Introduction
As we all know, there has been a lot of buzz about One Rincon and The Infinity – both two-tower high-rise developments. I must admit to contributing to that buzz. Lately, I have been thinking about these large projects within the context of the south of Market landscape and within the confines of the San Francisco residential market as a whole.

I have a few thoughts and issues I would like to share with you.

Think About the Exit
Condominium buyers (as opposed to single-home buyers) come in a number of varieties: owner/occupiers, investors or buyers who wish to use the property as a pied a terre. While each has his/her special reasons for buying, the idea of selling typically doesn’t enter their conscious thinking – at least at the time of purchase – other than the taken-for-granted expectation that the property will be sold sometime in the future at an appreciated price.

However, the bigger the building, the bigger the potential issues in reaching this profit goal. Another way to put this is: the larger the building, the less control buyers have over the ultimate selling outcome. This is not a reason to avoid purchasing in a large building, but I do lobby for people to consciously explore and understand a number of issues before making the decision to purchase. One of the factors you can control is being an educated consumer and thereby minimizing unintended surprises/consequences.

The “What’s Going to Happen?” Issue
I have a client from the East Bay who is looking for a pied a terre in the city. He and his wife would like a downtown condo in a safe area and close to BART. Views are not important to them. Fitting the bill: 199 New Montgomery. In preparation for a Sunday tour, I did a little research and found that there six units were currently listed. I thought this was beneficial news, since it would give my client a chance to get a feel for the building as well as provide an opportunity to compare several layouts and outlooks.

As a well-informed broker, I know there are always factors that I don’t even know I don’t know! I know that I always need to be ready to learn, regardless of my experience. When I spoke with one of the listing agents, I learned something unexpected that was not written anywhere: The developer still owned 17 units, which would be fed into the market as their leases expired and market conditions allowed. I had thought the building was sold out, and I guess you could say it was. In a more practical sense, however, it is not. According to my records, all the initial sales closed during Q1 and Q2 of 2005 – more than a year ago.

Coincidentally, two days before my tour I talked with a friend who bought a unit at 199 New Montgomery and moved into a different building a few months ago. The previous time we talked, she told me that she had placed her unit at 199 New Montgomery on the market to sell. When I spoke to her again last week, she said in a frustrated tone, “There are always six units on the market, and I got frustrated trying to sell, so I have just decided to rent it out.” When I asked whether she knew of the 17 developer units, her answer was, “Wow, I didn’t know.”

One of the issues that came up during our visit was the possibility that a new building could rise on the eastern side of 199 New Montgomery above the existing six-story building, and thus obscure some of the existing views of the Bay Bridge. This speaks to the issue of air rights, which I noted in Pulse of the Market titled “Lessons from New York”. More to the point, the existing crane at The Infinity at 300 Spear is clearly visible to the east, and it is a certainty that the Infinity towers, when completed, will obliterate existing views of at least one of the Bay Bridge’s towers. Did the buyers of units on the eastern side of 199 New Montgomery know about The Infinity prior to their purchase? This is an issue for many units in the burgeoning south of Market neighborhoods.

The Competition Issue
Here’s a brief look at the number of available units in four of the large buildings that have been completed in just the last few years in the south of Market neighborhood.   

If I am a seller in one of these buildings, I would be a bit nervous about the competition from my neighbors, not to mention from unsold units at Watermark (501 Beale), The Lansing (50 Lansing), the new 170 Off Third. as well as The Infinity and One Rincon.

As an owner in a large building, I am not able to control my destiny to the degree that I can in a two- to six-unit building. For example, If I own unit 401 in one of the above buildings and want to sell it for $800,000, I’m vulnerable to the owner of 501 selling his/her unit at the same time, for say $775,000. Also, If I want to rent my unit for $2,500 per month, I’m vulnerable to my neighbor being willing to accept $2,300 for essentially the same space.

Now, let’s say that I live in a six-unit building and want to sell. The odds are much lower that there will be another unit in my building available at the same time. I would probably know my neighbor and we could “adjust” our timing in the marketplace so that we are not competing.

From a marketing point of view, if I were the listing agent, I could make the case that my client’s unit is so much better than the other units that have previously sold in the building, notwithstanding the price. But even though I might be inventive and creative, I wouldn’t be able do this as easily in a large, recently built building where the units in the same stack are pretty much the same in layout and condition, not to mention the fact that there would be many more units from which I would need to distinguish myself.

Before my clients actually make an offer, in any situation, I spend quite a bit of time learning about their motivations and finding out about how long they plan to live in the property. No one can really time the market, but if they are planning to sell in 24 months, then I counsel them to rent instead of buy, unless we were able to negotiate a unique deal that might mitigate the circumstances.

I also tell them that should they really need to sell in 12-18 months, rather than the minimum 3+ years that they had planned, I am confident that I will be able to get them out with a whole skin, meaning that after commission, closings costs and transfer tax, they will recoup their investment. I feel much less confident in making that statement to clients with regard to the large buildings south of Market. I have less control and flexibility, as noted above.

The Competitive Landscape Issue
The buildings built in the 2000 to 2005 period are subject to more competitive pressures from the new and glitzy girls on the block; One Rincon, The Infinity, and their sisters yet on the drawing boards. If I am an owner at 199 New Montgomery, or The Brannan, or BridgeView, etc, I will have to compete with other sellers in my building, AND I will have to compete with the new girls on the block as well. This is already happening.

