Author Topic: San Francisco - basement conversion for rental. High risk high reward?  (Read 1088 times)

YoungStache

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Hi guys,

New to real estate investing here. Looking for some insight or advice from landlords, and people with experience with home improvement, unit conversions, home rehab, etc.


My parents have a single family home in San Francisco. My Dad wants me to convert the basement into a rental unit.

What would be some of the main considerations? Other than the project cost and rental return.

Would the new "unit" need to have it's own address, and what would be the process for making that possible? Or could the address be left the same?

Also, can the home improvement costs be used to deduct regular income from short/long term capital gains?
« Last Edit: July 27, 2018, 07:33:35 PM by YoungStache »

waltworks

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You need to consult with the city/county to find out what's legal and what's not. After that, you can come back and analyze what the numbers say wrt investment returns.

You don't need a separate address (in most cases). Just deliver the mail to your tenants downstairs.

-W

Dicey

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What Walt said. Plus, SF has some of the most pro-tenant laws anywhere. Learn all about this before you do anything.

YoungStache

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What Walt said. Plus, SF has some of the most pro-tenant laws anywhere. Learn all about this before you do anything.

Do you have any examples off the top of your head?

I saw this, which would be more landlord-friendly. https://www.sfgate.com/bayarea/article/SF-tenant-protection-law-dies-quietly-11254258.php


Also, can the home improvement costs be used to deduct regular income from short/long term capital gains?


« Last Edit: July 27, 2018, 07:33:26 PM by YoungStache »

Dicey

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I know of three SF homes that sit empty because the owner has had bad tenants and much difficulty evicting them. This seems a crime, given SF's excruciatingly tight housing market.

This is only anecdotal, which is why i didn't mention it in the last post. I merely suggested you familiarize yourselves with the extra layers of intricacy that are involved in the City. This goes double for building codes. Plus, due to all the homes lost in Santa Rosa, securing contractors these days is difficult and expen$ive. Now might not be the best time to attempt this. Which means you have plenty of time to research and plan :-)


waltworks

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Yeah, you'll want to research the laws and codes very carefully. I would guess that SF is very restrictive about granting permits for this sort of thing (which I think is stupid, but c'est la vie).

We just (a couple of years ago) converted half of our basement into a 2 bed/1 bath apartment (yes, it's a HUGE basement). We spent about $75k but a decent chunk ($5k?) was on furnishings and crap because we tried using it as an AirBnB (bad choice). So call it $70k setting aside that blunder. We make about $15k per year (net). Not bad! Plus I figure the improvements add $30-40k to the value of the house. We'll have plausibly broken even in 3 years.

There are non monetary considerations, of course. You won't be able to truly soundproof things, so you'll hear your tenants sometimes. You will see them in the driveway and they'll come and go at odd hours sometimes. You'll have to fix stuff and do the usual landlord crap. If you get a psycho tenant, you live *right there*, not fun.

I think if you are in the right situation, it's a great idea, though.

-W

YoungStache

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Thing is the basement already has a room with windows, closet, and door, albeit crooked/uneven. I have slept down there plenty of times. The house sits on a hill so that might be difficult, or it just wouldn't be as attractive of a granny-flat. There's a dungeon-type of area that basically is doing nothing except exist. There's already a full bathroom. So the project might not take a lot of money, and I wouldn't try to pursue perfection.

Also, not sure if we should keep the garage and back-yard access, or have that as part of the rental unit and convert the garage itself as well. The layout might be weird if we try to segment it.

If it could rent for $1500, I would probably be willing to sink 50-75K into it. The main thing would be to heavily screen for a "quality" tenant, or rent via word of mouth from personal networks.

What are some good ways to familiarize with the codes and laws, and what could be reasonably done regarding the structure and livable things? Who can I consult with?

