Add value through ADU conversion

[Marco Werner]

Hi all, 

I am looking at a duplex (1500 sqft), which has a large detached garage (~700 sqft floor area). 

I am thinking of adding 2 stories on top of the garage (essentially rebuilding the garage) and adding north of 1000 sqft livable space. The property is in LA and I am trying to think through how much value I am adding to the property. 

Is it fair to assume that the added sqft from the ADU conversion adds value to the property? Should I apply the simple math of average price per sqft in the area times the added sqft? Minus potentially a small discount since it's an ADU? The bank I have been talking to for the loan / construction loan seems to be willing to apply that logic.

Would love your thoughts!

[Dan H.]

ADU in sf areas of San Diego are seldom getting values from appraisers over $100k. This is n spite of it costing much more than that to add an ADU.

Look for comps of properties sold with an ADU then look for comps comparable to the house without the ADU. That will show you how the market values the ADU. If you cannot find at least 3 comp properties with an ADU, then be prepared for a horrendous valuation (<=$100k).

It s my view ADU additions in So Cal are one of the worse RE investments especially in SF areas. Here is a list of reasons:

1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged (HELOC, cash out refi, etc). Leverage magnifies return.
3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing.  This reduces exit options and affects the value.  
10) Small number of small units is the most expensive residential development there is.  This implies residential units can be built at lower costs and provide better return. 

Good luck