Who's adding an ADU to boost cash flow?

Question

We own a SFH that cash flows about $150/mo after all expenses. We're currently converting a detached garage on the property to an ADU. It's less than 700 sq ft but a 2/1 works nicely there. According to our PM, we should be able to conservatively get $900/mo in rent in our market. The rent from the ADU becomes a huge boost to our cash flow from this parcel for a relatively small price tag (about $20K for the ADU renovations). Obviously the numbers wouldn't work this well if we had to build from scratch because our expenses would go up, but we wouldn't get any more in rent. We're really liking the niche and we're on the lookout for similar properties. I'd love to hear from other investors about your experiences (good and bad) working with ADUs. What are you looking for? Things you wish you'd known? Tips? How to make the most of the space? Is it important to divide the space so each tenant has some sense of privacy and outdoor space? Etc. Thanks in advance!

Teri Feeney Styers · Answer

@Bonnie Low - my most recent completed project - all new construction.

Dan H. · Answer

I think there are better RE options than building an ADU, but the OP is an exception due to my belief with their skill set that they are qualified to provide a good cost estimate and therefore should be close to their $20k estimate.  Most investors building their first ADU, I would allocate over 3x the cost for hands off construction and hands on typically would not save much for the investor with zero experience especially when accounting for hold time.  Your garage conversion estimate is a tad lower than the range I would use for hands off garage ADU conversion in San Diego, but close enough (I would use $65k to $90k).

A protege of mine sold a 3/2 home with a garage ADU conversion (1 large br) just prior to Covid.  I estimate the appraisal gave him about 50% of the hands off cost for the ADU.  Combine this with the typically less that optimal financing, the work involved, the loss of the garage and my belief is that there are typically better RE investments.  I think your customer got a better appraisal than many investors who build ADUs are obtaining

The non garage conversion ADU does not lose a garage, but it costs significantly more.   It has the other same disadvantages and therefore I believe there are better options than building a ground up ADU.

Our BRRRR track record indicates we can achieve better return via BRRRR (similarly not passive).  As of this month, all of our BRRRR properties have had all our initial investment extracted.  We are also achieving better return on our current off market acquisition for much less effort (not counting all the networking that allowed us to be in position for this purchase).

In addition, with the ADU appraisals being significantly less than the hands off costs, an RE investor would be better off purchasing a property with an already built ADU (at 40% to 75% of the hands off construction cost) then building their own ADU.  Less work and cheaper.

It is my belief most RE investors can achieve better return via multiple other RE investments (including some syndications).  It is also my view that the OP has better experience/skill in this area and if they can do a garage conversion for close to their $20k estimate, then the garage conversion ADU can be a good strategy for the OP.  I would do these ADU conversions easily if I believed I could do them for $20k.  I cannot, so we do not concentrate on ADU conversions.

Teri Feeney Styers · Answer

@Bonnie Low I have built separate units, split houses to have several units, built two tiny houses on one lot, etc. It was profitable every time. However, I would suggest that you visit your local building department. A detached garage may not pass basic code for a residential structure. Often the slab is not the proper depth or design.

Dan H. · Answer

From your profile, I believe you may be able to do your garage conversion ADU for close to that price ($20k).   For most people, I would estimate the hands off cost at at least 3 times that amount.

For a hands off investor who spends $60k+ for a garage conversion ADU, the ADU is not a value add in that an appraiser is unlikely to give $60k value for the ADU.   However, if the ADU can be built at an all in cost of $20k, then it likely is a value add as I suspect an appraiser will give at least $20k of value and hopefully quite a bit more

If you can successfully convert a garage to a legal permitted ADU for $20k, I think you have found a niche that leverages your existing knowledge and skills and that you could do very well with this plan. I see little risk if the ADU addition is an additional value add to the standard BRRRR rehab value add.

No one that I am aware of has argued the cash flow benefit of the ADU. What makes it not a great option for many investors is the high cost of construction combined with the appraisals coming in less than the hands off cost. Your scenario does not have this issue because your cost will likely be less than the value set by the appraiser.

For most investors, the better return is purchasing a property that already has the ADU.  they will end up spending less going this route than doing a hands off ADU build.

When you complete your first ADU, please post your actual costs. I do realize subsequent ADUs will leverage the lessons learned and likely cost less. However, I am interested in how inexpensive the ADU build can be done by someone with the right knowledge/experience.

Good luck

Bonnie Low · Answer

@Teri Feeney Styers that is gorgeous! Love it!

Who's adding an ADU to boost cash flow?

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