If I had bought at The Metropolitan, I should have made my decision with knowledge of the future competitive landscape and what it is likely to look like five or more years down the road. This information is widely available if you know where to look for it. And should I buy at One Rincon, The Infinity, or any of the upcoming developments on Fremont, Mission, Folsom, etc., it should be with an eye toward future competition as well.

This Pulse is not a knock on the large buildings south of Market. I very much like many of these developments, each having their unique plusses and minuses. Rather, it is a call for conscious evaluation of the unique issues that buyers will be facing at the time they wish to liquidate their investment. The competition is primarily on two fronts: within the building and within the neighborhood, not to mention among available units across the City.

Some Hidden Issues
Both One Rincon and The Infinity are now asking buyers to enter into contracts to purchase in anticipation of construction completion and occupancy that may not occur until Q4 2007 or sometime in early 2008. Buyers need to check whether their contract is assignable in the event that their circumstances change prior to closing. I have not reviewed all the documents, but it is highly likely that these contracts are not assignable, in which case a buyer would forfeit the 3-5% deposit should he or she opt out of the contract. This is real money – and the price you pay for changing your mind.

And then there are the issues of restrictions on your ability to sell after close of escrow. There may be written restrictions that preclude you from selling within the first year after closing. There also may be a clause that requires you to give the developer a “right of first refusal” until his entire development has been completed, i.e. both towers are sold out.

Here we are in mid-2006, and unit delivery and occupancy may not take place until Q4 2007 or even Q1 2008. Buyers may not be able to sell, independently of the developer, until 2009 or even 2011. Whoa!

Ritz-Carlton Update
The March 2006 issue of Pulse of the Market, “Ritz-Carlton Fractional Ownership”, previewed the planned marketing of 52 condominiums (called “private residences”) on the top 12 floors of the renovated, historical San Francisco Chronicle building at 690 Market St., and 1/12^th fractional interests (called “club residences”) in 49 units on the lower 11 floors.

So what happened? The 52 condominiums flew off the market, and some 80% went into contract in eight weeks, which is a testament to the Ritz-Carlton brand, limited supply and attractive product and pricing. (As a point of reference, the Four Seasons has 142 units and 4 years to sell, and the St. Regis has 102 units and 18 months to sell. The Ritz-Carlton is a much smaller building, and thus has fewer big-building issues, as discussed above.

The fractional interests are an interesting product, and one that I believe is little appreciated so far.

Last week I had a chat with a business associate who is based in Palo Alto. He mentioned that he wants a pied a terre in San Francisco that’s similar to what he has in New York: a condominium that he can use when he is visiting and can rent by the week when he is not there.

The problem in San Francisco is that most condominium CC&Rs restrict owners to a 6- to 12-month minimum tenant rental. There are a few buildings in San Francisco that allow an owner to rent for 30 days at a time, but very few.

Even a 30-day minimum does not satisfy my friend’s needs.

So why not buy one or two fractionals at the Ritz-Carlton for $250,000-500,000 and call it a day? These are not 300 sq. ft. hotel rooms but 1,300-3,000 sq. ft. one-, two- and three-bedroom condominiums with Ritz-Carlton amenities. Each fractional (deeded) interest allows for 21-day usage by the owner plus additional usage at an attractive per-diem rate, and includes a 30% discount at every Ritz-Carlton Hotel worldwide.

Savvy investors who live in the Bay Area and elsewhere in California have already embraced the concept with early purchases. I am a strong advocate of focusing on a buyer’s ability to match investment with usage.

For example, if a buyer plans to use a pied a terre in the City say for four days a month (for example, two weekends/month or 48 days in a year), why not buy two fractionals for $500,000 total, rather than a condominium, which is going to cost at least $1 million+ for anything nearly comparable? The interest and property taxes saved on not making an incremental $500,000+ investment in a condominium will go a long way toward covering the HOA dues of the fractional interest.

On the issue of selling, owners can enlist the Ritz-Carlton to re-sell a fractional interest at a 10% commission, or retain an independent agent at a lesser commission. If the owner uses an agent other than the Ritz-Carlton agent, however, then the new owner would only have Club privileges in San Francisco and forego privileges at Ritz-Carlton clubs and hotels worldwide. So that second buyer had better beware.

If you have a desire to learn more, let me know. I have decided to spend some time becoming an expert on this product. And as you can see, innovative opportunities demand more than average scrutiny.

Summing Up
People have chosen and continue to choose the south of Market neighborhoods because of the location and the specific attributes of the various buildings – whether it is the fact that it’s walking distance to the Financial District, BART, Union Square, restaurants or the Embarcadero; whether it offers physical fitness amenities, a concierge, views or other perks. These are good buildings with lots of plusses.

But despite these unique and valued attributes, many of the owners and would-be sellers of existing units are experiencing some disappointment at being unable to sell in the current market – not because of increased interest rates and other economic factors, but because of the competition from other units in their buildings, as well as from the new girls on the block. There is one unit at 88 King that has been on the market for 9 months and has had five price reductions so far, amounting to 16.5%! Talk about being sliced like a salami!

So the take-away for would-be buyers is to be aware of all the potential issues around selling in the future at the time you are thinking about buying. These are issues for all owner-occupiers and investors.

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