San Francisco Multifamily Pricing Trends
Duplexes, 3-4 Units, and 5+ Unit Apartment Buildings
One discrepancy that I find highly interesting but might not be apparent to some is the difference in pricing between duplexes, 3-4 unit buildings, and 5+ unit apartment buildings in San Francisco, CA.
Why does pricing vary so dramatically between these product types?
Below is a chart that shows the average price per square foot by year across the city for the various apartment building types so you can see for yourself how the pricing discrepancy truly plays out in practice.
When reviewing the chart one of the first things that jumps off the page is my original premise - that 2-4 unit buildings sell at a premium on a PPSF basis to 5+ unit buildings (~$200/sf). Additionally, duplexes sell at the highest price per SF followed by 3-4 unit buildings with a large drop in value to 5+ unit buildings.
Why is that the case?
Duplexes
Let’s start with duplexes. Across the country the concept of house hacking has become very popular and the idea of targeting a property on the cheaper end of the spectrum in terms of down payment requirement is a logical place to start. Duplexes allow you to still have similar housing costs as a single family home but with the prospect of potentially adding a rent paying tenant into the mix to help offset your housing costs and to help pay down the principal on your loan. One thing that duplexes really benefit from is the prevalence of owner occupier loan options.
Owner occupier loan options typically are available on 1-4 unit properties. Lender’s refer to 1-4 unit properties as “residential properties”. Owner occupier loans typically have no prepayment penalties, more flexible term options (including longer fixed terms and longer interest only periods), and in terms of interest rates are among the cheapest loans available across any investment type regardless of asset class.
To qualify for an owner occupier loan typically the lender will confirm that at least a 33% investor in the property will be living onsite (varies by lender) then the lender will look at your personal financial situation as the buyer to make sure they qualify. In this case rental income from the duplex will help boost overall income and then the lender will put a variety of restrictions on the loan amount they are willing to dole out.
The first is Loan-to-Value (LTV)
It’s highly uncommon to see a lender lend over 80% of the purchase price (or appraised value) of the property.
The second is Debt-to-Income Ratio
In my experience lenders typically are uncomfortable lending beyond a 40-43% debt-to-income ratio. So on an owner occupier loan the lender will typically offer you the lesser of 80% loan to value or loan payments of up to 40-43% the borrower’s debt to income ratio.
In San Francisco, given the price of condominiums and entry level homes in general have gotten so high the prospect of buying a duplex, converting them to condominiums, and selling them off individually has at times been extremely popular historically. Because of the profitability of that endeavor, the city of S.F. introduced a condo conversion moratorium eliminating converting rental property to condominiums citywide unless a few criteria are met. One of those criteria is if you have a duplex with two owners living in separate units onsite. These buildings still have the ability to be fast tracked for condo conversions, but condo conversions on larger buildings are pretty much banned city wide.
Triplexes and Fourplexes
On 3-4 unit buildings you can still obtain owner occupier (“residential loans”) here, but the idea of selling off the units individually to homeowners through a condo conversion process is extremely unlikely.
5+ Unit Buildings
5+ unit apartment buildings require “commercial” loans or investment loans whose terms are typically shorter in duration, at higher rates, with prepayment penalties layered in.
Prepayment penalties introduce loan fees for not holding the loan to its maturity date or for harming the lender’s consistent stream of loan payments they were expecting. Be careful with these loan terms, coming from the residential side there are some buzzwords in here that might cause confusion such as defeasance, yield maintenance, declining points, etc. You can still owner occupy these buildings but the loan offerings do not mirror what you could get on a single family home or a “residential” property (2-4 units). So because of this nuance on the debt side the buying pool is largely limited to investors and values are adjusted downward accordingly.
In the residential space (2-4 units), property values have almost nothing to do with the rents the tenants are paying and property level cash flow. When you get to the 5+ unit arena, property cash flow is the largest driver of value. Because this is a largely levered asset class these 5+ unit buildings are the most susceptible to value swings based on what interest rates are doing.
One interesting investment decision that may come up is what do you do if you have a 4 unit building, but you have the space to build an ADU or add another residential unit.
Should you do it?
I personally have run into this dilemma on one of my investments.
The answer is do your own math but given 5+ unit buildings sell at ~$200/sf discounts on average relative to their smaller brethren the return on your invested dollars maybe negligible, in fact doing this work could hurt your value. An alternative plan could be adding square footage to an existing unit in your fourplex by optimizing under utilized spaces without increasing the unit count at the property.
If you can build it for less than you can sell it for on a per square foot basis and you determine it to provide a good return on capital invested then that could be a way to take advantage of underutilized space without fighting the value erosion headwinds that building a fifth unit presents.
Hope that helps. If you are going through a similar decision or if you would like to invest in larger buildings, but don’t know where to start, feel free to reach out via our contact us link and we can discuss some of Echo Valley’s investment offering options as well as best practices before taking that jump.