Gas

If you are doing a full demolition or need to relocate your meter, you will need to have PG&E do a gas cutoff.  A gas cutoff is where they go to the neighborhood gas main, and they cut off the main feed to your meter.  To do that, they usually must dig a 4 ft x 4 ft x 4 ft hole at the connection point to the neighborhood gas main to be able to get inside the hole and cut off your gas.  There’s no other way to do it and no valve on the line like you would have at your water meter.  If you are doing a new construction, they need to cut it off so that there’s no chance a piece of heavy equipment accidentally rips into the live gas line. If you need to relocate your meter, PG&E wants you to replace your main feed with newer materials, and, there’s no way to connect the meter to the neighborhood gas main without running a new pipe.  So, PG&E and the City will typically require you to do your gas cutoff before you even start your project.  As of now, PG&E will do your gas cutoff for no cost, even though there is a significant amount of work.  However, it may take some time.  I’ve seen the time range for my projects from 2 to 6 MONTHS.  Keep this in mind and plan ahead.  Even if you are living in the house and you request your gas cutoff too early, it shouldn’t be a problem, as they’ll take your guidance for the date you want to do the cutoff, even if it is further out.  

You’ll need to request that your gas be connected back, which also will take some time.  I’ve also seen it take several months but since the last house and new houses are all-electric, I don’t know the current lead times.  Before they do the installation, you will need to have a trench done according to the PG&E Greenbook, and it will have to be done with a company that is “certified” by PG&E to do the trenchwork. Because of the limited number of “certifications”, this can get costly.  PG&E will give you the option for them to do the trenching, but it will be a lot more expensive and take a lot more time.  Regardless of who does the trenching, there will be a significant charge for them to run the new gas line between the neighborhood main and the location of your meter.  Many cities in the Peninsula now only allow gas for cooktops and fireplaces (and California is moving away from gas altogether) and going all-electric is great for the environment and can be big cost savings.

Electric

If you are doing a full demolition or need to relocate your main panel in your remodel, you will need to put in an application to have PG&E disconnect your electrical service from the house and connect it to a temporary power pole before you can do the demolition.  If you are doing a remodel in which you don’t have to remove the wall that has your current main panel, PG&E, and the City may not require you to use the temporary power pole, and you can skip that step.  Given the number of projects each PG&E rep is assigned, engineering lead times, and crew lead times this also may take several months.  Again, plan ahead to avoid slowing down your project.

For new construction, most cities will want you to do underground electric.  If you are doing a remodel, your city may allow you to keep your power overhead.  Underground is going to cost more, but it looks much nicer.  To do underground, you will need to dig a trench for PG&E in accordance with their Greenbook.  If the closest power pole to your house is not in the corner of your yard, you may want to and may be able to get an exception with your city, but it will take some work.  Regardless of whether you are doing overhead or underground, if you are doing a new construction or significant remodel, you will likely need a new, larger electric service.  That new electric service will require another PG&E application.  On the last project, PG&E suggested that I apply for my new service when I started the construction of the house!  I didn’t believe it, but I requested the new service at the start of construction anyway.  When we moved in 6.5 months later, PG&E still took an additional 3 months to connect power, so we lived with temporary power until then, always making sure that the car charger or air conditioning wasn’t on at the same time as the water heater or clothes dryer.  My family wasn’t happy with me.  It would have even been a few months later if it weren’t for daily emails requesting immediate service from when we moved in.  So, under realistic conditions, it would have taken PG&E 12 MONTHS to reconnect service from the time I put in the request.  Plan ahead!

Having built 4 houses, and working on my fifth now, I have learned a lot along the way.  It gets easier, faster, and better every time, and I learn additional ways of saving costs each time.  I built the last house in 6.5 months from start to finish (and during the rainiest season in 70 years) and for 40% of the price that I’ve heard builders recently quoting for houses with equally nice finishes and without cutting any corners.  The keys are:

• Knowing how to design cost-effectively
• Finding and using good, licensed contractors and service providers who don’t have absurd margins
• Clear scopes with contractors
• Knowing what to do and when
• Mitigating change orders
• Good project management
• Knowing where to buy high-quality fixtures and materials at a discount
• A little bit of sweat equity

Recently, a couple of families have asked for help in building their own house, and so I’ve decided to provide consulting services for people on the Peninsula who want to build their own house (or build a significant remodel) quickly and for a fraction of the price of a builder.  

