California ADU below cost appraisal issue

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California ADU below cost appraisal issue

Angelique Herman
Member since 2018 · 8 posts · 5 votes

Hi BP folks

I’m wondering if any California investors have experienced this same issue…

Backstory, I am in the mid stages of a long term live in BRRR. I have a SFH that's has the garage converted to a Junior ADU fully permitted. It's separate from the main house and currently rents for 1445/month. I'm in Santa Maria, CA in Northern Santa Barbara County.

We just got an appraisal done and got a very low value assigned to the JADU portion. The issue is that this appraiser only has 1 other property that has a converted garage studio and derived a value of 50k for it, then applied this value to the other SFH comps in our neighborhood. The lack of a garage penciled out to -10k so the net increase for the studio only netted +40k on this appraisal worksheet. This studio costs us 84k to build, so having it appraise at less than half of the cost is obviously a problem. This particular refi could still work out for us but the larger concern is for the future moving forward.

If the future appraiser values the as-yet-to-be-built future ADUs at roughly half of what it costs to build, I don't think that's something we can continue to do. Are there any options for instances where there aren't good comparables in the area? The issue seems that ADUs have not been built a lot in the area yet and that properties with ADUs have not been sold much. I would think that a buyer would value a permitted studio ADU that costs 84k to build higher than 50k already built, especially considering it grosses 1445 per month in rent. Is there a way to value it differently as if marketed to an investor as a multi family? Or does anyone know of lenders that are more friendly or like to work with folks trying to do a cash out refi on a property with an ADU that doesn't really have close comps? Thanks for your help.

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  • Dan H.Pro Member
    Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
    5y

    This is common in many areas of CA, but not all areas.  I have made many posts on this subject.  It is very important to know how the ADU will be valued by the appraiser before proceeding to add the ADU.  This means finding multiple comps that can justify the desired value.

    In your case you are starting with a negative $44K of value.  This will consume multiple years of cash flow to recover the initial negative position.

    As you indicated, the issue is not only that the initial negative position consumes years of cash flow, but it also implies the ADU investment cannot be extracted until appreciation has been high enough to make it possible (this could also take years).

    My initial protege had a 1 BR garage conversion ADU that hands off would have been ~$100K (value just before COVID, it would cost more to build today). He fortunately played an active role and it did not cost him $100K. He received an appraised value of ~$50K for the ADU when trying to sell which was ~$50K below the agreed upon selling price. Fortunately his buyer wanted the unit enough that they bridged much of the appraisal gap (it was the only way they were going to be able to purchase as my protege was willing to rent it). So it is not just an issue when refinancing, but it is also an issue when trying to sell.

    His experience educated me on this issue which has resulted in me posting the warning about appraisals associated with ADUs many times.  Make sure you know how the ADU will be valued by appraisers.

    I am sorry about the low appraisal. You will know for your next ADU addition to be sure to know the value of the ADU as set by appraisers before proceeding.

    Good luck

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  • Angelique Herman
    OP
    Member since 2018 · 8 posts · 5 votes
    5y

    Hey Dan,

    Thanks for your response. Do you have any good tips on how to know what an appraiser will do without knowing one? That was the problem I had. There aren’t comps in my immediate vicinity so didn’t have that to look at either. 

    It’s also not as bad as it sounds because I still get good cash flow from the studio unit  but just had to invest the 44k to get it. 

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  • Angelique Herman
    OP
    Member since 2018 · 8 posts · 5 votes
    5y

    Hey Dan,

    Thanks for your response. Do you have any good tips on how to know what an appraiser will do without knowing one? That was the problem I had. There aren’t comps in my immediate vicinity so didn’t have that to look at either. 

    It’s also not as bad as it sounds because I still get good cash flow from the studio unit  but just had to invest the 44k to get it. 

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