Real Estate

Real estate: a way to diversify

Income drives investment in multi-residential properties

by Kimberlee D'Ardenne

The stock market is volatile, interest rates are negligible and the economic future is uncertain. So, what is a good investment today?

In a supply-constrained market like Palo Alto and Menlo Park where there are limited amounts of land available for development, real estate can be a good investment. Investment properties purchased by individuals typically are multi-residential properties. Such properties range in size from a duplex all the way up to small apartment buildings.

Keri Nicholas, who has worked in real estate on the Peninsula for 23 years, said the majority of the multi-residential buyers she deals with pursue the properties as a way to diversify their investment portfolio.

"(Multi-residential properties) are a tangible asset that brings in income," Nicholas said, "and work well as a retirement vehicle because you know long term that you will have monthly rent."

With the current rents in the Bay Area and the positive economic outlook in Silicon Valley, multi-residential properties are an investment capable of a healthy income stream, Nicholas added.

"Most buyers are savvy investors, and they want these properties to hold on to," she said. "Some buy them for their kids, and they see it as a vehicle for not having their kids' rent be too high while also having an asset."

In Palo Alto and Menlo Park, multi-residential properties are generally located in proximity to business areas, train stations and bus depots.

"There are clusters of multi-residential properties (in Palo Alto)," said Kathleen Pasin, who has worked in Palo Alto real estate for 12 years. "Some are in Midtown, a number near College Terrace with a lot of renters from Stanford, and then there are a lot downtown."

Most multi-residential properties are usually older structures; building a new one is possible only on specifically zoned lots, Nicholas said. Some multi-residential structures in Palo Alto and Menlo Park date to the early 1900s.

"Downtown North (in Palo Alto) has a lot of Craftsman-style bungalows that may look like a single-family house on the outside but are actually multi-residential dwellings," Pasin said.

The market for multi-residential properties is similar to other real-estate markets in the Bay Area. Though multi-residential properties make up a small part of the real-estate market, in the past three years the multi-residential market has seen growth similar to the single-family home market, Nicholas said.

"It is very tight," she added.

Pasin also said the Palo Alto market is very competitive.

"For both income properties as well as single-family properties, inventory is extremely low," Pasin said, "but there is big demand for both."

Like single-family home and commercial property sales in Palo Alto and Menlo Park, multi-residential sales involve multiple offers almost always over the asking price. The recent sale of 360 Hawthorne Ave. in Palo Alto yielded eight offers, sold in cash for a million dollars over the asking price and closed in just four days, Pasin said.

Cash purchases for multi-residential sales are common, but not just because of the competitive market. Many buyers are investors looking to purchase property via a 1031 exchange under federal tax law. Such exchanges allow investors to defer taxes incurred from the sale of a property by buying a similar property within a timeframe specified by state and federal governments.

"1031 exchanges are tax deferring for investors to move up or diversify their investments," Pasin said, "and most exchanges are local."

Nicholas said sometimes groups of people buy multi-residential properties together, for investment purposes but also as a creative way to afford more home in the current market.

Though cash purchases are common, Pasin said whether a property sells depends on the terms and price of the offer. Some buyers who can afford cash purchases often opt to take loans because of favorable interest rates, Pasin added.

Selling a multi-residential property presents different challenges than selling a single-family home.

"Usually for a single-family home, there is more time to prepare (the) property for sale," Pasin said. "If the income property is tenant-occupied, you (might not) have the opportunity to (prepare) it before the property comes on the market. Often it's difficult to show the insides of units of multi-residential properties because they are tenant-occupied."

When a tenant-occupied property sells, any ongoing leases transfer to the new owner, Nicholas said.

"Before sale, usually the term of the lease is up or made month-to-month," Nicholas said.

If leases are not month-to-month, they are kept until the term expires, Nicholas added, at which point rents can be adjusted.

While some buyers do redevelop multi-residential properties, others keep them as is and instead bring the rents to current market value, Pasin said.

Motivation to purchase a multi-residential property varies. Roughly 70 percent of buyers Nicholas has worked with use the property only as an investment while the remaining buyers reside in the property, she said.

Freelance writer Kim D'Ardenne can be emailed at dardenne.kim@gmail.com.

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