Buying & Selling Real Estate
Market News & Data
General Info
Real Estate Strategies
Landlording & Rental Properties
Real Estate Professionals
Financial, Tax, & Legal
Real Estate Classifieds
Reviews & Feedback
Updated almost 2 years ago, 01/05/2023
Building an ADU or buy a triplex
Hi, I'm facing two options: build an ADU or buy a triplex.
ADU of 1200sqft, 3bed 2bath
cost: $250k~$300k
appreciation: not sure. the value of existing SFR is $550k, 1100sqft.
collecting rent: $3000/month
Triplex:
purchasing price: $900k
PITI with 25% down: $6k/month
collecting rent: $7400/month
If building the ADU, most likely I can cash out all the investment, finish the circle of BRRRR.
Also like the rental income of Triplex.
Which one will you choose? Thanks in advance.
@Jeffrey Zhang is this in Los Angeles City? I don't know the area that well but less than $300/SF construction cost seems on the low side unless you are very experienced in managing contractors and cost. Is it a personal residence you plan to live in? If you can BRRRR it I would go the ADU route since you then get all your original investment back and find another triplex or property you can have enough value to, in order to BRRRR that
Quote from @Sean Walton:
@Jeffrey Zhang is this in Los Angeles City? I don't know the area that well but less than $300/SF construction cost seems on the low side unless you are very experienced in managing contractors and cost. Is it a personal residence you plan to live in? If you can BRRRR it I would go the ADU route since you then get all your original investment back and find another triplex or property you can have enough value to, in order to BRRRR that
Thank you for pointing the direction. It's in San Bernadino County. I might not be accurate on estimate or too optimistic. I haven't decided if I'll live in the SFR. You are right, this triplex is not really a "deal", and there is no much room to do value add, so it's hard to BRRRR.
My view is that adding an ADU in CA is often one of the worse RE investments. Here are some of the reasons:
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 acquisition 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 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.
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 number 1, 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?
Good luck
@Jeffrey Zhang I don't see the value of ADU's penciling out versus purchasing a full property. I believe you get way more bang for the buck with the triplex or another full property versus a bonus door on the current home.
- Ryan Kelly
@Jeffrey Zhang. I think with this choice I'd buy the triplex. With that said, down the road you could get a heloc to build the ADU to increase the property cash flow. By getting the heloc you essentially build it without real cash out of your pocket. After the build go for increased heloc if possible. I can't help but kinda luv the idea of ADU's on multi unit properties but of course there's opportunity cost by choosing to build ADU's. Personally, I'm building 3 ADU's in Santa Monica because rents are high and it's worth it in my opinion. Also, the construction cost was built into the loan when I bought the property.
Quote from @Chris Miller:
@Jeffrey Zhang. I think with this choice I'd buy the triplex. With that said, down the road you could get a heloc to build the ADU to increase the property cash flow. By getting the heloc you essentially build it without real cash out of your pocket. After the build go for increased heloc if possible. I can't help but kinda luv the idea of ADU's on multi unit properties but of course there's opportunity cost by choosing to build ADU's. Personally, I'm building 3 ADU's in Santa Monica because rents are high and it's worth it in my opinion. Also, the construction cost was built into the loan when I bought the property.
Using a HELOC to add an ADU or purchase a property is an unleveraged investment. The easy ability to use leverage on RE investments is one of the primary reasons RE can be such a great wealth builder. If you do not use leverage on your RE investment, there are many investments that are likely to produce better returns and require less effort (be more passive).
As an example the lifetime return of S&P 500 is almost 10%. This exceeds the average return on unleveraged residential RE and is much more passive.
Similar, I can invest in an RE syndication and in recent times achieve ~20% return (may be challenging going forward in part due to the recent rate hikes). Syndications are significantly more passive than owning residential RE.
In summary, if not using leverage on your RE investments, you should evaluate in the RE investment is the best use of investment dollars.
Quote from @Dan H.:
Quote from @Chris Miller:
@Jeffrey Zhang. I think with this choice I'd buy the triplex. With that said, down the road you could get a heloc to build the ADU to increase the property cash flow. By getting the heloc you essentially build it without real cash out of your pocket. After the build go for increased heloc if possible. I can't help but kinda luv the idea of ADU's on multi unit properties but of course there's opportunity cost by choosing to build ADU's. Personally, I'm building 3 ADU's in Santa Monica because rents are high and it's worth it in my opinion. Also, the construction cost was built into the loan when I bought the property.
