Single-Family Rental (With an ADU) Walkthrough and Deal Analysis

Welcome to episode 3 of the “Real Estate Ride Along Show“! This property is a fairly basic single-family home, but what you can’t see from the front is that there is an accessory or additional dwelling unit (ADU) in the back—which turns this ordinary investment into a winning investment full of long-term opportunity!

Investing in single-family rentals is a great business model for long-term investors, especially in a market like Denver that has an affordable housing shortage and continues to have massive positive migration year over year. When you add the ADU on to a single-family investment property, it only juices the returns and makes the opportunity that much more attractive. However, the cost to build ADUs in Denver is often $200,000 or greater, making it cost-prohibitive.

In addition to the ADU, this particular property is located in a rapidly growing part of Denver commonly referred to as “West Highlands.” Unlike some of the other apartment buildings and rentals that we renovate and sell quickly, the plan for this property is to hold long-term. We will fix it up and hold it for 10-15 years, because we really believe in this area’s potential in terms of redevelopment and appreciation.

We found this deal on the good ole fashioned Multiple Listing Service (MLS). It had been listed for 2-3 months and became “stale” because the agent overpriced the property to begin with and the sellers were unwilling to negotiate when they received lower offers. When talking with the listing agent, he let us know that the sellers had a family emergency and really needed to be out of the house by the end of December. They were ready to consider lower offers, as long as they had a quick due diligence period and closing.

Once we heard that, we wrote up an offer immediately. We were able to come to an agreement on price and terms that worked for the seller. We negotiated a seven-day inspection and 21-day close in exchange for knocking $60K off the purchase price.

Game Plan

Minor renovations to the exterior and interior of the main house while vacant.
Full renovation on the ADU to increase its desirability and rental potential.
Lease to market-rate tenants once construction is completed.
Allow the leases to season on both the main house and the ADU for four to six months.
Refinance into a conventional 30-year, fixed-rate loan, and hold to capitalize on the appreciation.

Funding the Project

Luckily, because we are able to do so many deals with certain banks, we were able to get a warehouse line of credit that covered 90% of the cost to purchase the property. This means that we had to bring the remaining 10%, and we were responsible for all construction costs. We were able to do a five-year, fixed-rate mortgage at 4.4% interest and pay interest-only for two years.

The goal is to paint the interior of the main house, do some minor repairs to drywall and baseboards, and do a full renovation on the ADU. When the renovations are completed, we will have a four-bedroom home, along with a one-bedroom ADU with laundry and a full kitchen to rent out.

Once we are able to show 12 months of rental history, we will be able to refinance the property into a 30-year, fixed-rate loan and pull out a significant percentage of our construction capital, while still meeting our desired cash flow figures.

A key factor to making this deal work was our relationship with this particular lender, which did not require 20% down as most lenders do on this kind of single-family property. The lender knows our business model, has an extensive history of working with us, and is comfortable extending additional leverage to us on small projects like these.

It takes time to build these relationships, but once you are able to get your lender comfortable with your performance and business model, it will pay off for a long time! If you’re just getting started with real estate investing, you’re more likely to see putting 20-25% down with either a conventional loan or a 5- to 7-year ARM loan. Our advice is to find a good institution that you trust, then work with them to prove yourself, and you will be able to get similar terms down the road.

Walkthrough

In this area of the city, we will most likely rent to a family, which means room count is important. Most of the houses nearby that are not renovated have two to three bedrooms and one bathroom. This property has four conforming bedrooms. One of the bedrooms is in the basement and already has egress windows installed, which is a big value-add to the future tenant and provides protection for us as the landlord.

For those not familiar with egress windows, these are important in Colorado (and Denver, specifically), because a “conforming” bedroom allows you to collect more in rent, while simultaneously lowering your liability as a landlord. If there is ever a fire in the property and someone were to get hurt, as the landlord, you can be held responsible if you don’t have egress windows or two ways to get out of any room (usually one through a door, one through a window).

