Investment Real Estate 101 in the SF Bay Area: Building Wealth through Multifamily Properties
Nearly 10 years ago when I first entered into the real estate industry, I was assigned a small portfolio of properties to manage. I handled everything from maintenance requests, tenant screening, turnover renovations to monthly financial statements. I can’t think of a time in my career more impactful than those early years. Professional property management was a crash course on home ownership and allowed me to see, first hand, the benefits of owning investment properties in the Bay Area.
We recently received a few calls from clients interested in purchasing investment properties. The asset commonly discussed is residential multifamily (2-4 unit buildings) and in this blog we discuss the advantages of investing in real estate outside your primary residence. In addition, we will discuss some of the challenges associated with managing rentals and how to be best prepared to optimize this investment.
The Benefits of Multifamily Investments
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Passive Income Stream
Owning a multifamily property allows you to collect rental income which is often used to cover the mortgage and other property related expenses. In the Bay Area, where rental demand remains high, in time, this can be a significant source of passive income. -
Tax Advantages
Investment properties come with numerous tax benefits, including deductions for mortgage interest, property taxes, property management fees, maintenance, and depreciation. These can reduce your taxable income and increase your net returns. -
Leveraging Equity
As you pay down your mortgage, you build equity in your property. Over time, this equity can be leveraged to purchase additional investments or fund other financial goals. -
Hedge Against Inflation
Real estate generally appreciates over time, and rental income tends to rise with inflation. This makes property ownership a reliable hedge against the eroding power of inflation on your wealth. -
Portfolio Diversification
In the SF Bay Area many residents receive significant stock packages and actively invest in the securities exchange. Real estate investments offer stability and diversification to balance other financial assets like stocks, reducing overall portfolio risk.
There are also more sophisticated tools that become accessible to you through owning investment properties. For example, there are ways to accelerate depreciation on specific components through a cost segregation study. This study identifies assets like appliances, HVAC systems, and interior improvements that can be depreciated over shorter periods (5, 7, or 15 years). Additionally, certain interior improvements may qualify for bonus depreciation, allowing for a 100% deduction in the year they're placed in service. By using these strategies, you can reduce your taxable income in the short term to increase cash flow.
Why the Bay Area?
There is very high rental demand in the Bay Area as only 57% of the population is a homeowner, less than the national average. With a thriving job market and limited housing supply, duplexes and other multifamily assets in the Bay Area are highly sought after by renters. This ensures a steady income stream and low vacancy rates. During the first quarter of 2024, the average vacancy rate for multifamily properties in San Jose was approximately 5.0%.
Although the primary focus on your investment search may be cash flow through rental income, the Bay Area real estate market is known for outsized gains in the form of property appreciation. The chart below outlines how duplexes have fared against single family homes in Santa Clara County over the last 10 years.
|
Primary Year |
Single Family Median Sale Price |
(%) Appreciation YoY |
Multifamily 1-4 Median Sale Price |
(%) Appreciation YoY |
|
2014 |
$850,000.00 |
$778,000.00 |
||
|
2015 |
$950,000.00 |
11.26% |
$917,500.00 |
13.27% |
|
2016 |
$1,011,000.00 |
6.45% |
$994,250.00 |
5.50% |
|
2017 |
$1,168,590.00 |
11.94% |
$1,175,000.00 |
22.11% |
|
2018 |
$1,325,000.00 |
17.69% |
$1,340,000.00 |
7.76% |
|
2019 |
$1,250,000.00 |
-6.15% |
$1,297,500.00 |
0.80% |
|
2020 |
$1,370,000.00 |
10.91% |
$1,350,000.00 |
7.64% |
|
2021 |
$1,615,000.00 |
16.09% |
$1,390,000.00 |
3.07% |
|
2022 |
$1,750,000.00 |
9.54% |
$1,410,000.00 |
2.29% |
|
2023 |
$1,737,500.00 |
-1.94% |
$1,357,500.00 |
-5.59% |
|
2024 |
$1,900,000.00 |
9.21% |
$1,550,000.00 |
11.74% |
In summary, duplexes have historically kept pace with single family home appreciation. However, it is important to point out that during the pandemic (2021-2022) we saw a noticeable migration from the cities to the suburbs. This increase in demand significantly impacted single family home values.
Duplex 10 Year Annualized Return 6.8% YoY
Single Family 10-Year Annualized Return 8.5% YoY
Key Considerations for First-Time Duplex Investors
Although the purchase contract and escrow process may look very similar to that of a personal residence or single family home, there are a few things one should be aware of when working with an agent to purchase a multifamily property.
-
Understand Local Market Trends
The Bay Area housing market can vary significantly by city and neighborhood. Research rental rates, property appreciation trends, schools and local amenities to identify the most promising locations. The most prestigious neighborhoods aren’t guaranteed the best returns.
-
Evaluate the Numbers
Conduct a thorough financial analysis, including potential rental income, expenses (taxes, insurance, maintenance), and financing costs. Tools like a financial calculator or underwriting model can help put together a pro forma that predicts cash flow, ROI, and the cap rate. -
Navigate Complex Tenant Laws
California has some of the most tenant-friendly laws in the country. Understanding local and state rent control ordinances and eviction policies is crucial to managing your duplex effectively. This is very important as multifamily assets have different tenant protections than single family. The laws also vary city to city as local rent control measures supersede state legislation. -
Secure the Right Financing
Explore financing options such as Debt-Service Coverage Ratio (DSCR) Loans, where the lender evaluates the property's potential rental income relative to the borrower's total debt obligations. In some cases where the property is vacant, lenders may use rental income projections from the subject property (e.g., future market-rate rents) to qualify borrowers. Typically, lenders will require an appraisal report with a rental income analysis to estimate market rents.
Maximizing Your Investment After Closing
Investing in a duplex is just the beginning of a journey to maximize returns. To truly capitalize on your property, consider hiring a professional property manager if you prefer a hands-off approach. They can handle tenant screening, rent collection, routine maintenance, and even manage evictions, though hopefully, that won’t be necessary. Regular property improvements are key to boosting rental income and attracting high-quality tenants. Updates such as adding in-unit washers and dryers, modernizing plumbing and electrical fixtures, and replacing old carpet with affordable yet stylish hard surface flooring like luxury vinyl planks (LVP) can make a significant impact. Additionally, once your duplex has built sufficient equity, it can be leveraged as collateral for future investment opportunities, helping you expand your portfolio.
What If This Will Also Be My Primary Property?
Many reading this, may not have a primary residence. First-time investors should also consider a duplex as their first purchase. By living in one unit and renting out the other, you reduce your living expenses while building equity and benefit from property appreciation. This strategy, often coined "house hacking." It can also be done by renting out separate rooms.
When financing the purchase of a duplex as your primary residence you are also able to tap into conventional financing with lower down payments, better interest rates, and easier loan approval. Some lenders will use the rent from the second unit to help you qualify for the loan amount.
Final Thoughts
Investing in a duplex in the SF Bay Area is a great way to build wealth, generate passive income, and diversify your portfolio. Whether you're looking to house-hack your way to financial freedom or start your journey towards a real estate empire, the opportunities in this market are abundant if you know where to look and how to assess returns.
Ready to take the first step? Let’s explore the benefits of a duplex investment for you.
