Analyzing Pros and Cons: Building an ADU vs. Buying Rental Property in a Cheaper Mark

[Adam Sha]

I'm at a crossroads and need some advice from those with experience in real estate. I'm trying to decide between building an Accessory Dwelling Unit (ADU) on my existing property (secured permit) and investing in a rental property in a cheaper market. Each option has its pros and cons, and I'm hoping to get some insights from this community to make a more informed decision.

Option 1: Building an ADU

Pros:

1. Increased Property Value: An ADU can significantly increase the value of my primary residence.
2. Control and Proximity: I can closely manage and maintain the property since it's on my land.
3. Potential for Higher Rent: ADUs in bay area can fetch a good rental price.
4. Flexible Use: ADUs can serve multiple purposes – home office, guest house, or rental unit.
5. No Additional Land Purchase: Utilizing existing property means no extra cost for land acquisition.
6. Foundation improvements: I will get an upgrade for my foundation which increase house stability.
7. Time to recover investment: around 10 years if I rent it for $1700 - paying cash.

Cons:

1. Impact on Primary Residence: Construction can be disruptive, foundation is old, and having tenants nearby might affect privacy.
2. Time to cash: The rental income will be delayed by at least 6 months as I'm building the ADU.
3. Tenant risk: California is tenant friendly and eviction can be difficult.
4. Time sink: takes so much effort and time while working full time.

Option 2: Buying Rental Property in a Cheaper Market

Pros:

1. Time to cash is immediate is about 40 days from closing time.
2. Landlord friendly: which means eviction and rent control in Landlord
3. Diversification: Investing in a different location spreads the risk.
4. Property Appreciation: Some emerging markets might offer significant appreciation over time.
5. Established Rental Market: Easier to find tenants in established rental markets with a high demand.
6. Potential to build an ADU: i can build on the property land.

Cons:

1. Lower Cash Flow: Properties in cheaper markets often have lower rental yields because I have to pay taxes, insurance, CapEx.
2. Market Risk: Cheaper markets might be cheaper for a reason, with slower appreciation and higher vacancy rates.
3. I won't fix my foundation.
4. Tax and insurance: have to pay those for the property
5. time to recover investment is 20 years assuming 1k cash flow - paying cash.

I would love to hear your thoughts and experiences with either option. What else should I consider? Are there any hidden pitfalls or unexpected benefits I might have missed?

Thanks in advance for your insights!

[Alecia Loveless]

@Adam Sha I was looking at adding an ADU at the cost of about $110,000. After consulting my realtor I discovered the ARV would only be about $60,000 and that it was going to take about 10 years to get my money back and likely 10 years to get the value of the property up consistent with what I had put into it.

I opted to buy a separate property with better cash flow.