Build ADU or buy investment property?

Question

Long time reader first time poster.  I am debating between building an ADU in our backyard or buying an investment property out of state.  We have an external garage that we could build a small ADU, 350-400sq ft, on top of.  Cost would probably be around 125k from talking to my contractor.  We live in a nice beach community in north San Diego, so rent I'm guessing would at least be 1500/mo. Downfall is privacy, we could probably build it with a separate entry but lots in our in neighborhood are all 5000sqft, so it's tight. Bonus would be have extra room for family members down the road if we decided not to rent it out.

My other option is buying a rental out of state, MN, where my other rental is.  Cost about 300k for a decent house and rents around 2000+/ mo. I have a property manager that is great and already looking after my 1st investment property.

ADU would be funded 60k cash and home equity loan for remainder. Investment property 60k cash and mortgage.

I know it's a pretty vague question but just wondering what you all might think.

Carlos Ptriawan · Answer

This was my problem a few years ago: choices are (a) OOS (b) ADU (c) BRRR/S in CA.
I did (a) and (c) finally and turn out the total return is much better just by doing BRRS, I made 120% IRR in total return post-tax.
I avoided ADU due to appraisal issues and unless the house is used for Airbnb (or family needs), it's not worth trying, too much hassle, I think ADU is very location and needs-specific and could be a profit maker if the location is perfect. If you have cash, rehab and build are much2 better options. OOS is okay but unpredictable repair although it's a turnkey house, is frustrating :) lol.

Thanks!

Dan H. · Answer

Those that mention the appraisals are a moving target are using it as a euphemism for most ADUs add an appraised value significantly below the hands off cost of the ADU.  This implies that hands off ADU additions start off with a negative position, often in excess of $50k negative position.  The initial cash flow goes to recover this negative position.  It typically takes years to recover the negative position.  I suggest you understand how the ADU will appraise before proceeding with the ADU build.

The appraised value of the ADU will have a big impact on being able to extract your investment in a timely manner to re-leverage.The financing options on ADU builds are also typically worse than investment property purchased.

The loss of privacy in effect detracts value from the primary structure.

All these factors result in the cash flow often being a Lorelei that leads to results that often fall short of other options.

Good luck

David Frandsen · Answer

I second what has already been said and think you will have no problem renting out an ADU for top dollar in San Diego PLUS you have the potential appreciation that San Diego has to offer.

Travis Biziorek · Answer

Hey Nick, have you actually had these numbers quoted out or are you ball parking on the ADU? Also, are you able to do short-term rental on the ADU?

We're going through this right now on the Central Coast. But we're being a bit aggressive with it, tearing down the garage and putting in a 1,060 sq ft 2/1 above it along with a guest bedroom and full bath behind the new garage.

We're through the initial design phase with the architect and now doing our soils report so we can get a structural engineer involved. You may be able to skip most of that give the smaller size of your ADU.

Anyway, we've been talking to a lot of contractors and are deciding to simply white box the structure. We'll do the finishes ourselves and save about 50% of the build costs. We'll be able to get the structure up, windows in, roof done, plumbing, electrical, etc. for ~$150k. That's a footprint for 1,060 sq ft but total square footage of 2,112 (including the garage).

All this to say... if you're handy or think you can do the finishes you could really get those costs down. And if you could operate it as a STR you'd like be able to push your rental income a good bit higher.

Peter Mckernan · Answer

Yes those are really the best ones to go after since the builders back in 50s-70s built smaller homes due to the make up of a family back then, and also the builders were not using all areas of the lot overall.

These are the key ones to look at and go after as you said as well that OOS and ADU are different purposes including different numbers in returns and exit strategies.

Peter Mckernan · Answer

Do you have an alley is it a corner lot, those are always a lot better for an ADU with entry/exit for tenants which translates to higher rents, better tenants, and higher value.

Maxwell Ventura · Answer

@Nick Lawrence

I have a team in which you should be able to finance more of the ADU project if you're interested. As Kenneth said, ADU appraising is a bit of a moving target right now, but the CF should be there initially. Having separate access (out of sight/out of mind) is great. Keep in mind you're also adding SQ ft to your property and I believe appraised values should start increasing. Our inventory crisis isn't going to get any better anytime soon. Also keep in mind the gains you'll make on Appreciation out here will compound significantly faster than a 300k property.

Huong Nguyen · Answer

Hi! Can I have the company name to contact them? I am in the Bay Area

Travis Biziorek · Answer

That sounds like a blanket statement. And rules/regulations tend to be very localized.

Farzan Setayesh · Answer

@Travis B.you can’t do  STR in ADU.

Build ADU or buy investment property?

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