300k to build 1100 SF 3/2 ADU or invest in stock market

[Victor Latimer]

Hello all. So I live in the south bay of Los Angeles (Torrance/Harbor Gateway). My primary property is a 3/2 1266 SF home on a 7500 lot. We have in a hand the permit to build a 3/2 1100 SF home in backyard. I I can get the build done for 275k. This is a very reasonable price. And yes it's legit. The upside would be passive income in the range of $3500mo. Not sure about the added value to overall property since this is relatively new. Of course the new bill allowing us to possibly sell off either property is enticing but not sure how to value that either. The down side would be having tenants in our backyard along with all of the other potential landlord headaches. We have a duplex and a lake townhouse that we rent long and short-term out of state so we have some experience as landlords. Now I just want to ask any of you out there would you build in my position or invest that same amount of money? They both have have uncertainties. I'm enticed by stock market as I believe AI will likely make for greater returns in future due to companies running more efficiently. Assuming I could get ROI of 10% over 20 years investing in the market, what would you do?

[Jason Wray]

Victor,

I would avoid that high cost ADU and use that money to invest outside of California. California has become a trap for investors and home owners. The homes prices are way above reality as well as the taxes and most HOA's. In my 18+ years as a Banker I have seen over 90% of my CA investors either move or continue to buy outside of the state.

States like FL, IN, OH, TN, TX, AZ, NV all offer great LTR and STR options to capture a solid cash flowing property under $300K. Why spend $300K to build an ADU when you can buy literally (8) or more investment rentals with $300K. Using that $300K as a down payment on (8) $250K homes at 15% down is $270K total.

I would stretch that $300K out over several rentals and avoid the headache of a crowded property, that may or may not appreciate beyond its current value. Just because you add an ADU doesn't mean it's going to add enough value to recapture that $300K.

If it sounds slightly out of your comfort zone a simple conversation can be extremely impactful Thats where breaking down the payment management tools, local experts on small repairs, credit and background checks for renters, all comes into play. If you have any questions feel free to reach out I enjoy helping and talking REI.

[Victor Latimer]

Thanks Jason. Definitely the type of feedback I'm interested in. You'll likely hear from me for more input. 

[Travis Biziorek]

This is a highly personal decision. I'm going through an ADU build right now up on the Central Coast. We demolished our garage, expanded the footprint, and have an addition + garage on the lower level and then the 2/1 ADU as the top level. The total build is about 2,060 sq ft.

We'll operate it as a STR and probably do $4,000 - $5,000/mo in rents and then have the flexibility to block it off for friends and family when they visit.

I will say the process has taken longer than hoped. The planning phase took about 10 months and we've been in the build phase for nearly 7 months now. That said, we're nearly done.

[Rick Albert]

There are certainly pros and cons and will come down to your personal goals.

Pro: Because it is two properties on a lot, that is one insurance, one property tax bill, one gardener, etc. That makes managing things easier.

Con: You aren't getting dollar for dollar value back and if you use that money to buy another property, now you have two appreciating properties. From a leverage perspective, with $300K you can buy a $1M asset. Between appreciation, loan buy down, and cash flow, you may exceed that $3,500 in cash flow. 

You do win in either scenario so it really is a preference. For me, I'm focusing my investing right now on doors. Vacancies are a killer so having more doors allows for some diversification (having one vacancy in a fourplex is 25% vacancy versus a SFR vacant and that's 100% vacancy).

[Dan H.]

Quote from @Rick Albert:

There are certainly pros and cons and will come down to your personal goals.

Pro: Because it is two properties on a lot, that is one insurance, one property tax bill, one gardener, etc. That makes managing things easier.

Con: You aren't getting dollar for dollar value back and if you use that money to buy another property, now you have two appreciating properties. From a leverage perspective, with $300K you can buy a $1M asset. Between appreciation, loan buy down, and cash flow, you may exceed that $3,500 in cash flow. 

You do win in either scenario so it really is a preference. For me, I'm focusing my investing right now on doors. Vacancies are a killer so having more doors allows for some diversification (having one vacancy in a fourplex is 25% vacancy versus a SFR vacant and that's 100% vacancy).

