How Should I value adding ADUs to a property?

Question

I’m trying to buy a small SFH and build multiple ADU units in the backyard. I’m doing it in an area where students pay about $1,100/room (in shared homes). I’m having difficulty determining the home value after the ADUs are built. Can you guys help me? I’m trying to buy a 4 bed SFH with a large flat lot. In the backyard, I’m going to build two 1,200 sqft homes. Each home will be a 4/2 for a total of 8 extra bedrooms. For the sake of this discussion, let’s assume this build complies with zoning laws. Here are the four ways I’m calculating rough profit in this product. I’d love some advice on which one you think is best! Assumptions I’ll be adding 8 bedrooms for about $8.8k in added monthly rent. Assuming 4 bedrooms and 1300 sqft in the primary home, I’ll be collecting about $13k/mo. The primary home will cost about $900k. The complete cost of 2,400 sqft of ADU is $800k (including permitting, hookups, overhead, etc). Rent Multiplier San Diego rent multiplier is 14.1 annual rent. 14.1* 13k * 12 months = $2.2M. $2.2M - $900k - $800k = $500k profit SQFT Margin The neighborhood is about $700/sqft. ADU build cost is $330/sqft. (2,400 sqft + 1,300 sqft) * $700/sqft = $2.6M $2.6M - $900k - $800k = $900k profit NOI Cap rate = 4.5% in San Diego. ($13k/mo * (1 -20% opex) * 12mo/yr) / 4.5% = $2.75M $2.75M - $900k - $800k = $1,150k profit Comps This is very difficult. Every comp I look at with ADUs is a tiny 400 sqft office space or a 600 1bd 1 bath guest house. I can’t find anything with 2,400 sqft of housing targeted at generating as much rent as possible. So with that being said, which model do you think makes the most sense? Any other advice?

Pavan Sandhu · Answer

Not many comps out there. Your best bet is to put an ADU on a SFR that’s surrounded by 2-4 unit MFRs. Then you can try to argue your SFR + ADU should be valued similarly to that 2-4 unit. I’ve been successful at doing so and also failed many times at doing so.

Jo-Ann Lapin · Answer

Comps are going to your worst problem . For sure try and find surrounding multi family to assist.

Whitney Hill · Answer

Just chiming in on multiple units. These are the situations in which you may add multiple ADUs:-Multifamily property (incl duplexes) in CA -- up to two detached ADUs, plus unlimited conversions of existing non-habitable space-City of San Diego -- outside transit priority area (TPA), you can build one additional affordable ADU and one unrestricted ADU (in addition to the 1 ADU on single family or 2 ADUs on multifamily). You are right that in TPAs there is no upper limit on these bonus ADUs, so long as you conform to the underlying zoning on FAR, lot coverage etc.

Sergey A. Petrov · Answer

Watch out for zoning laws. Not too familiar with CA but believe it’ll be impossible to build multiple ADUs on one lot in San Diego

Andrew Erickson · Answer

I'm in the middle of San Diego. There are no vacant lots here. Good point on the price per square foot! In many of these neighborhoods, condos are the norm. So people living in areas where they don't have as much yard or privacy is very normal. Yes, you are right. Evaluating these as multi-family rentals is the way to go.

Dan H. · Answer

The only valid way to value this property post adding the ADUs is via comps. If you cannot find appropriate comps, you have no justification for any value and are very dependent on the whims of the appraiser. In general appraisers in San Diego seen to be valuing ADUs between $50k and $90k which is far below their hands off costs. Make sure you have appropriate comps to justify any valuation that you need prior to building the ADUs. There are numerous RE investors in San Diego who added an Adu only to be disappointed by its valuation. Good luck

Charles Renn · Answer

Sounds like you looked into it. Well done. Any luck finding out ADU regulations?

Andrew Erickson · Answer

@Charles Renn, my understanding is that SB9 is only allowed for primary residences. You have to plan on living there for at least three years and can't kick out tenants to do it.

Bill B. · Answer

Survey the 2 or 3 people in California that will pay over 2 million to live in a 1300sf home where they share their backyard, that should give you a good answer. Make sure the numbers work if you have to hold for 2-5 years to get your money back. Hopefully you’re immune to the horrible rental laws because you live onsite in the small home. Otherwise you could actually lower the value if you get stuck with people you can’t evict and those 2 or 3 buyers don’t want living in their backyard. Assume 30-35% taxes if they don’t hit you with the flipper/Medicare/self employment tax. Can you find a vacant lot and just build a triplex? You’re saying you can build for $330/sf and sell for $700/ss\f. But the first property is $900k for 1300sf with a huge lot so even that property is only worth $690. You’re going to try to sell properties with 1/3rd the land and a heck less privacy. You could pay $500k for a lot and then build 3 x 1200sf for the same price. Maybe that’s the key. Look up what a triplex is worth. Or a 3600sf 4plex. I’m just happy to see someone that says interest rates aren’t going cause price drops, and I appreciate the optimism. You’re just pretty far out on the “custom build” limb. Good luck and let us know how it turns out.

Andrew Erickson · Answer

No, it is possible to build multiple units if you are in a special transportation area.