My second ADU project in the Bay Area (why and how?)

[Chen Zhou]

Hi everyone,

I've got tremendous help and support from this forum in the past 3 years. To give back to this community, I thought I'd share information on the second ADU project I'm working on in Santa Clara. I posted about my first ADU project in San Jose back in 2019 and shared 3D visual, pictures and numbers if you are interested: https://www.biggerpockets.com/...

Building an ADU could be a daunting task and takes a lot of $$ and effort. So why is ADU a good idea? 

The short answer: strong cash flow and immediate equity creation! It's been almost 2 years since my ADU project in San Jose was completed. I not only found (and kept) amazing tenants but also took out a home equity loan (through Figure.com) from the San Jose property at really good rates (whole process took 5 business days from application to money in my bank). Thanks to the red hot housing market, I was able to take out $250k, $50k more than the initial $200k that I invested into the San Jose ADU project. I'm planning on using the $250k home equity loan towards my second ADU project in Santa Clara.

In fact, I realized that as long as I can create strong cash flow for each of my ADU projects, I can just rinse and repeat this process - invest the equity created from the last ADU project into building the next ADU. If done right, the rents from the last ADU would more than cover the home equity loan monthly payments + increased property tax.

A little more about the Santa Clara ADU project I'm working on now:

With the experience from the first project, this time around I'm more confident about who I should work with, budget, timeline, what kind of tenants and rents I'm able to get, and of course things to watch out for. In addition, California loosened the ADU regulations at the beginning of 2020. All bay area cities reduced fees, and made it easier for homeowners to build larger ADUs, which also made my decision easier.

This time, I'm building a 2B1B 1200 sqft detached ADU in Santa Clara. The reason I designed a 2B1B instead of a 2B2B is that Santa Clara only allows 1 bathroom maximum at this time. However, I do expect the codes to relax overtime, so my architect designed a large walk in closet for one of the bedrooms that could be potentially convert into a bathroom in the event that Santa Clara allows a 2nd bathroom for ADUs in the future. Here's the floor plan if you are interested:

I budgeted about $400k total for this project. Will see if I can pull this off.

Other factors taken into account:

1. Time horizon. I'm a buy-and-hold investor and I'm planning on holding on the property for decades, so instead of immediate resale value (which ADU doesn't compare very well with perhaps other rehab/flip projects), I care much more about long-term cash flow and long-term resale value. In the long-term, I think SFH with ADUs will sell very well because I do believe multi-generational living will be more and more common with 1) more immigrants moving to the bay area with their elderly parents and 2) baby boomers starting to take care of their elderly parents who need long-term care. Demographics are in favor of ADUs for sure. Also, who doesn't like additional rental income to help with the mortgage payments? But the ADU design needs to take these various scenarios into account and create enough separation/privacy between the 2 households living on the same lot.

2. Rental market in the bay area. When the pandemic first hit in 2020, I wasn't very sure about building ADU since everyone started working from home and the bay area rental market was suffering as more people moved to cheaper places. However, since the vaccine rollout started, I saw more and more people moving back to the bay, and I'm confident most tech companies in the bay area are going to adopt a hybrid working model instead of a 100% remote model, which still requires people to live close to the offices/campuses.

3. Cost of construction is going up every year (raw materials, labor, fees, etc.). So if you are contemplating on building an ADU, it doesn't hurt to start planning early. To me, the earlier I can start and finish the project, the lower the building cost will be and the earlier I can achieve better cash flow. Each day of delay is $$ lost.

4. Effort and commitment. It IS hard work to build an ADU and it will take roughly a year from planning to finding tenants, but once it's done, you will benefit from the hard work for decades. So you want to make sure you are mentally prepared for the hard work going in and are committed to see it through. It will be a very gratifying process. Because of the large investment and high stakes, don't underestimate the importance of choosing the right designer & contractor to work with. You want experienced experts that can guide you through the process, not someone who adds additional stress to the whole process.

Lastly, happy to answer any questions. Would love to connect with you if you are also building ADUs in the Bay Area.

Cheers,

Chen

[Dan H.]

Originally posted by @Chen Zhou:

Originally posted by @Hai G.:

Thanks for sharing, Chen. Curious what kind of rent are you foreseeing for the new ADU build? Are you doing it for long term rental purposes?

I recently completed an ADU build (attached ADU) in one of my properties. While the return is good with that one the prospect has gotten worse with plummeting rent in the Bay Area and higher build cost that I'm not sure if I would build another one. Curious about your thoughts.

Congrats! Do you mind sharing the numbers for the attached ADU?

I had the same dilemma last year, but now want to build my second ADU ASAP. for the following reasons:
- I think the pandemic actually makes ADUs better/more attractive options than apartment complexes. If designed well, you are talking about renters getting SFH like experiences with a private yard. If you make your ADU a premium unit/super cute, you can attract high quality renters who will stay longer.

- Also building cost is only getting higher in the future, so it's better to lock in lower price/property tax now than to wait further.

- Overtime, the math will continue to get better as rents go up over time. 

Chen

What makes you believe building costs are not coming down?  The price of plywood is up almost 300% in the last year.  There are a few reasons, but they do not seem likely to be long term impacts to the price.  I had to purchase many sheets of plywood recently; the increase in plywood cost is astronomical.  I suspect plywood will drop 50% in the not too distant future.  OSB similar.  Other lumber has risen less significantly, but seems likely to drop in the near future. I expect building costs will come down as the cause of much of the increase is not something that should be on-going.

I agree that apartment living is currently as a significant low.  What I am less certain is if it will stay that way as the risks associated with COVID are reduced.  No way to know, but what I suspect is the lower costs associated with apartments will result in many migrating back to apartment living.  

In time we will know, but I will be surprised if supply costs do not come down.

Good luck