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BRRRR - Buy, Rehab, Rent, Refinance, Repeat
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Updated almost 2 years ago on . Most recent reply

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Nicholas Spinazze
  • Investor
  • Fayetteville, AR
7
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ADU appraisal and valuation on BRRRR Questions

Nicholas Spinazze
  • Investor
  • Fayetteville, AR
Posted

Hey there Bigger Pockets community! My wife and I have plans to build to build a 3BR single family and an 2BR Accessory Dwelling Unit(ADU) on one of the lots we split recently. Our plan is to use the ADU as a short term rental and the single family as a long term rental. We had planned something similar to a BRRRR except we are creating value by building as opposed to creating value by rehabbing.

The trouble is the way lenders in this area value ADUs. They value them at a flat 90k regardless of the condition or rentability of the unit. The ADU we are building costs approximately 150k to build and has a significantly higher cost per square foot for construction than our single family unit. Our lender said that after a year of seasoning we could come back and they would evaluate the value of the ADU based on the cashflow it generates.

So it would take approximately 2 years to get the total amount of our initial investment back and I don't have any guarantees that they will even value it at its cost of construction. We are also concerned about how the buyer's appraiser is going to value the ADU if and when we choose to sell the property. As having the ADU is taking our value per square foot down from $235 psqft (which is what the single family appraised at by itself) down to $189 psqft.

Do other areas value ADUs the same way? Given all this does it make sense to build an ADU still? We haven't broken ground yet so can we go back to the bank and tell them we just want to build a single family now? Greatly appreciate any thoughts/advise/opinions!

  • Nicholas Spinazze
  • Most Popular Reply

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    Dan H.
    #2 General Real Estate Investing Contributor
    • Investor
    • Poway, CA
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    Dan H.
    #2 General Real Estate Investing Contributor
    • Investor
    • Poway, CA
    Replied

    >Our lender said that after a year of seasoning we could come back and they would evaluate the value of the ADU based on the cashflow it generates.

    Traditional residential Fannie/Freddie loans value on comps and not cash flow.  The type of loans that will value on cash flow have worse terms than if you valued the property on comps.

    >Do other areas value ADUs the same way?

    In the absence of comp data to show differently, ADUs in my market (San Diego) are being valued like accessories and can come in even lower than the $90K that you state they are valued in your market. In virtually all cases, they are being valued less than the hands off cost to add the ADU. This evaluation seems to be supported by the selling data I am seeing. In vast majority of the cases, you can purchase a property with an existing ADU for less than purchasing a similar property without the ADU and then adding the ADU (hiring out all of the construction).

    In my market there are many reasons that adding an ADU is one of the worse RE investments. They include: The negative initial position resulting from the ADU value being less than the cost to add (in your case you are starting negative $60K) can consume years of cash flow. There is no income until project completion versus most RE investments have income starting at acquisition. The effort is similar to doing a BRRRR, but the return is far worse. It is cheaper to purchase a property with an ADU than to purchase property without an ADU and add one. It detracts from exiting property whether it is a garage or just yard space. The interest rates of ADU construction loans are typically do not have terms as good as Fannie/Freddie residential acquisition loans.

    There is no way that I would choose to assume a negative $60K position.  The lower your investment amount the better the return.  The negative $60K position is worse than bringing an additional $60K to the investment because bringing an additional $60K typically is associated with $60k of value.  In this cast the $60K has zero value.

    Good luck

  • Dan H.
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