Also, if the house is under my parent's name, would I even be able to use rehab costs to offset taxes?
« Last Edit: July 27, 2018, 08:47:13 PM by YoungStache »

YoungStache

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Yeah, you'll want to research the laws and codes very carefully. I would guess that SF is very restrictive about granting permits for this sort of thing (which I think is stupid, but c'est la vie).

We just (a couple of years ago) converted half of our basement into a 2 bed/1 bath apartment (yes, it's a HUGE basement). We spent about $75k but a decent chunk ($5k?) was on furnishings and crap because we tried using it as an AirBnB (bad choice). So call it $70k setting aside that blunder. We make about $15k per year (net). Not bad! Plus I figure the improvements add $30-40k to the value of the house. We'll have plausibly broken even in 3 years.

There are non monetary considerations, of course. You won't be able to truly soundproof things, so you'll hear your tenants sometimes. You will see them in the driveway and they'll come and go at odd hours sometimes. You'll have to fix stuff and do the usual landlord crap. If you get a psycho tenant, you live *right there*, not fun.

I think if you are in the right situation, it's a great idea, though.

-W

Why was AIRBNB a bad idea? And good job, seems like the project paid off! How did you divide your basement?
« Last Edit: July 27, 2018, 08:43:00 PM by YoungStache »

waltworks

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We are approaching peak AirBnB, IMO, where *everyone* thinks short term rentals are going to make them rich. The demand (in our resort town) is now well below the supply, so prices are cheap. We have a shortage of long term housing, though, so it's literally more profitable (if you include all your expenses) to rent our place long term, even if you assign zero value to your cleaning/hosting labor.

-W

YoungStache

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We are approaching peak AirBnB, IMO, where *everyone* thinks short term rentals are going to make them rich. The demand (in our resort town) is now well below the supply, so prices are cheap. We have a shortage of long term housing, though, so it's literally more profitable (if you include all your expenses) to rent our place long term, even if you assign zero value to your cleaning/hosting labor.

-W

Interesting, I didn't think about that consolidation and supply and demand.  I have heard people quote that AirBnB generates 50% more revenue than long-term rental. I guess it's good that vacations are much more affordable though. What area are you in?

Dicey

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Check out Paula Pant's series where she chronicles her experience running one of her rental units as an Airbnb over at "Afford Anything".

waltworks

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Interesting, I didn't think about that consolidation and supply and demand.  I have heard people quote that AirBnB generates 50% more revenue than long-term rental. I guess it's good that vacations are much more affordable though. What area are you in?

Sure, lots of people say they win at video poker at the casino, too. And they do, if you don't count those 5 times they lost for every time they came out ahead...

What I mean is that while in some cases doing short term makes sense, there are a lot of people out there who have no idea how to run a business who aren't accounting for any of their costs and paying themselves zero to manage/clean who are looking at the gross income number and saying "man, we're killing it!"

That assumes they even track the income properly, of course. I've met people who think that if they can get $100 a night part of the year, that they're going to make $36,500 a year and just will tell you that's what they make.

So even setting aside the oversupply, the buddies you talk to who say they're making a fortune (or the bloggers who want you to click on ads on their sites or use their VRBO referral codes) are mostly full of shit, in my experience.

There are situations where nightly rentals (if you live *right by* a major attraction where people can walk out the door to the concert/ski slope/whatever) make a ton of sense. If you live in a normal residential area, it's IMO probably not going to be more money than long term, and it'll be a ton of unpaid work, to boot.

YMMV. I tried it, I did several hundred hours of work that I didn't need to, I'll never do that again. Long term is easy.

-W

MoseyingAlong

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Also, can the home improvement costs be used to deduct regular income from short/long term capital gains?

Hi,

First and foremost, do you and/or your dad have a burning desire to be a landlord or just feel like you're missing an opportunity/easy money?
As a former landlord in California, I don't plan to do it again. There's a lot of risk. Personally I'd rather work a few hours or shifts at my day job for the same expected income.

Second, please listen to Waltworks and Dicey and research the CA and SF codes and rules. You might start by reviewing the Nolo press products for California landlords. They are generally easy to read and cover a lot of information.