 FYI separate units (not attached) on one property is 2 insurance policies.  

OP:

>Of course the new bill allowing us to possibly sell off either property is enticing but not sure how to value that either.

only jurisdiction in the state that has adopted the law allowing separating of the parcel is San Jose.  Note the law was in effect nothing because a jurisdiction could have allowed this prior to the new law and must op In with the new law.  So all the new law did was basically make clear an opportunity that already existed.  In general I believe very few jurisdictions will op in.  

The 2 biggest down sides in Southern CA is 1) in Single family zoned areas ADU additions add a value far less than the cost of the ADU addition. I suspect your $300k ADU will add less than $100k value. There was one recently posted on BP that appraiser gave less than $40k valuation. Search BP or attend local RE investor meet ups. You will hear numerous stories of appraisals almost universally providing value below $100k. 2) in most jurisdictions the primary if less than 15 years old will be rent controlled. I believe this is incorrectly applying the law, but good luck convincing the parties that enforce rent control.

Other issues that you did not mention with ADU addition is it requires a lot of work. Likely more than a BRRRR, but the returns are far worse. RE is great investment due to the easy leverage. ADU additions have more challenges to leverage. Related to the poor appraisals, it is cheaper to buy a property with an ADU already added than build one. There is a BP RE investor who uses this approach as one of his primary acquisition strategies.

>The upside would be passive income in the range of $3500mo

Normally I do not see people with residential experience refer to it as passive income. Note even with use of a PM, I would not refer to residentisl RE as passive (especially compared to the stock market). Next what expense ratio did you use for the $3500/month? I suspect this high number means it has zero leverage. The stock market has provided better returns than average RE if not using leverage. my view is in higher appreciation markets, leverage accounts for the bulk of the return. I further question if you are using rent to equate to income which is not reality. If your rent exceeds 1% which seems to be the case here, 50% rule is conservative but it provides a quick estimate. Using 50% rule with no leverage equates to $1750/month. Return from cash flow is 7%. Add 4% from appreciation (with no leverage you return equals the appreciation rate, note at 80% LTV the 4% appreciation equates to 20% return) for a total of 11%. Very close to S&P return but s&p is less effort.

I would not add an ADU in single family areas of southern CA. on any RE investment I do in moderate to high appreciation areas, I take advantage of leverage.

In your case as presented stocks is easy decision.  

Good luck

[Tim Ryan]

Hi Victor. I live in LA also and I am building many ADU's (contractor). And I also invest in rentals out-of-state. Here my thoughts: the deal is very decent on numbers, considering the land is free. Hard to get $3500/mo from a $275k investment in Cali!

Going forward depends on your living situation. I would not want renters in my backyard. My wife and I wouldn't have done it when raising kids and now that they are out of the house, we still wouldn't.

But we love rentals.  In your case, I would buy rentals out of state.  I would trust real estate way more than the stock market.  The key is to invest in the best markets in the US - best meaning growing (not already grown).  

More I can tell you about this. We should get a coffee since we are close. My daughter lives in Redondo.

[Alecia Loveless]

@Victor Latimer I quickly discovered that dollar for dollar an ADU build for me did not make sense. After the fact my property would only be valued initially at about 60% of the cost to build and I was only going to see about a 6% ROI.

I instead took my $100,000 and am leveraging it to buy a $450,000 7 unit building that will give me about a 15% ROI and 3X the cash flow each month.

I was able to stay locally whereas I would recommend you look out of state to do the same with your $300,000. If you want you can buy upwards of $1.2MM with a $300,000 down payment.

