What are these crazy California buyers thinking…and where can I find one for my property?
Shannon Waltchack recently joined TCN Worldwide. TCN is the seventh largest commercial brokerage group in the US and provides a network of CRE offices servicing 200+ markets. We now have the ability to assist our clients’ needs literally across the world.
TCN’s annual convention was held in San Francisco last month. Part of the itinerary was a commercial real estate bus tour through the city, narrated by Starboard Commercial, our sister firm in San Fran. The theme of the tour was “The Valley Come to Town.” Silicon Valley has invaded San Francisco with a bang, both in terms of techies wanting to live in the city and tech firms taking office buildings. A big reason for this migration is the millennial worker’s desire to live in an urban, walkable city. (This is happening all across the US.)
This recent migration of people and jobs has caused San Francisco’s rents to double and triple in less than five years time. Making it even harder on middle class residents, strict rent controls on apartment buildings built before 1979 have forced rents five and six times higher on newer, non-rent-controlled units. Talk about unintended consequences.
Witnessing the action in this city of rapidly appreciating values was endlessly fascinating and made for much stimulating conversation among our six attendees. For me, it finally clicked as to why these Californians are paying such outrageous prices in our market.
To understand the California buyer better, let’s pretend you are the owner of a duplex located at 5442 Tehama Street in San Francisco. You’ve owned the property for 17 years and have a basis of $475,000. Coming out of the recession it was worth $1.7 million in 2009. This year, brokers have been calling non-stop to tell you that they think your duplex is worth north of $3 million. You cry uncle because your wife is threatening to leave if you don’t ‘take the money’. Within 48 hours you get multiple offers and end up selling at $3.2 million. Now what?
Given your basis, you owe $545,000 in capital gains to the Feds and $335,175 to the state, congratulations! But if you exchange into a replacement property, you can delay paying $880,175 in taxes and enjoy a return on those very dollars.
So you look around and decide you want mailbox money, and therefore want a NNN property with a long-term lease. Your broker finds a Wendy’s down the road in Salinas, but it’s trading at a 4 CAP. You’ll only get a 4% cash-on-cash return on your $3.2 M. Wanting more yield, you look around at other markets and find a Wendy’s in Atlanta at a 5 CAP and one in Birmingham for 5.5. You settle on Atlanta, given your comfort level with the size of the city. That exchange property will now produce $160,000 in cash flow each year.
Had you sold the apartment complex in 2009, that same Wendy’s was trading closer to an 7 cap and while it had a better yield, it would have provided $119,000 annual cash flow on your $1,700,000. So the owner is better off today, due to the radical appreciation experienced in San Francisco, despite the reduction in cap rates.
To Birmingham eyes, current cap rates seem absurd, but to someone paying with tax-deferred “California house money,” it makes a ton of sense. And if you are fortunate enough to own one of these NNN assets, you can import property appreciation from 2,000 miles away. Not bad.
All this to say, if you own a NNN property, now would be a great time to consider selling. Shannon Waltchack can certainly assist you, and now that we have six sister offices in California, we can bring those West Coast buyers.
Local market is heating up.
In the past six months we’ve noticed a marked increase in competition for local assets. A couple weeks ago, we were pursuing a fairly vanilla, multi-tenant property in a stable area. Last year, that property might have received two or three offers at 75-85% of asking price. Much to our surprise, this asset received five offers within a week, two at asking price and the other three 90-95% of asking.
We’ve also noticed lenders beating our doors down for business and offering aggressive terms. One local lender proposed 3.5% fixed for five years or 4.5% fixed for ten for a retail redevelopment. Amazing.
We are clearly entering the upswing portion of the real estate cycle—somewhere between optimism and excitement. Time to be careful and choosy.
All the best for a great fall and holiday season,