Don't know which direction to take - analysis paralysis

[Ashley Bitner]

Hi there,

Long time listener, first time caller ;)

I'm located in coastal Southern California. I live in an HCOL area, walking distance to the beach. I have a $250k HELOC, which I had been planning on using to build an ADU in the backyard. A few friends in the neighborhood already have the same, and they generate approximately $3000 monthly rent. It turns out my garage isn't permitted (?!) (The house was built in the early 40s not sure when the garage was built, but the city doesn't have any record of it being permitted). This opens up a whole new can of worms and makes it likely that it would need to be demo'ed and rebuilt along with the ADU. Estimates I'm getting for this are in the $350k range (yikes). I wonder if I'm better off buying an investment property rather than building the ADU. BUT... I don't feel confident enough to buy out of state and the property taxes/interest rates/home prices are so high anywhere around me. I feel like I waste days trying to decide: build the ADU? Buy somewhat locally (Julian? Idywild? Borrego?) and try to STR? Sit tight and save more liquid and wait for the prices to drop? (Trying to time the market is not ideal, I know). I've considered selling and buying a place that already has an ADU but I purchased in 2008 so my property taxes are low and I'm locked into a 2.6% rate. It seems crazy to ever sell this place. Anyway, I have major analysis paralysis trying to decide which direction to take. Would love to hear some thoughts.

[Dan H.]

Hands off ADU additions in southern Ca are often one of the worse RE investments most due to the cost to build being higher than the value added by the ADU addition. Your expense is magnified due to the unpermitted garage.

I suggest you search the BP forums for values that appraisers are providing ADUs I further suggest you understand the value that will be added by the ADU addition prior to proceeding

Here are reasons hands off ADU additions are poor RE investments in So Cal:

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. Make sure you know the value the ADU will add to the property before building the ADU.
2) The financing on an ADU is typically far worse than for initial investment property acq
uisition or is often not leveraged (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) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
6) this is related to the value added by the ADU, 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.
7) 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.
8) Related to the value added by the ADU, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
9) Fannie/Freddie will NOT finance a 2-4 unit building with an ADU. This lowers refinance options. It can potentially limit your buyers when/if you go to sell. This is another reason ADU resale values are lower than hands off cost to add an ADU.
10) if CA an ADU and JADU can be added to virtually all homes. However, Freddie/Fannie will not finance a parcel with 2 ADUs. This lowers refinance options. It can potentially limit your buyers when/if you go to sell.
11) JADUs require OO. Note this is not only to rent the JADU, but in strictest interpretation to even have a legal JADU. This limits purchasers to house hackers significantly limiting the potential buyer. JADU are value subtract as they typically reduce the value of the RE and often best option at selling is to remove the JADU.
12) if the ADU is being added to a SFH, the ADU can make the house rent controlled (if it is over 15 years old). See AB1482.

good luck