Hi all -- I'm trying to understand why more people haven't built ADUs on their investment properties. The rough math says they could themselves be up to an 8%+ yield.
@Brian Bakerman, it's as @Adam Mayberry said. Financing ADUs aren't easy. Most homeowners take out a HELOC or cash out some of their equity to pay for them.
Some people also like their privacy and are unwilling to have a separate family living in their backyard.
Here's the issue that I heard during the investor ADU meeting: First is appraisal, the appraisal doesn't value the ADU accordingly so the builder in this case is end up losing money and advising people not to build ADU. Second is building cost, some builder charges very high cost to build an ADU that will not help in any way when it's being rented out. The third issue is there're so many city regulations that's hard to negotiate.
I think ADU shall work for some people but for many it doesn't.
All these comments are true. ADUs are too much money and not enough return on the appraisal for most investors.
However, you can still make it work if you are creative. You need to work really hard to decrease the upfront cost. Two big solutions are to do the project on an owner-occupancy site AND be a self-builder (aka your own general contractor).
Check out this random YouTuber. His cost is insanely low because he did exactly these 2 things.
Speaking from personal experience; this process is way, way harder than most people make it look online. In other words, I am spending way, way more money on my ADU Project.
A lot of it comes down to 3 major factors. 1. Local zoning regs creating major roadblocks 2. financing challenges (bank appraisers have no idea how to appropriately incorporate ADU's into property values) 3. construction capacity (ADU's make sense financially when you have local modular construction infrastructure in place so that you can build the ADU at a much better price point than stick built.
There are some other factors too... but that gets into the secret sauce.
It also depends on your market. My husband and I converted a workshop to an ADU in Southern California and made $1000 month rent for three years before we sold the property. So a year of work turned into $36000 rental income. It wouldn't have been worth it if the rental rates weren't so insane where we lived.
Lots of good info here. Yes the appraisals have not standardized yet. So may not work as a flip or development opportunity. If you can hold long term I think it's a fantastic move. The reason more people have not done it is
1) It is still a fairly new concept to most. I have found the average person has no clue about ADU's.
2) It can feel like a big undertaking if you don't know the way.
3) and of course the financing and appraisal piece was already mentioned.
Thanks for all the replies everyone! We've generally been curious why the bulk of the interest for ADUs isn't from investment property owners looking to improve yields (and maybe even taking their homes to cashflow positive) -- I think these replies help explain some of that, although the investment potential is fairly undeniable, especially with turnkey solutions like ours out there.
Other have hit on a lot of good topics, but I can add one as well. It was only in the fall of 2019 that many of the local zoning ordinances were forced by state ordinances to allow for Adu's on investment property. Prior to that in my areas (Alameda county and various towns within) had restrictions that the main house had to be owner occupied. This also blocked it from occuring on multifamily property. Both of these restrictions have since eased, but that doesn't make it an obviously good choice for many. I have one adu in plan review and my sites set on two more eventually. These processes take a while to get off the ground, especially with covid slowing down every planning step along the way. A process which might have taken a few months before is now taking twice that at least.
Some more observation on building ADU from business perspective:
-I think building ADU is making more sense if the objective is to use it to family member HOWEVER people can always upgrade or downsizing by selling their SFR and switch to buy a duplex or triplex if they want ( Eg: cost of per unit duplex in San Jose is 400-600-ish , cost of building 2BR 3BR ADU from ground up is $250-350K, not much different but with ADU you can't leverage that much.
- In case you're using it for investment then THE Construction cost is the major problem that you need to solve: you need to make sure all the cost associated with building ADU must be at least 0.6 from the projection revenue. Lets say you build an ADU 1/2BR with $200K with cash, you rent it for $2000/mo. This makes sense from CoC however this might *NOT* be the best investments. Why ? because you can't do leverage too much in construction and the cost of building/cost of money is much higher and rental value in Bay Area is actually still pretty cheap ( market in bay area is showing rental is cheap and construction cost is expensive and home affordability is at its lowest).
- It is also very market specific: making 2 BR ADU with the same cost is more profitable if you have high equity house in Palo Alto compare if you have low equity house in East San Jose as their markets are totally the opposite.
- But as general rule -- building ADU is better financially if you also live in the same property, you could literally live for free in Bay Area if you financing the rehab cost with low interest.
- Another investment perspective: If you have 200K to spend , rather than building ADU , you could literally buy Four/Five 7-8% CashOnCash (20-25% down) with almost similar equity appreciation like in CA, from home out of state.
- Next issue is the appraisal, currently nobody know how the market or appraisal going to appraise house with ADU. There're more negative story in this aspect.
As summary, from investment perspective: building ADU is a "good" speculation with possible reward, if you're lucky enough it may be good for you if you meet your objective and financial/non-financial goals.
Great observation. Really depends on each investors situation equity,land size etc . Affordable housing is one of this state’s biggest challenges and it is a great help for sure . With that being said not every property should have one .
Keep in mind folks that adding an ADU to a 2-4+ unit building is a different animal. Namely, the appraisal should account for the added unit's direct value. You may need to have your county adjust their official record to include the ADU in their unit count, so a duplex is categorized as a 3 unit bldg, etc. Then the appraiser should be able to appraise it accordingly.
That's a big difference from the appraisal challenge with SFH+ADU everyone mentioned above.
I just purchased a property in Lake Forest, CA near Irvine down in OC with plans to build a 2bed + den / 2 bath 1000 sq ft ADU from the ground up for approximately 280k using a HELOC from my primary residence. Anticipated rents for the ADU are 2700-3000/month which gets close to the coveted "1%" rule. The main 4bed/2bath house is renting for $3500/month. According to various lenders I've spoken to, for every dollar spent on the ADU, it will add 50 cents at best to the property value (i.e - 280k ADU will at best add 140k value to property). After the ADU is completed in July 2021 and rented out, I hope to refinance the property to pay off a portion of the HELOC. It will be interesting to see how the house appraises.
@Steven Nguyen - I'm curious to hear if you have already finished the ADU and how the process went? How is renting going? Would you recommend building an ADU right now to others, given the increased building costs (due to post-COVID lumber prices, etc.?)
Having bid out a good number of ADUs, I found that the cost per SF was higher than a typical build because of the energy requirements that the City/County was demanding (this was in San Diego). So people were thinking that they could throw one together in their side yard for $80k....when they found out it was $150k, that made them think again.....and often cancel the project.
They may work for some people on some lots, but they are not even close to being a panacea for the 'housing crisis'....