Should I buy or build on my backyard

Question

I refinanced my home and pulled some money out. I am not sure whether to use the money to buy another property or build in my backyard.

I have checked with the city and I can build two apartments. I feel like building on the back will give me more cash flow than buying, since LA is very expensive. I am not sure if the money I have is enough for the project since I will not get a contractor and I will be in charge of the project. I know some people that can help me.

Any input would be highly appreciated. If there is a need for clarification, please let me know. I have never done this before. I only have one property.  Also, I am not in construction I do tech for my job.

Dan H. · Answer

Apparently I am the contrarian.  I believe in many cases adding an ADU produces the worse return of an RE investment.

Here are some issues with ADUs:

1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover.
2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often in leverage (HELOC, cash out refi, etc). Leverage magnifies return.
3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
4) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
5) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
6) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.

If you choose to ignore the reasons for not adding an ADU, look into the $40k adding ADU grant. This can reduce the impact from my item #1 which is the primary reason ADUs are such a poor RE investments.

As for your option 2, I am typically an advocate for buying coastal Ca property and historically it has done awesome (I have multiple properties that have created over $8k/month value over their hold). However, I am currently only interested in local purchases significantly below market price or that have outstanding value adds.

I believe that you should evaluate other options than jumping into coastal CA RE at this time. In general, I am not a fan of OOS small unit count residential either. There are many investment options available including other RE options.

Whatever you decide, do your research.

Good luck

Robert Reynolds · Answer

I think you should buy a second property. The time and money loss of building an adu is often a lot higher than one would think. I have been working on mine for over a year now and in that time I could have bought several homes with that money. I like STR's right now and with the $150k I spent on my ADU I could have bought two STR's in Big Bear or Joshua Tree.

Theresa Harris · Answer

You could buy in another city and have a property manager take care of the property.  If you build in your backyard, make sure there is room to section off a small part of the yard unless you want to share that with the tenant.  I've seen a few ADUs that are quite nice (apartments above a garage with a small balcony area or a place with an area fenced off.  Also think about where they are going to park.

Nathan Gesner · Answer

It won't make sense to buy another investment in California. I would keep the property you've got and expand on it.

Nate Wiger · Answer

Have you considered an SB-9 lot split since you are occupying the property? You could split the lot and build a total of 3 new structures, 1 ADU on your lot, and 1 main + 1 ADU on the new split lot. SB-9 is a great option if you are occupying the property, since that's one of the key requirements. And a separate lot will generate more value.

Alex Otto · Answer

Hey @Jose Herrera!

From our experience designing and building ADUs across LA City/County, the $/sf of new construction is far, far lower than the $/sf for buying anything, so my gut reaction is to just continue developing the land you have. I guess it depends on your long term strategy though.

In terms of what exactly you can develop on your lot, I would look into the difference between adding ADUs vs adding regular residential units. The setback requirements for ADUs are typically a lot smaller than for regular residential units, which might allow you to squeeze larger units onto your lot. I'd also look into what kinds of development fees will be levied against your project by the authority having jurisdiction -- ADUs under a certain size can avoid some of these fees.

The CalHFA $40k ADU grant program could also help cover some of the pre-development costs for an ADU. I know the program is backlogged right now, but if you're serious about building an ADU, then it's worth looking into it. A few groups/people (e.g. Maxable, How to ADU) have recorded some youtube videos on it that are helpful.The downside to ADUs in this case would be that, depending on the # of units already on your lot, you might not get the 2 units, or you might have to make one attached to the primary structure and one detached. However, you could only determine this by looking at your zoning, how many units are currently on your property (and whether they are physically attached to one another), and your jurisdiction's ADU ordinances.

Should I buy or build on my backyard

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