Advise on ADU vs invest somewhere else?

Question

Hi All,

I am just starting out and read as much as I can on the forums and ready to take the first step.

The option I am leaning towards is to build an ADU in my backyard, rent it out and get first hand experience on managing rentals and then expand out. The other option is to go with out of the state rentals. While this may be ok for the experienced, i am worried about not choosing the right area when I don't have any rental management experience given where we are at in the RE cycle.

My ultimate goal is to own a/some multi family units for scale and increased cashflow to not worry about day job.

Here is why the ADU makes sense to me:

• Proximity: to deal with any issues.
• Minimal cash outlay while increasing the house value from adding new space
• Expensive rents in the area

Financials:

• Thinking of constructing about 620 Sq.Ft ADU given the zoning restrictions and lot space.
• Cost estimate : 150k (Have not validated this with a GC yet but will do). 
• Expected Rent : $2300/month = $27600/year. Thats 1.5% which is above the 1% rent rule
• Will take a HELOC on the current house at approximately 4.5%.
I can fund the project without taking the HELOC also.Is there any better way to do this than the HELOC? Since this will be new construction, For a few years the CAPEX should be minimum.
• I can fund the project without taking the HELOC also.
• Is there any better way to do this than the HELOC? 
• Since this will be new construction, For a few years the CAPEX should be minimum.

• I can fund the project without taking the HELOC also.
• Is there any better way to do this than the HELOC? 
• Since this will be new construction, For a few years the CAPEX should be minimum.

Two questions:

1. Important question: can I use the $150k (HELOC) along with the other money I have (Upto $500k) in a better way for the long term? To be clear, am I wasting time to reach my end goal by taking baby steps instead of starting out say, with a Multifamily syndication and figure things out as I go. Because to me either path requires me to learn the ropes. I can also probably take the hybrid approach and do both may be?

2. Less important but, With an ADU, Should I be worried about future sellability of the house in any way? I understand that some people may be turned off especially when purchasing at high costs. On the other side, equally, given the high cost of housing locally, there may always be someone who may want an ADU to reduce costs. I plan on living in the house at least for the next 8-10 years. So may be this is a non-issue?

Thanks.

Steve K. · Answer

@Mike Re , ...there are mixed opinions on short-term rentals (i.e. airBNB), but some folks were advocating the ADU could make 2x or 3x the monthly rent if you tried short term rentals, as opposed to a 12-month lease. Search on those threads here at BP

Arlen Chou · Answer

@Mike Re the ADU is definitely something that can be done and an interesting strategy. However, I think your construction budget is low. You are penciling approx $240/sqft, does that include you doing some of the work or providing materials? By no means do I know everybody in construction in the area, but everybody that I know is way to busy and working on projects that have much higher profits for them to pick something up in this price range. More clearly, it might be really hard for you to find somebody that will do a $150K job. Even if you do find somebody, be prepared to be at the bottom of the totem pole in terms of project priority. They will undoubtedly use your job as "fill work". This translates to the potential of delays and frustration on your part.

I think that if you were to do much of the GC work yourself, you would have a stronger chance of getting done at this budget point. That does not mean that you need to swing the hammer, but if you cut the project down to smaller pieces and do all of the coordinating you should have a better chance of controlling time lines with the subs. As this is on your primary residence, you should be able to pull of the permits you need from city without any problems.

I think that if you were to do much of the GC work yourself,  you would have a stronger chance of getting done at this budget point.  That does not mean that you need to swing the hammer, but if you cut the project down to smaller pieces and do all of the coordinating you should have a better chance of controlling time lines with the subs.  As this is on your primary residence, you should be able to pull of the permits you need from city without any problems.

Account Closed · Answer

Hi Mike,

I think you will be better off just buying out of state property/properties with a good cash flow.

It is definitely doable even in this market...

I just think instead of doing big construction project you could buy multiple properties out of state,

and the cash flow much faster than building a property from scratch...

Also the rules and regulations in Bay Area typically very tenants friendly so even if you have a good cash flow it can be challenging to evict bad tenants, rent control issues ...etc.