Contact me if you are interested in some help.

What does this mean?  If you own property in Santa Clara, North San Jose, Milpitas, or Sunnyvale that you rent out or you are thinking about leaving those areas for another area, now could be a great time to take advantage of the low inventory in those areas and maximize the sale price of your property.  If you are considering it, do it before many of the owners of rental properties decide to sell and increase the inventory.  Worried about the tax on the gain?  You could 1031 into another income-producing property (if you own a rental) or use the $500,000 gain exclusion on the sale of your primary residence.   If you need recommendations for a real estate agent or information on 1031’s send me a note.

As everyone knows, housing prices are typically a function of total available income and housing costs.  By using San Mateo County employment data, median income data, interest rates, and median house prices, I determined a formula for what I’ll call the Shroff House Price Affordability Index or SHPAI (Trademark Pending).  Unfortunately, the most recent median income data was in 2020. Based on nationwide data, I made some assumptions about the median income in San Mateo County for 2021 and 2022, so my numbers there could be off.  To forecast house prices, I projected the following:

• the SHPAI would return to pre-pandemic levels
• 30-year mortgage rates would average 6.5% in 2023 and 4% in 2024 as the Fed cuts interest rates to achieve a stable economy and housing market
• The employment base would shrink by 10,000 people in 2023 and 2024
• Unemployment will increase to 5.9% in 2023 and 7.2% in 2024
• Wages will increase by 2% in 2023 and again in 2024.  

In 2022, the average median price in San Mateo County was approximately $1,420,000.  Based on my model and assumptions, I believe that the average median price in 2023 will be  $1,180,000 (a 17% drop from July 2022 to June 2023), and it will further decline in 2024 to $1,100,000 (an additional 7% drop from July 2023 to June 2024).  While the median price is the best indication of relative home price trends, it has its biases.  In recessionary times, people are more likely to buy smaller homes, and during prosperous times, people are more likely to buy larger homes.  People buy smaller houses during recessionary periods, and that reduces the median price more than the actual price decrease.

As layoffs increase, people (primarily renters) will leave the area for other areas where the cost of buying a house will be less.  Prices of rental homes will also decrease (alongside owner-occupied homes) because the rental market won’t be so frothy.  Generally, those that already own homes in the Bay Area don’t leave as quickly because they own a home in an area that has historically been one of the best asset classes over time and property tax is relatively stable compared to other states (because of Prop 13).  From anecdotal evidence, those who leave the Bay Area frequently keep their homes in case they want to return.  Thus, I don’t anticipate the number of houses going on the market will increase dramatically, but the number of people who can afford houses here will decrease.  

If you agree with my predictions and have money to deploy, here’s the best course of action:

• Buy as much real estate as you can in 2024.  While the inventory may not rise substantially, further price cuts will allow you to buy more for your money.
• Buy the most expensive real estate since more expensive properties will be at a higher discount because fewer people can afford those homes.  You’ll obtain a significant amount of appreciation when prices go back up.

While I’m frequently wrong, I’d like to think that I’m correct more times than wrong.  However, how the Fed modifies interest rates and how mortgage rates play out will affect the home market.  There is a good chance that the Fed will realize that the economy and inflationary environment we are in today are not the same as it was earlier this year and adjust course.  By then, it will be too late.  

Going beyond 2025 is just too difficult to predict anything as there are so many macroeconomic possibilities.  If I’m correct in mid-year 2023, I’ll look at making further predictions based on where we are in the economic cycle.

Please contact me if you want to test out different assumptions in the Shroff Home Price Affordability Index.

If getting out to the greatest number of people (e.g. putting on the MLS) typically provides the best price to the seller, why would someone want to sell off-market?  Typically, most people sell off-market because it saves them the significant hassles of fixing up, cleaning up, and the inconvenience of open houses and showings and saves them significant costs (e.g. staging, real estate commissions, etc.).  In addition, if they want to be able to rent back, extend close, or do a 1031 exchange, selling through the MLS gives them less of an ability to negotiate that.   So how does one go about finding an off-market listing?  