Another reason we liked this property is all the work that was already completed prior to us purchasing the home. That way, we did not have to invest additional dollars into improving the interior of the primary home.

Appeals of the main house:

Updated kitchen and countertops
Newer kitchen appliances
Bathrooms clean and already tiled
Roof replaced within last 5 years
Landscaping updated within last 2 years (hard to tell with snow on the ground)
Windows functioning and newer
Mudroom updated
New washer and dryer that came with the house
Hardwood floors in good condition
Finished basement with 2 egress windows (saving us $5-6K)
Recessed lighting in basement (saving us $800-$1,000)

We will be cleaning the carpets and giving the interior a fresh coat of paint, but the goal is to spend less than $1,000 to get the main house as we want it and really focus most of our time and money to update the ADU.

We hoped to get about $3,000/month in rent on the main house (but rented for $2,695 + $100 RUBS due to renting in the middle of the winter).

The ADU is about 800 square feet and was being used for laundry, storage, and a workshop. The plan is to make this a 1-bedroom/1-bathroom with a kitchenette and laundry room. We aimed to rent this out for $1,200-$1,400/month (and ended up renting it for $1,395 + $100 RUBS).

Not only does this ADU allow us to get great additional cash flow, but with the housing shortage in Denver and the city recently passing a bill to allow rezoning for ADUs, this will be a highly desirable asset when we are ready to sell it in the future.

If you want more information about the zoning laws and the changes Denver is expected to adapt, you can Google “Blueprint Denver.”

ADU renovations:

All-new exterior
New roof
New plumbing for kitchen, bathroom, laundry
Increase waterline to support shower, laundry line, and larger kitchen
New kitchen, including cabinets, countertops, appliances, backsplash, shelves
French doors in bedroom to exterior patio
Large closet
Full bathroom
Living space
Add insulation
Add electric baseboard heat
Add mini-split system in bedroom (AC & heating)

We are hoping to stay in a rehab budget of about $60K for the ADU.

As far as the exterior of the property, one of the major issues is the main sewer line. It hadn’t really been touched in about 80 years. It was part galvanized and part clay. It was corroded and in need of replacement. While this is a major expense item up front, it’s better so that the tenants don’t constantly get clogged sewer lines, toilets that won’t flush, or things coming back up the pipes. We should save on maintenance the next 5-10 years as a result of getting this taken care of prior to tenants moving in.

We also want to do a privacy fence separating the main house and the ADU. This will give each unit a dedicated backyard area. Plus, the tenant of the ADU will have a clear path from parking to the back of their home.

We also know that there is a huge demand for rentals allowing pets. With each unit having separate outdoor space, it makes it more accommodating to someone with a dog/pet.

The Numbers Behind the Deal

We bought the house for about $515K. The seller was in a distressed situation, which allowed us to get about $25K off the list price. With our renovations, we will be all-in for around $575-$580K.

We will not be collecting any rents while we do the renovations. Our carrying costs will be about $2K/month, and we should have everything updated in three months.

We hope to collect between $2,800-$2,900/month for the main house and about $1,200-$1,300/month on the ADU, so $4,000-$4,100/month total in rents.

Utilities are on one water meter and one electric meter so we will be billing back utilities to the tenants each month. Tenants will be responsible for lawn maintenance and snow removal.

While the operating expense ratio is smaller than what we typically see from multifamily, the ADU rents still help us hit a ratio in the low 20s, which is great.

The plan is to hopefully go back to the same lender in the next 12-24 months and refinance once we have that rental history and possibly pull some money out.

The Bottom Line

This is essentially a long-term BRRRR strategy (buy, rehab, rent, refinance, repeat). While these are really tough to do in the Denver area, we were lucky to find a deal where it was able to work in our favor because we looked at it from more of a long-term perspective.

If you’re in Denver or coming here, reach out to @Chris Lopez to talk about joining us for an episode!

What are your thoughts on this deal?

Join the discussion in the comment section below.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.