Using a HELOC to add an ADU or purchase a property is an unleveraged investment. The easy ability to use leverage on RE investments is one of the primary reasons RE can be such a great wealth builder. If you do not use leverage on your RE investment, there are many investments that are likely to produce better returns and require less effort (be more passive).
As an example the lifetime return of S&P 500 is almost 10%. This exceeds the average return on unleveraged residential RE and is much more passive.
Similar, I can invest in an RE syndication and in recent times achieve ~20% return (may be challenging going forward in part due to the recent rate hikes). Syndications are significantly more passive than owning residential RE.
In summary, if not using leverage on your RE investments, you should evaluate in the RE investment is the best use of investment dollars.
Quote from @Chris Miller:
Quote from @Dan H.:
Quote from @Chris Miller:
@Jeffrey Zhang. I think with this choice I'd buy the triplex. With that said, down the road you could get a heloc to build the ADU to increase the property cash flow. By getting the heloc you essentially build it without real cash out of your pocket. After the build go for increased heloc if possible. I can't help but kinda luv the idea of ADU's on multi unit properties but of course there's opportunity cost by choosing to build ADU's. Personally, I'm building 3 ADU's in Santa Monica because rents are high and it's worth it in my opinion. Also, the construction cost was built into the loan when I bought the property.
Using a HELOC to add an ADU or purchase a property is an unleveraged investment. The easy ability to use leverage on RE investments is one of the primary reasons RE can be such a great wealth builder. If you do not use leverage on your RE investment, there are many investments that are likely to produce better returns and require less effort (be more passive).
As an example the lifetime return of S&P 500 is almost 10%. This exceeds the average return on unleveraged residential RE and is much more passive.
Similar, I can invest in an RE syndication and in recent times achieve ~20% return (may be challenging going forward in part due to the recent rate hikes). Syndications are significantly more passive than owning residential RE.
In summary, if not using leverage on your RE investments, you should evaluate in the RE investment is the best use of investment dollars.
If you use the HELOC as down and take loan out for rest of vale, it is leveraged. If you use the HELOC to buy the property or build a unit, which is what I thought you were indicating, it is not leveraged (or at least not well leveraged). It is because money that is not fully utilized to obtain top purchase amount is under leveraged (meaning can be leveraged further). In addition, such capital (HELOC, margin loan, etc) is constrained by equity position versus cost of asset. To me leverage is leverage using the value of item being purchased or built (borrow on financed asset).
I look at such purchase (no loan against purchased property or built unit) as equivalent to cash purchase. When I make cash purchase on RE investment, I expect significant discount over financed option. Ideally at least 20% below what I would pay if financed.
Using a HELOC to purchase or build in full is under leveraged and should produce returns comparable to cash deals. Building an ADU with a HELOC does not meet my requirement and therefore I would not recommend this route.
Good luck
Quote from @Jeffrey Zhang:
Hi, I'm facing two options: build an ADU or buy a triplex.
What is your IRR and COC on the ADU versus the Triplex? Once you have those numbers, you will know what the better investment is.
ADU of 1200sqft, 3bed 2bath
cost: $250k~$300k
appreciation: not sure. the value of existing SFR is $550k, 1100sqft.
collecting rent: $3000/month
Triplex:
purchasing price: $900k
PITI with 25% down: $6k/month
collecting rent: $7400/month
If building the ADU, most likely I can cash out all the investment, finish the circle of BRRRR.
Also like the rental income of Triplex.
Which one will you choose? Thanks in advance.
@Dan H. hit the nail on the head. ADU's have expensive upfront costs, and don't appreciate your property as much as you'd like to think. I'd choose the triplex.
One thing, why isn't there a third option: buying a BRRR-able triplex? Wouldn't you get the best of both worlds? You'd be able to cash out some of your investment, while having cash flow? If you're looking in the Inland Empire, let me know. I can help you find a property.
You will not be able to build a quality ADU for less than $300k at 1200sf. Also, you will not be able to build a 1200SF ADU with the primary house at 1100sf.
All the other negatives are valid regarding the ADU although I would argue that the value after building possibly being underwater is irrelevant so long as your timeline to exit is 7 years plus. Also, appraisals will get better and more inline once there are years of comps for them which should improve over time.
That said, buying a multi could be a better fit if you buy right. Money is made at purchase in multi and then adding value adds to that money/profits.