Here are a few tips:

1. Tell everyone you know you are looking for a house to buy.  Friends might have other friends that are looking to sell/move.  Talk to your neighbors, they might know someone or they may want to move themselves.
2. Get a well-connected real estate agent.  They might know people that are going to want to sell in the near future or they might have some strategies to find sellers.  However, once you use a real estate agent, they are going to want to represent you and probably the seller (if they don’t have an agent) and the price of your property would go up 5%.
3. Write a letter to everyone in the area that you are looking to buy.  This is what I did and it worked.  I sent out approximately 300 letters and received approximately 25 replies: 10 just wishing me well and saying they will keep an eye out and 15 interested in selling or possibly interested in selling that I went to go visit.

Here was the process I used to send out letters:

1. Determine the area and houses you would be interested in purchasing.  First, start out just in your optimal area.  You can always expand later.
2. Next, try to get the names of the owners of each house that you are interested in.  Since I’m a broker, I was able to access a database with this information.  However, there are other ways you might be able to find this.  You could Google each address and poke around to find the owner’s names.  Your city’s planning or building department may be willing to send you a download of that information.  If you can’t find a name, just don’t put a name on the envelope and mail it or drop it off. 
3. Write a personalized letter to each house.  I just used Word to do a mail merge and differentiated my letter between owners who lived in their houses and owners who rented out their houses (i.e. tax mailing address different from house address).  However, the more specific you make the letter to that person (e.g. the appearance of their house), the more likelihood you have of them responding.  In the letter, include details about yourself/family, why you like the neighborhood, etc.  To top it off, include a picture of your family.  I used half of a 4”x6” print.  
4. Handwrite the address on the envelope.  If you print it on there, the open and response rate won’t be as high.  
5. Wait for replies.  I received replies all the way up to a month from when I sent the letters.
6. Make offers on the properties that you like.  This is another area where it helps to have an agent because they have offer forms that are industry standard.   You may be able to talk to an agent about working on a limited engagement and give you or the seller credit back on the commission.  However, you can also work with a real estate attorney or Google “Residential Purchase Agreement” and your state and you might be able to find the necessary forms.  
7. If you get this far, make sure you then work with a reputable title company to make sure that they help you through the process correctly and that you have clean title to the house. 

This whole process is a substantial amount of work you might find rewards like I did or you might get nothing.  If you do decide to embark on this endeavor, contact me and I can answer any questions or provide additional wisdom.  

In order to heat a house without a gas furnace, the current energy-efficient electric method is a heat pump.  A heat pump is like a A/C condensing unit in that it separates the heat and the cool from the air and puts the appropriate air in your house to heat it or cool it.  For heating, it’s great because it isn’t combusting natural gas and is putting cool air (instead of warm air and carbon dioxide) back into the planet as long as it’s coupled with solar.  It’s a drop in the bucket for sure, but it doesn’t hurt.  

In order to heat water without gas, you can get an electric tankless water heater which uses a heating element and a very large and potentially costly electrical hookup.  This requires a large electrical panel and large wires going to the heater.  One alternative I’m considering is installing multiple point-of-use tankless water heaters in each general room that requires hot water.  This should decrease your plumbing installation costs but increase your electrical installation costs.  The other alternative is a good old tank water heater that uses a heat pump to heat the water.  I’m leaning towards the electric tank water heater.  

As we are all busy and don’t like to wait for our stoves to heat up, induction heating will probably be the way to go.  You are limited on the types of pots and pans you can use, but who uses glass, copper, and aluminum pots and pans anyway?

The final gas-consuming appliance is the fireplace.  If that is the only gas requirement, I’m seriously considering whether it makes sense to have a gas line installed to the house.  When you demolish your house, PG&E requires that you request a gas cutoff and they permanently cap off your gas line near the gas main in order to make the demolition safe.  When you have a gas line put back to the new house, they require a very specially certified and trained contractor dig a big hole near the gas main and trench from the gas main to the house.  Then you are at the mercy of PG&E when and for how much they can install the line to your house and then eventually the meter.  Typically, PG&E gas is the worst part of any new build in my opinion.  The overall cost to get a gas line from the gas main to the house and then to the fireplace and then install a gas fireplace is likely to be $30K to $35K.  It hardly seems worth it for a house feature I rarely use.  I do worry that the house will look odd without a fireplace so I’m inclined to use a modern electrical fireplace which seems to have a more realistic appearance these days and they are a lot less than a gas fireplace. 