After all that, if you still want to evaluate this project, let's talk about the tax treatment.
Generally, improvements to a property are capitalized, i.e. added to the basis (cost) of the property and depreciated over their expected life. The IRS has tables of what they expect for depreciation time for various things. The IRS website and instructions for Schedule E for rental property will get you in the ballpark. Note that these are reported on Schedule E for your tax return, not Schedule D for capital gains, so your question doesn't have a direct answer.

If there is a tax loss on the rental business, even if it's cash flow positive, that loss might offset some regular income. (Unless your income is over the IRS limit, then the loss is "suspended" and you'll use it later, maybe when you sell the property.)

In summary, as you evaluate this opportunity, I recommend
1. Read some of the Nolo press offerings on California landlording
2. Call and talk to the SF planning/permit department about what permits are needed and what their process is
3. Look at the IRS website and instructions for Schedule E and pencil one out with your projections and your particular tax situation and
4. Really think about whether you want to deal with tenants.

My 2 cents. Hope they help.




YoungStache

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Also, can the home improvement costs be used to deduct regular income from short/long term capital gains?

Hi,

First and foremost, do you and/or your dad have a burning desire to be a landlord or just feel like you're missing an opportunity/easy money?
As a former landlord in California, I don't plan to do it again. There's a lot of risk. Personally I'd rather work a few hours or shifts at my day job for the same expected income.

Second, please listen to Waltworks and Dicey and research the CA and SF codes and rules. You might start by reviewing the Nolo press products for California landlords. They are generally easy to read and cover a lot of information.

After all that, if you still want to evaluate this project, let's talk about the tax treatment.
Generally, improvements to a property are capitalized, i.e. added to the basis (cost) of the property and depreciated over their expected life. The IRS has tables of what they expect for depreciation time for various things. The IRS website and instructions for Schedule E for rental property will get you in the ballpark. Note that these are reported on Schedule E for your tax return, not Schedule D for capital gains, so your question doesn't have a direct answer.

If there is a tax loss on the rental business, even if it's cash flow positive, that loss might offset some regular income. (Unless your income is over the IRS limit, then the loss is "suspended" and you'll use it later, maybe when you sell the property.)

In summary, as you evaluate this opportunity, I recommend
1. Read some of the Nolo press offerings on California landlording
2. Call and talk to the SF planning/permit department about what permits are needed and what their process is
3. Look at the IRS website and instructions for Schedule E and pencil one out with your projections and your particular tax situation and
4. Really think about whether you want to deal with tenants.

My 2 cents. Hope they help.

Thanks for the detailed recommendations. I will definitely look into them.

The situation is more one of investment/generating more income. Neither of us particularly want to be landlords and I don't even live in San Francisco. We did rent out the basement (unmodified) for about a year to my college roommate's brother in 2009 for 650 a month on a casual basis. The basement has a bathroom and bedroom, but no kitchen or kitchenette.

The risks of renting in California seem to be a recurrent thing. What were some of your risks or negative scenarios you encountered?

clarkfan1979

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Re: San Francisco - basement conversion for rental. High risk high reward?
« Reply #14 on: August 04, 2018, 10:22:48 AM »
If you do a kitchenette (microwave, toaster oven) you don't need to pull a permit or ask for permission. You write up the lease as a roommate. If you want to build a full kitchen or add a separate entrance, then you need to go to the city and county website for rules and regulations. The rules are also going to be different depending on what zone the house is located in.

For airbnb.com, if it doesn't work you can always go back to long term renting. People who do airbnb.com typically make a little extra money but find out it's not worth the extra work.

I have a friend that has two single family homes in Boulder, CO. They were long-term rentals for about 10 years. He switched them to airbnb.com about 3 years ago and it's been totally worth it for him. Once it's no longer worth it he can always go back to long term tenants.