[Shiloh Lundahl]

@Victor Latimer I would definitely build an ADU in the back yard but I wouldn't build a 3 bedroom 2 bathroom home. I would either build a 2-bedroom home or 2 1-bedroom homes, or if I built a 3 bedroom 2 bathroom home, I would rent it out by the room. The reason is because a 3-bedroom home is for a family. That means that your backyard would be their front yard and the kids in the home would want to play so they would be playing in your backyard a lot. And it would have an impact on privacy and it would create noise. If you have a 1-bedroom or maybe even a 2-bedroom home then it likely won't attract families and you'll have people that are just looking for a place to live less expensively in a very expensive area and they don't need a lot of room and they likely won't be spending much time in your backyard. They'll probably just be walking from the home to their car and back each day. Building a one bedroom home will probably cost a ton less and it's more common than having a three bedroom home in the backyard. And you could probably still rent it out for $1500-$1800 a month.

When we lived in Burbank, California, we rented out our 300 square-foot studio guest house for $1500 a month. We had no issues with the tenant at all. In fact, the tenant became a good friend of ours and has since lent me money on some of my real estate deals even after he moved out and we sold that home. 

So I would definitely build the ADU, but I would do it smaller or figure out how to divide the space into more units.

[Jeremy Holden]

Quick rules of thumb on an ADU return on investment, can you achieve the 1% rule with gross rent?

[Nesha Renucci]

Hey Victor,

Diversification is always going to be the best thing to do so definitely invest also in the stock market in general but I would advise that you move forward with that ADU. So stocks are good but the issue is as you liquidate the asset depletes and till its eventually gone. With real estate your cash distribution is not from the asset it is based on the cash flow that you are getting in excess from the monthly rent. If you plan your expenses properly the income you get from your properties will cash flow for decades and that is money you can reinvest into stocks if you want but it is a stream that is ongoing and you can pass down if you want.

[Dan H.]

Quote from @Nesha Renucci:

Hey Victor,

Diversification is always going to be the best thing to do so definitely invest also in the stock market in general but I would advise that you move forward with that ADU. So stocks are good but the issue is as you liquidate the asset depletes and till its eventually gone. With real estate your cash distribution is not from the asset it is based on the cash flow that you are getting in excess from the monthly rent. If you plan your expenses properly the income you get from your properties will cash flow for decades and that is money you can reinvest into stocks if you want but it is a stream that is ongoing and you can pass down if you want.

Have you added an ADU? Can you provide addresses of the properties you added an ADU?
There is a reason experienced flippers are not doing ground up ADUs in CA

In general, ADUs cost more to add than the value added creating an initial negative position and typically cause the primary structure to now be rent controlled (even though I believe that is not applying the law as intended).  The issue is building a single small unit is very expensive development.  It is why developers that build in small numbers  (1 to3 units) always build large units. 

Add the finance issues, level or effort it requires, loss of something from primary unit (even if it is just yard), and the amount of time between first capital outlay and initial income.

In general, adding a ground up ADU in SF zoned area is a poor investment.

Best wishes

[Nesha Renucci]

.

[Nesha Renucci]

Quote from @Dan H.:

Quote from @Nesha Renucci:

Hey Victor,

Diversification is always going to be the best thing to do so definitely invest also in the stock market in general but I would advise that you move forward with that ADU. So stocks are good but the issue is as you liquidate the asset depletes and till its eventually gone. With real estate your cash distribution is not from the asset it is based on the cash flow that you are getting in excess from the monthly rent. If you plan your expenses properly the income you get from your properties will cash flow for decades and that is money you can reinvest into stocks if you want but it is a stream that is ongoing and you can pass down if you want.

Have you added an ADU? Can you provide addresses of the properties you added an ADU?
There is a reason experienced flippers are not doing ground up ADUs in CA

In general, ADUs cost more to add than the value added creating an initial negative position and typically cause the primary structure to now be rent controlled (even though I believe that is not applying the law as intended).  The issue is building a single small unit is very expensive development.  It is why developers that build in small numbers  (1 to3 units) always build large units. 

Add the finance issues, level or effort it requires, loss of something from primary unit (even if it is just yard), and the amount of time between first capital outlay and initial income.

In general, adding a ground up ADU in SF zoned area is a poor investment.