Not having gas also eliminates the ability to have a natural gas grill outside for BBQing and a fire pit.  You could use 5 gallon tanks for that, but it’s a bit of a hassle.  Overall, I’m still on the fence but leaning towards going with no gas, which I guess is the intended purpose of the new laws.  

“If a house is stripped and taken down to the studs, and the restoration is such that the house has been converted to a state comparable to a new house, the value added by such a conversion would be re-assessable as new construction. The Assessor will look at the project and determine whether structural components such as roof structure, exterior walls, floor structure, foundations, substantial portions of the plumbing, electrical and/or HVAC (heating, ventilating or air conditioner) systems are being replaced.”

Thus, if you are doing a typical Bay Area remodel, they will consider the entire existing footprint as new construction and possibly give some credit for the foundation, subfloor, and few walls you left behind.  New construction (and any portion of the remodeled house that is actually new) is assessed by:

“In estimating new construction, only the value of the improvement being added is considered. That is, if a new building is constructed on vacant land, the land will retain its existing indexed, base year assessed value. If an addition to a structure changes its size, for example, increasing the size of a single-family residence from 1,200 square feet to 2,000 square feet, only the market value of the additional 800 square feet is added to the assessed value. A new base year value is determined for the addition only. The indexed base year assessed value of the land and existing structure(s) remain unchanged.”

This means they are reassessing your remodeled house as new construction with some small credits.  Now, how do they value that new construction?

“When the Sales Comparison Approach is employed, an appraisal of the land and the improvements is done as of the date of completion to determine the value of the new construction. 

The Cost Approach is often employed by the Assessor to appraise new construction. It is important to note that proper application of the cost approach considers all the costs incurred in the course of construction. These “Full Economic Costs” include labor and materials, permit fees and contractor’s overhead and profit. In addition, there are indirect costs such as developer’s administration expense, professional fees, construction financing, insurance, and entrepreneurial incentive or profit.”

From my experience, in order to determine the “Full Economic Costs” including “entrepreneurial incentive or profit”, the County starts with the Sales Comparison Approach to determine the fair market value and then deducts the value of the land.  They then add back in the base year value of the land which should be the value of the land when you bought it plus 2% per year.  You would think they would just add back the value of the land on your property tax assessment.  Typically, when you bought a property, the County would split the purchase price into land and improvement by half (now they put more into the land) each because it normally doesn’t matter.  When you do a significant remodel or new construction, it does matter.  Just because your property tax assessment has a break out for land vs improvements, the County can change the value of the land if it believes that it was not accurately split.  They did that to me, but I have heard anecdotally somewhere that if the land has been owned for more than 2 years, they can’t reassess the land but I can’t find that in writing anywhere.  For anyone that believes that they are going to get a much lower assessment on a “remodel” or a new construction than fair market value, think again.  The Bay Area counties are fairly aggressive.  For those who think they can build inexpensively and get a low property tax value, the County really doesn’t care how much you spent.  

Here are the benefits of doing the “remodel”:

• You might get to keep your existing setbacks that may not conform to current standards.
• You won’t have the cost of concrete for the portion of the foundation you are keeping.
• You won’t have the cost of the subfloor for the portion of the floor you are keeping.
• Likely an easier Planning Department process.  In San Carlos, where I will soon be building my new house, the Planning process is expected to take 4-6 months on new construction and the requirements of notification and process are quite onerous.  However, in Redwood City and Menlo Park, the additional work/time going through Planning for a new construction vs a remodel was minimal.
• You might be able to get away with not doing fire sprinklers if your addition is small enough (e.g. addition of less than 400-500 sq. ft. and not tearing out drywall in the existing structure).
• Currently, you would not be required to add solar panels.
• Currently, you would be able to keep a gas furnace and gas water heater.  Most Bay Area cities are now banning these on new constructions.

Here are the benefits of doing a new construction:

• You’ll save significant labor (and maybe time) by not retrofitting the existing foundation that will likely need significant upgrades for seismic loads and the added upstairs because it can be done mostly with machines.
• You’ll save yourself the unknown of doing exploration on the existing foundation to find out its condition and how much rebar is in there.
• You’ll have a brand new foundation that will last for another 100 years.
• You won’t have to deal with a possibly less optimal layout.
• You can go higher on your ceilings.
• You may not have to use rigid insulation to meet Title 24 requirements because you’ll have 6” walls.  Title 24 compliance is still required on significant remodels.
• You don’t have the risk of your contractor knocking down walls they are supposed to keep and potentially causing you to go through the new construction permitting process (I’ve heard it happen before).

