How to sell a unique property (ADU duplex in Los Angeles)

[Justin Gottuso]

Hello! My wife and I bought a 3 bed 1 bath well maintained sfh in a great area of LA four years ago as the market was rising. Both sets of parents contributed to the down payment. Then California passed the law legalizing Accessory Dwelling Unit's (ADU's) in January 2016. Seeing the opportunity I secured additional funding and we are 6-8 weeks away from the ADU completion. Here's the thing, it is 1180 sq ft, 3 bed 2.5 bath ADU. Original plan was to house hack and live in the new house and rent out the front until recently when we decided it is time to leave LA and move to Columbus, Ohio where my wife's family lives and where we have more social support and lower cost of living and less congestion - LA is a beautiful and exciting place, but insane to raise a family. There is nothing like our property on the market (yet) as the vast majority of people doing ADU's simply convert garages and maybe build out to 600-800 sq ft. So, very soon I will have 'two on a lot' yet it is zoned R1 single family. I've spoken to two different appraisers in my area who have ADU experience and they scratched their heads and didn't know what to tell me since there is nothing like it out there. Since the lot is R1 it cannot be compared to duplexes they say. Any advice about selling unique properties that do not fit into traditional market boxes?

Other helpful details: 

Purchase price in 2016: 755k

Median market value today for original house: 950k

ADU construction costs: 300k

Estimated value after ADU is completed: 1.3-1.4m. But not sure. New flips that are 3 bed 2 bath that are 1,700 sq ft sell for 1.35-1.45m in our neighborhood and small 3 bed 1 bath homes sell for 950k median in our area. We already had an interested buyer willing to offer 1.35m before their funding fell through, but that was the top of his loan limit.

Bottom of market rents: 3,500 for older front house and 4,500 for new ADU/8k per mo

We debated whether to keep it as a rental or sell it. The numbers didn't seem to add up to keep it as a rental. After refinancing our payment would be about 7k per mo, plus taxes, insurance, repairs and property management (since we will be out of state) expenses seem to be about 9.5k per mo with rents right now likely being around 8k, but increasing over time as Google and Facebook have offices 2 miles away, giving our area the nickname 'Silicon Beach.' So doesn't look like we will be cash flowing on it. I'm sure it will appreciate well over time since ADU's are still new and in 5 years there will be more properties to compare it to for appraisers - but we are not comfortable with covering vacancy costs that could be up to 7k per mo. So, selling and cashing out on 300-400k and re-investing seems like the smarter move at this point (I am considering ways to invest the money, but that's for a future post as I need to get the property sold in the first place). I am open to advice and thoughts to think about my situation in ways I have not thought of before. Thanks!

[Dan H.]

Originally posted by @Luis Lopez Valencia:

@Dan Heuschele

NOI is ~$40,000 conservative at $3790 gross monthly for the property. Main 3/2 home market rent is $1995, 3/1 ADU market rent is $1795.

Very good point, appraisal is going to be our main consideration. That being said, we decided to proceed with the build as our office has a ton of all cash buyers looking for a home for their money. What cap rate would you use and what do you think you'd value the property at? Excited to hear your thoughts

That is, at best, a projected NOI because you have not obtained that income yet. NOI is not set on projected rents. It is established by actual income achieved.

$5480 of expenses seems very optimistic on 2 units. The prop tax alone at 1.1% (I use a conservative 1.25% in my projections but am using low value to depict the operating expense flaw) at a $400K assessed value would be $4,400. That leaves just over $1K for all other expenses. I expect the insurance on a SFR with ADU will be about that cost. That leaves nothing allocated for the other costs.

I suspect you are going to find it difficult for someone to accept a cap rate evaluation because 1) their financing will not be based on a cap rate evaluation 2) you do not have the actual NOI that would allow a cap rate valuation.

The cap rate valuation is not likely to work even if you had NOI because this RE does not require commercial financing. A very large percentage of the purchasers will want to use conventional financing which does not use cap rates.

Use actual comps to obtain the valuation.  It will likely save you from being disappointed at the time to sell.

Good luck