Every property in CA should have at least 1 ADU

[Pavan Sandhu]

Every SFR in CA should have at least 1 ADU. I'd even go as far as to say you are losing money every month by not having an ADU on your property. These new laws are only in effect till 2024. What's stopping you from adding an Accessory Dwelling Unit to your property?

[Dan H.]

I disagree if you are advocating a hands off ADU addition (use of GC, contractors, designer, etc). Doing the effort yourself likely only makes sense if you already have the skills or plan on doing more than one ADU addition (can leverage the learning on future ADU additions).

The appraisals in most markets are coming in greater than $50K below hands off construction costs. The financing typically does not present terms that are as favorable as purchase financing. The level of effort hands off is about the same as a rehab (BRRRR) with far more money required for the ADU addition. The ADU subtracts value from the existing unit by reducing either the yard or by consuming a garage (assuming not in current living space which would even more significantly reduce the cash flow). The under value as set by the appraisal implies that the investment capital is trapped until appreciation can surpass the negative position by at least 33% of the total value (assuming 75% LTV REFI). The initial cash flow goes to recover the negative position as set by the current value of the ADU. It is often years before there is any cash flow in excess of the negative position.

In most markets, the ADU addition is one of the worse RE investments. I can do a BRRRR, trap very little into my asset and have added value in excess of the costs (versus a hands off ADU typically adds value far less than the costs). I can do a turnkey investment and start far less negative than an ADU addition.

However, if you are referring to purchasing a unit with an existing ADU, this could provide a good value. The purchase would be at market based value of the ADU which in most markets if over $50K less than the hands off costs. The financing would be at purchase financing (typically superior to ADU addition financing). The cash flow would be similar to adding the ADU, but the costs would be substantially less.

Note, I also use the term "hands off".  If you are a developer, GC, a skilled worker with time to do significant amount of the work then these are different scenarios than the hands off scenario that I reference.

Anyone who wants to do add an ADU should start by understanding how the ADU will be valued for their property/market. If it is going to be valued significantly less than the costs (most markets), this initial negative position has to be factored into the decision. Recognize any negative position implies that the costs are trapped until appreciation provides the opportunity to extract any part of the ADU investment. Then look at the financing terms.

Virtually every COC calculation I have seen for ADU additions do not reflect the negative initial position and therefore are not accurate (or at least not an apples to apples comparison with COC calculations on most other investments).