YoungStache

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Re: San Francisco - basement conversion for rental. High risk high reward?
« Reply #15 on: August 04, 2018, 04:38:18 PM »
If you do a kitchenette (microwave, toaster oven) you don't need to pull a permit or ask for permission. You write up the lease as a roommate. If you want to build a full kitchen or add a separate entrance, then you need to go to the city and county website for rules and regulations. The rules are also going to be different depending on what zone the house is located in.

For airbnb.com, if it doesn't work you can always go back to long term renting. People who do airbnb.com typically make a little extra money but find out it's not worth the extra work.

I have a friend that has two single family homes in Boulder, CO. They were long-term rentals for about 10 years. He switched them to airbnb.com about 3 years ago and it's been totally worth it for him. Once it's no longer worth it he can always go back to long term tenants.

Actually yeah, technically it doesn't need renovation. All the permits and consulting and rehab sound like a huge pain and risk, and also very time-intensive and costly. It already has a side door that leads to the basement and main floor, but there's a door that closes off the main house and the basement. It already has a bathroom and a bedroom. Main thing would be adding a kitchenette with running water, and providing a refrigerator, toaster oven, and electric burner stove. I actually live in a converted basement with a kitchenette and it works fine. For airbnb - probably not worth the extra time and effort anymore, and the "good days" are gone.

electriceagle

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Re: San Francisco - basement conversion for rental. High risk high reward?
« Reply #16 on: August 05, 2018, 06:44:38 AM »
What would be some of the main considerations? Other than the project cost and rental return.

The first thing you should ask yourself is whether the building was constructed after June of 1979. The second is whether prop 10 passes. The third is whether the legislature & new governor change Costa-Hawkins even if Prop 10 fails.

If you don't know why you should care about these things, you shouldn't even think about offering housing in SF.

YoungStache

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Re: San Francisco - basement conversion for rental. High risk high reward?
« Reply #17 on: August 05, 2018, 01:51:58 PM »
What would be some of the main considerations? Other than the project cost and rental return.

The first thing you should ask yourself is whether the building was constructed after June of 1979. The second is whether prop 10 passes. The third is whether the legislature & new governor change Costa-Hawkins even if Prop 10 fails.

If you don't know why you should care about these things, you shouldn't even think about offering housing in SF.

The house was built before 1979, so regardless of Prop 10, it wouldn't be subject to rent control, right?

electriceagle

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Re: San Francisco - basement conversion for rental. High risk high reward?
« Reply #18 on: August 06, 2018, 08:04:26 PM »
What would be some of the main considerations? Other than the project cost and rental return.

The first thing you should ask yourself is whether the building was constructed after June of 1979. The second is whether prop 10 passes. The third is whether the legislature & new governor change Costa-Hawkins even if Prop 10 fails.

If you don't know why you should care about these things, you shouldn't even think about offering housing in SF.

The house was built before 1979, so regardless of Prop 10, it wouldn't be subject to rent control, right?

You're not prepared for this in the slightest. I don't mean to be harsh, but either spend 4 hours ($2000) with an SF landlord/tenant lawyer who can explain SF rental regulations to you or put this idea aside.

Not spending the $2000 can easily cost you 50x later.

Dicey

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Re: San Francisco - basement conversion for rental. High risk high reward?
« Reply #19 on: August 07, 2018, 10:02:45 AM »
What would be some of the main considerations? Other than the project cost and rental return.

The first thing you should ask yourself is whether the building was constructed after June of 1979. The second is whether prop 10 passes. The third is whether the legislature & new governor change Costa-Hawkins even if Prop 10 fails.

If you don't know why you should care about these things, you shouldn't even think about offering housing in SF.

The house was built before 1979, so regardless of Prop 10, it wouldn't be subject to rent control, right?

You're not prepared for this in the slightest. I don't mean to be harsh, but either spend 4 hours ($2000) with an SF landlord/tenant lawyer who can explain SF rental regulations to you or put this idea aside.

Not spending the $2000 can easily cost you 50x later.
^^This^^