The main reason that I hear that people typically go through the “remodel” process instead of new construction is that they believe that they are going to save significantly on property taxes.  This is typically a myth and an issue that I address here.  

Here is a summary of tax breaks that you get from investing in a Qualified Opportunity Fund: 

• Tax deferral of your gain until tax year 2026.  For those who invested prior to December 31, 2021 also received a 10% reduction in their gain.  Unfortunately, if you invest now, you won’t get the reduction.
• Tax-free returns on income received after 10 years from the close of the fund invested in.

Most states participate in the same tax benefits as the federal tax benefits above.  However, if you live in California, you will get the federal tax benefits above but not any of these benefits on state taxes.  

While the above sounds good, there’s a few things that most people won’t tell you that really makes some of these funds quite attractive.  The following are some of the benefits that will get with many OZ funds but not all, so it’s imperative to choose a fund that meets your investment and tax goals.

• When you own real estate for investment purposes, you may get to depreciate the structures on the property.  This means you get to reduce your income by the depreciation.  However, when you sell the property, you have to declare the excess depreciation you took and pay ordinary income on that depreciation recapture.  With a Qualified Opportunity Zone Fund, you may get a pass-through depreciation over the 10 years, effectively reducing the income on your personal taxes.  When the property is sold after 10 years, you won’t have to pay depreciation recapture
• Most funds will pay back most of your investment after the first few years after they refinance the completed project and so your capital is not actually tied up for 10 years

If you are selling an income property, you also have the opportunity to do a 1031 Exchange (see the article on 1031 Exchanges).  A 1031 is a great option to defer taxes but there are some differences from Opportunity Zones.  With a 1031, you will need to purchase replacement properties in amount equal to or greater than the property you sold to get the full tax deferral of the gain.  With Opportunity Zone Funds you only need to reinvest the gain into the fund.  In addition, there is no 45 day identification period like there is with 1031’s, which is typically the most difficult part of a successful 1031.  OZ Funds can also be used in conjunction with 1031’s but it can be more complicated and many advisors don’t know the nuances of doing both together.  

Typically, you have 180 days from the date of your gain to invest into an Opportunity Zone Fund, but if your gain is held in a pass-through entity and you will get a capital gain on your K-1, you may have a lot longer.

I have invested in a quite a 1031 replacement properties and Opportunity Zone funds.  Email me if you have any questions.  All of my knowledge is derived from my experience as an investor.  I am not a tax professional and so this is for informational purposes only and should not be considered tax advice.

The commercial properties I bought didn’t cover the total amount of my sale, so I decided to invest in DST’s (Delaware Statutory Trusts).  DST’s are an interest in an income-producing property, which also qualifies toward your 1031 exchange.  Typically, when you invest in a DST, the property due diligence is done by the fund, they already own the property in another fund, or they are in contract to buy the property.  The DST’s agreements are standard and typically non-negotiable so there’s not much to negotiate.  The DST’s sponsor will manage the fund and property so all you do is collect a check, maybe somewhere between 4-10% of your investment annually.  Plus, you will receive the proceeds from your share in the DST once the DST sells the property.  In general, purchasing a DST was much less stressful.  In addition, many DST’s have debt (that you won’t have to personally guarantee like you might on a full property purchase) on the property, and so what you invest might translate into a larger property investment.  For example, you buy a 10% share of a $10 million building and there is 50% debt on it.  You will only be putting in $500,000 but you will get the equivalent of a $1 million purchase value.   You still want to do diligence on the sponsor and the building owned by the DST to make sure you are buying a sound investment with a good sponsor.  Good DST opportunities do take searching not all DST’s are a good investment.  While your investment is secured by the real estate, you have to be careful of a fund manager that can walk off with your cash or can make a poor decision.

If you still don’t qualify for a full 1031 tax deferral from your sale because of a lack of opportunities or you miss the 45 or 180 deadline, there is another way to defer the gain.  See my article on Opportunity Zones. Capital gains tax rates are 23.8% federally (and possibly climbing) and if you live in California, you’ll pay an extra 10-13% so being able to defer the capital gains is highly effective in creating long-term wealth.