If you want to learn more about out of state investments and especially multifamily apartments feel free to check this meetup:

meetup.com/Los-Gatos-Real-Estate-Networking-Meetup/

Amit M. · Answer

@Arlen Chou yes that makes sense. An ADU is probably an asset in the budget to mid range neighborhoods, and possibly a liability in high end ones. Unless you could repurpose it as a "pool house" or cool office space for dad to use ;). Or the nanny...could be a nanny's quarters too.

Arlen Chou · Answer

@Mike Re I don't think it is the actual $ per sqft number that I would be concerned with in this area.  It is finding a good GC who will think it is worth while to take you as a client.  I think if you did all the GC work yourself you might be able to get in at your target number.  But then you will also have architectural costs on top of that.  ALL of the guys I personally know are running multiple multi-million dollar projects and have multiple projects waiting in the wings.

If I were personally doing it, I would look for something that is prefabricated and get them to help you as much as possible.  They should provide you with all of the drawings that you need and I assume they will make revisions per city requirements.  I would then find my own foundation, electrical and plumbing guys.  To save on final costs, I would probably do the interior finish work myself.  But I only say this is what I would do because I personally like the planning and organizing.  I also know that I am a pain in the a*$ when it comes to finish quality, and I would end up with a long "punch list" for the GC which equals time and headaches.

@Amit M. All of the construction I have seen in Los Altos has been scrape and build, with a trend in full basements for either entertainment rooms or massive garages.  Everybody in this area is maxing out their square footage for their own use and I don't see people really wanting or needing a "tenant" for extra cash in the mid-pen area.  Going into Los Altos Hills, its a different story.  They are not called ADU's up there, they call them "pool houses" or guest houses... hahaha. Much of the recent construction that I have seen up in the hills has some type of stand alone building.  However, the "guest houses" that I know of are either used as offices or are actually used for extended family or friends.

Amit M. · Answer

Few comments:

1- I'd absolutely invest locally. You have enough money to do so. Doing an ADU is a great way to start off. Your appreciation in 10+ years will make you glad your stayed locally imo.

2- consider doing a cash out refi, and use that instead of a heloc. Why?  It will then become long term debt at a fixed rate.  Conserve your cash. you can use it in 1-2 years as down payment on something locally, like 2-4 units. And if prices soften more, you will be well aligned to make your next move.

3- the value of an SFH with an ADU in YOUR SPECIFIC CITY AND NEIGHBORHOOD is an Important question for you to understand. Unforch, you will get various opinions. i.e. Usually, higher end neighborhoods are not interested in ADU's, as most buyers are wealthy enough to buy regular homes, plus they want the privacy. BUT that sentiment may be changing. So I'd talk to lots and lots of local realtors who know the area well and try to get a consensus on that. Also ask about the added value of the new sq footage you're adding. It should be considered legal sq feet of living space. That's a tangible difference in value, unless again, people in that area don't want it.

@Arlen Chou curious what is your take is on point #3?  For instance, in your neighborhood of Los Altos, do you think an ADU would help or hinder value?  And try to think of that through your neighbors perspective. You're an RE investor and maybe wouldn't mind an ADU in your back yard, but would your neighbors entertain the thought?

We have the same quandary here in SF, and TBH, I don't have a clear answer in my mind, yet. But I'm quite sure it's neighborhood dependent :)

Chris Mason · Answer

Hi @Mike Re,

If you're going to pay the ARM HELOC off relatively quickly, like flippers do, HELOCs are great. In your scenario, however, it'd be easier to just skip that middle step and pay cash. If you want to leave that debt outstanding, by contrast, may as well do it with a fixed rate cash out refinance.

I really doubt it. California is getting more ADU friendly, not less. If anything, buyers see it as a positive when I tell them that the down payment, interest rate, etc, is that of an SFR, and not that of a duplex, but they can still turn around and rent the ADU out to their heart's content. .

Advise on ADU vs invest somewhere else?

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