On Sunday my friend Charles and I did a rapid-fire tour of 3 properties in the Pacific Heights / Presidio Heights neighborhoods. I’m going to write about 2980 California Street, because it was the main event of the afternoon. 2980 California Street is a 3,000 square foot Victorian on California Street, listed at $2,499,000, and it’s in BAD shape.
On the one hand single family homes in this neighborhood don’t come up that often and when they do, they’re much more expensive than this. On the other hand this is a serious project. It’s not a home that you could move into and make some small improvements as you go. You would start by ripping out everything – the whole kitchen, every bathroom, every counter, cabinet, carpet, probably all the windows, and then you would need to start knocking down walls and reshaping both the main floor and the upstairs. Given that the home is being sold through an estate sale and the owner had not been residing in the property for a while, there’s a good chance a lot of other things need work too – maybe the foundation, roof, sewer and water lines, etc.
Okay, let’s take a look: (all listing photos here)
What’s the right price given all the work, risk, and uninhabitable time?
My guess is that an investor is going to buy this home – someone who has the expertise to bring it up to move in ready condition and then sell it at its retail price. This process is sometimes called flipping and there is a vibrant community of people around the country who look for these projects – the diamond in the rough that needs $30k of kitchen remodel work to add $60k of resale value. There’s an art to knowing what the home can sell for in its fully finished state and to managing the execution of the project so that it is on time and budget.
The economics for a flipper are roughly – what can I get the home for, how much work do I have to put into it, and what can I sell it for afterwards net of fees. You also have to factor in carrying cost – things like home insurance, property tax, and the cost of short term debt financing.
My guess is that the after repair value (ARV) for this home is around $4m, working up from $1,300 per square foot. A home on a different block in Pacific Heights could command more, but I’m not sure that California Street, with no real yard or view is going to get you there. And as an investor you should be a little conservative on the ARV anyway.
I don’t have the experience to estimate the cost of doing a full remodel, but there are some sites – BiggerPockets is one of them – that are great resources for people who are getting into this industry. A forum post from a few years ago touched on the ballpark gut remodel price tag for San Francisco and the general consensus from that thread was around $250 / square foot. At 3,000 square feet that’s $750,000 to gut remodel this home. A few people at the open home on Sunday guessed closer to $1m or more – so $750,000 is probably a low estimate.
The main source of the carry cost on this project is going to be the debt service on an interest only loan. Assuming the $2.5m asking price is in the ballpark where the math works out, you need $3.25m to do this project ($2.5m + $750k). Some firms will lend up to 90% of the total cost, but let’s use 80% to be more conservative. 80% of $3.25m is $2.65m. If you manage to get a loan at 10% with 1 origination point (and estimate the project will take a year) you’ll be paying $26,500 (1 origination point = 1 percent of the loan amount, paid up front) and $265,000 in interest. You’ll also pay one year of property tax at ~1%, for another $25,000. We’ll ignore some of the smaller line items but that’s $316,000.
When you list the home, even if you list it yourself, you will probably be paying a 2% buyers commission against the target $4m sale price, or another $80,000. Add this to your carrying cost and you’re looking at ~$400,000 in non-project costs.
$2.5m + $750k + $400k = $3.65m. Against a target $4m sale, this is probably not a margin on a complex, high risk, year long project that is going to get a lot of investors out of bed. Especially since the project estimate might be low and you might think the worst case sale price is closer to $3.5m.
As such, I think this home needs a couple hundred thousand dollar haircut to find a buyer and I estimate a final sale price of $2,100,000.
As always let’s see what happens! If you have a different estimate on the after repair value (i.e. what a fantastic version of this home sells for in a year) – please drop it in the comments. Is $4m low or high? Also for those of you who know more about home flipping economics, please let me know where I might have gotten the back of the envelope math wrong.
Final amusing note – Redfin estimates the sale price at $2,744,668 which is both very precise and very high. This home highlights one (understandable) limitation of their model and it makes me continue to feel strongly that you could build a better estimator by being able to augment the formula with a few human inputs.