condos, which we hear is lucrative here in San Francisco. What should we be worried about? Should we get a partnership agreement?
First, call me to find out.
Okay, you wanted me to answer that?
Well all right. Yes, you should get a partnership agreement in place before closing escrow if not much earlier than that. The agreement can be as sophisticated or basic as you need. This varies because every situation will be different — especially in San Francisco. You’re likely to find a 2-unit building that is either tenant-occupied entirely or 1/2 owner-occupied. There are times when the entire building is vacant. There will be a lot of attention if that’s the case and the price will go up correspondingly. A general rule of thumb is that a vacant unit will get at least $30,000 to $50,000 more in price than one that is tenant-occupied because of San Francisco’s complicated Rent Control and Eviction Control laws and because of the City’s stringent planning and housing regulations.
For example, if you guys came across a completely done, finished and evenly split building, with completely equal values, then you could say each party gets 50% of x and pay 50% of purchase price. Everything is 50/50.
But that’s rarely the case. Instead, what you’re likely to find is the following:
- Unit A is tenant-occupied with a private roof deck, better parking space and bigger repair bill.
- Unit B is owner-occupied and has exclusive yard access, a smaller space but is completely renovated.
- Zoning is RH-2, but use is single-family home and/or 2 rental units or single-family with in-law.
Now, suppose, the building itself has to get a new roof because the roof deck wasn’t built correctly, which has made repairs more urgent. But for the deck, you all could have waited 5 years to do the roof over. Also, turns out the yard has a bad grade which causes water to flow toward the foundation instead of away from it. Let’s suppose, when you guys buy it as as group, Couple A gets the top unit, and Couple B the bottom one. The purchase price is $1M. Is the purchase price then $500k each? Are the costs then split 50/50?
Most likely, you end up with two TICs subject to rent control laws. But you have to check and do a lot of diligence on the rental history, occupancy use and permit history to see what your real options are as it can be complicated.
Next, Couple B can move in right away because the owner is leaving when escrow closes. But Tenants A don’t want to leave or want money to do so. Couple A must do an owner-move-in-evition (OMI), provided there’s never been one done in the past in the building of Tenants A (assume it’s a couple, no children, no one claiming protected status). What happens?
Couple A would theoretically be the ones who should pay the extra $10k to $11k to Tenants A plus an amount — say $2500— in legal fees, right? (They may be able to buy the tenants out too with a cash-for-keys agreement). Should Couple B have to pay anything toward this action? And, what about the repair costs mentioned above? What if the building is completely dilapidated and you guys all want to remodel but unequally so; just because one couple wants to put in marble while the other likes butcher block countertops the costs will be very different for each unit.
You can see that having an agreement really starts to matter.
Enter, Rent Control
Now, let’s throw-in the intersection of rent control laws with buying multi-unit buildings.
What if Unit A and Unit B both have tenants who don’t want to leave? Because you can only do one OMI per building this means that while one Couple can do the OMI, the other Couple will have to buy-out the other set of tenants. Do both Couples pay for that? Consider that the buy-out price is oftentimes already factored into the list price.
One way to get around that is to have a partnership agreement in place that apportions who pays what, or to say everything is in one pool. Or another way you can do it is to have each unit appraised and use that as the percentage basis for costs, i.e., Unit A is worth $600,000 and B is worth $500,000 therefore A’s owners will pay 60% of the bills and B 40%. There are other ways to allocate costs especially if one party is bringing more cash to the table initially and/or if one party can pay more each month than the other.
Last, when purchasing the property you’ll most likely use a group loan. For that, any bank should be able to do it, but be sure to use someone local. A bank many folks use is First Republic but they will have pre-payment penalties for all of their loans without exception. Sterling Bank is one of the only lenders who will do TIC loans fractional at all and/or (and more relevant here) be able to do a construction loan too. Unless you have your own money coming in this is a good way to go. Remember those rates will be higher, but you won’t be paying that for long as you’ll be converting in less than 2 years most likely. Also, remember you can get a 3-year ARM loans at 2.75% (thereabouts) to purchase and then refinance once you’re both condos. Don’t forget that in order to convert, you’ll need another set of lawyers to facilitate your conversion. That process will cost anywhere from $20,000 to $30,000 in fees, costs to prepare condo HOA documents, surveyors, recording and inspections. The bill will be more if there are repairs that are deemed necessary by the City’s BDI.
Just like everything else in San Francisco it’s complicated and doable with a huge upside potential for those who can navigate it. This is why working with a pro like me is great because I can help guide you but I also have a good network of professionals that you can consult. I’ve had good personal interactions with all of these folks and can only speak to my experience, but nevertheless you should investigate to your own satisfaction.
With all that, here’s a short-term action plan:
(1) Have that ‘awkward’ conversation among yourselves about who does what, when and who pays for what, why and when. Write down the salient points. I would then contact one of the following attorneys (or their firms) who are expert in this area to help do the agreement. Twenty or thirty minutes of awkwardness now is worth it as the situation can become very cloudy and bad if everyone’s needs and wants are taken into account.
- Andy Sirkin & Lisa Paul (TIC experts) Sirkin & Associates T: (415) 462–5925 (direct) www.andysirkin.com W: [email protected]
- David R Gellman Goldstein, Gellman, Melbostad 388 Sutter Street, Suite 1000 San Francisco CA 94109–5494 T: (415) 673–5600 F: (415) 673–5606 E: [email protected]
(2) Financially, I believe you’ll have to qualify together. If you want to use your own cash for renovations (if needed) then I’d say any bank or mortgage broker will do. I’ve included a few folks I’ve worked with and like, including ones for First Republic above and for Sterling (if you need monies for renovation).
- Ryan Ogata (Res/Portfolio) Branch Owner/Mortgage Advisor Opes Advisors, Inc. 435 Pacific Avenue, Suite 350 San Francisco, CA 94133 T: 415.869.6132 F: 866.304.2325 E:[email protected] DRE# 1399180 | NMLS #299251
- Connie Buchanan (Res/Constr/Bus) California Real Estate Loans, Inc. 600 N San Mateo Dr San Mateo, CA 94401 M: 415–999.2172 T: 650.342.4466 F: 650.342.9504 www.CRELINC.com E: [email protected] DRE #01200004 | NMLS #241170
- Dan Murphy Relationship Manager First Republic Bank 111 Pine Street, 9th Floor San Francisco, CA 94111 T: 415.288.8003 F: 415.262.2565 E: [email protected] NMLS #487268
- Henry T. Jeanes Mortgage Consultant / TIC Financing Specialist Sterling Bank & Trust Noe Valley Residential Lending Office 3800 24th Street San Francisco, CA 94114 T: 415.970.9889 x12204 C: 415.990.5620 E: [email protected] F: 248.351.7232 / 415.970.9880 NMLS #657755
(3) After all this, report back to me on what you’ve all decided mutually and we can start in earnest.