Rent, sell, or refi in San Diego

[Eric Aldridge]

Good morning you happy people. The wife and I own a 3/2 house in San Diego with a studio apartment in the converted garage. Current estimate for the value of the property is $1.6m and we owe $900K. We are able to add a 1 bedroom ADU to the property if we invest about $300k-$400k. If we add the ADU (making the property a triplex essentially) the value would shoot up to almost $2.5M. For you experienced investors, my question is whether to add the ADU and sell immediately? Keep and rent out all 3 units which would bring in over $10k per month? Or keep and rent all 3 units and cash out refi to have some cash to reinvest in other properties. I understand all of these options have their advantages and disadvantages but I am looking for someone smarter than me to give some input that may be helpful. Thank you all so much! Happy New Year.

[Dan H.]

Where did you get the ARV? It is rare that a hands off ADU addition adds as much as it cost to add. It would be very rare that an $400k ADU addition to add $900k of value. It is rare that a $400k hands off ADU addition adds as much as $400k. My protege added a ADU that would have cost $120k if hands off. Appraisal placed a value of ~$50k. Therefore I am skeptical of your ARV. Search these forums and you will find many cases of disappointing ADU appraisals. Note the initial cash flow goes toward recovering the initial negative equity.

There are numerous other short comings in ADU additions. This includes less finance options, many months between initial vestment and first income, if added to a SFH it typically places existing structure under rent control (AB1482), the detraction from existing unit(s). ADU additions do not make the property a duplex, triplex, etc. there are various constraints n ADUs that do not exist on zoned multiplex units including no STRs in most jurisdictions.

Assuming your value is correct (I am skeptical), the rent ratio is real bad even for San Diego where most rent ratios are bad.  This will produce bad cash flow but historically the return in San Diego is from appreciation.  However, I desire better cash flow than you depict (still poor, but better than what you depict). 

Have you evaluated what the cash flow is at with the 50% expense rule?

I seldom suggest selling a San Diego property, but this one I would consider selling.  

good luck