Best wishes

No I have not added an ADU myself, I have only worked with developers that have added ADU's on their properties and have seen return but that is in the Hollywood hills so not sure what market you are in. As you know it is not one size fits all so it worked for their personal strategy. My response was specifically in regards to investing in the stock market vs real estate. If the numbers are right holding his real estate could be a better option. I never said anything specific about the ADU. You provided a good perspective. Not sure why you felt the need to single out my post and not just answer his question. Best wishes to you also.

[Dan H.]

Quote from @Nesha Renucci:

Quote from @Dan H.:

Quote from @Nesha Renucci:

Hey Victor,

Diversification is always going to be the best thing to do so definitely invest also in the stock market in general but I would advise that you move forward with that ADU. So stocks are good but the issue is as you liquidate the asset depletes and till its eventually gone. With real estate your cash distribution is not from the asset it is based on the cash flow that you are getting in excess from the monthly rent. If you plan your expenses properly the income you get from your properties will cash flow for decades and that is money you can reinvest into stocks if you want but it is a stream that is ongoing and you can pass down if you want.

Have you added an ADU? Can you provide addresses of the properties you added an ADU?
There is a reason experienced flippers are not doing ground up ADUs in CA

In general, ADUs cost more to add than the value added creating an initial negative position and typically cause the primary structure to now be rent controlled (even though I believe that is not applying the law as intended).  The issue is building a single small unit is very expensive development.  It is why developers that build in small numbers  (1 to3 units) always build large units. 

Add the finance issues, level or effort it requires, loss of something from primary unit (even if it is just yard), and the amount of time between first capital outlay and initial income.

In general, adding a ground up ADU in SF zoned area is a poor investment.

Best wishes

No I have not added an ADU myself, I have only worked with developers that have added ADU's on their properties and have seen return but that is in the Hollywood hills so not sure what market you are in. As you know it is not one size fits all so it worked for their personal strategy. My response was specifically in regards to investing in the stock market vs real estate. If the numbers are right holding his real estate could be a better option. I never said anything specific about the ADU. You provided a good perspective. Not sure why you felt the need to single out my post and not just answer his question. Best wishes to you also.

>Not sure why you felt the need to single out my post and not just answer his question. 

I was curious because your comment “I would advise that you move forward with that ADU.". I was curious if you had done what you were recommending the OP do. if you had done a ground up ADU addition, I was curious what your valuation was. Maybe you had a different experience than what many investors are encountering. I did not mean any offense, just curious. Apologies if I offended.

Search the forums to see the appraisals many of these ground up ADU additions in SF zoned areas  are getting.  They are regularly getting poor valuations compared to the cost to add the ADU.   

Again I apologize if I offended you.  

Good luck

[Dan H.]

Quote from @Nesha Renucci:

Quote from @Dan H.:

Quote from @Nesha Renucci:

Hey Victor,

Diversification is always going to be the best thing to do so definitely invest also in the stock market in general but I would advise that you move forward with that ADU. So stocks are good but the issue is as you liquidate the asset depletes and till its eventually gone. With real estate your cash distribution is not from the asset it is based on the cash flow that you are getting in excess from the monthly rent. If you plan your expenses properly the income you get from your properties will cash flow for decades and that is money you can reinvest into stocks if you want but it is a stream that is ongoing and you can pass down if you want.

Have you added an ADU? Can you provide addresses of the properties you added an ADU?
There is a reason experienced flippers are not doing ground up ADUs in CA

In general, ADUs cost more to add than the value added creating an initial negative position and typically cause the primary structure to now be rent controlled (even though I believe that is not applying the law as intended).  The issue is building a single small unit is very expensive development.  It is why developers that build in small numbers  (1 to3 units) always build large units. 

Add the finance issues, level or effort it requires, loss of something from primary unit (even if it is just yard), and the amount of time between first capital outlay and initial income.

In general, adding a ground up ADU in SF zoned area is a poor investment.

Best wishes

No I have not added an ADU myself, I have only worked with developers that have added ADU's on their properties and have seen return but that is in the Hollywood hills so not sure what market you are in. As you know it is not one size fits all so it worked for their personal strategy. My response was specifically in regards to investing in the stock market vs real estate. If the numbers are right holding his real estate could be a better option. I never said anything specific about the ADU. You provided a good perspective. Not sure why you felt the need to single out my post and not just answer his question. Best wishes to you also.

>Not sure why you felt the need to single out my post and not just answer his question. 

I was curious because your comment “I would advise that you move forward with that ADU.". I was curious if you had done what you were recommending the OP do. if you had done a ground up ADU addition, I was curious what your valuation was. Maybe you had a different experience than what many investors are encountering. I did not mean any offense, just curious. Apologies if I offended.

Search the forums to see the appraisals many of these ground up ADU additions in SF zoned areas  are getting.  They are regularly getting poor valuations compared to the cost to add the ADU.   

Again I apologize if I offended you.  

Good luck

[Hanh Hoang]

I am a southern California real estate agent and I would say that the stock market may get you a better return on your 275K in capital invested. There is no right or wrong way to invest. 

You could also look for a small multi family for 1 million and have the 275K (down payment) for that duplex or fourplex.  There will be more work and headaches but the property will be more advantageous in regards to deprecation, principal pay down, appreciation over the next 10 years. 

It just all depends on what you want, if you perfer a tenant in your back yard paying you 3500$ and that helps you sleep better at night then go that route.

If want a small multi family about 30-45 mins away from your home that has 2-4 tenants in there thats also a good way to go also. 

[Nesha Renucci]

Quote from @Dan H.:

Quote from @Nesha Renucci:

Quote from @Dan H.:

Quote from @Nesha Renucci:

Hey Victor,

Diversification is always going to be the best thing to do so definitely invest also in the stock market in general but I would advise that you move forward with that ADU. So stocks are good but the issue is as you liquidate the asset depletes and till its eventually gone. With real estate your cash distribution is not from the asset it is based on the cash flow that you are getting in excess from the monthly rent. If you plan your expenses properly the income you get from your properties will cash flow for decades and that is money you can reinvest into stocks if you want but it is a stream that is ongoing and you can pass down if you want.

Have you added an ADU? Can you provide addresses of the properties you added an ADU?
There is a reason experienced flippers are not doing ground up ADUs in CA

In general, ADUs cost more to add than the value added creating an initial negative position and typically cause the primary structure to now be rent controlled (even though I believe that is not applying the law as intended).  The issue is building a single small unit is very expensive development.  It is why developers that build in small numbers  (1 to3 units) always build large units. 

Add the finance issues, level or effort it requires, loss of something from primary unit (even if it is just yard), and the amount of time between first capital outlay and initial income.

In general, adding a ground up ADU in SF zoned area is a poor investment.

Best wishes

No I have not added an ADU myself, I have only worked with developers that have added ADU's on their properties and have seen return but that is in the Hollywood hills so not sure what market you are in. As you know it is not one size fits all so it worked for their personal strategy. My response was specifically in regards to investing in the stock market vs real estate. If the numbers are right holding his real estate could be a better option. I never said anything specific about the ADU. You provided a good perspective. Not sure why you felt the need to single out my post and not just answer his question. Best wishes to you also.

>Not sure why you felt the need to single out my post and not just answer his question. 

I was curious because your comment “I would advise that you move forward with that ADU.". I was curious if you had done what you were recommending the OP do. if you had done a ground up ADU addition, I was curious what your valuation was. Maybe you had a different experience than what many investors are encountering. I did not mean any offense, just curious. Apologies if I offended.

Search the forums to see the appraisals many of these ground up ADU additions in SF zoned areas  are getting.  They are regularly getting poor valuations compared to the cost to add the ADU.   

Again I apologize if I offended you.  

Good luck

I appreciate you replying and apologizing Dan. I should have been more clear in my response so that was my fault for not elaborating about working the numbers on the deal. I was just trying to make a point of analyzing it from all sides first before giving up. I had no idea about how bad the valuations are for building the ADU units. Of course it sounds good as extra income but as I am looking it does sound like a headache and not appraising well. Again appreciate you Dan for taking the time inform me.