Does my property value increase after adding ADU's, thus allowing me to refi?

[Sean A Lewis]

Hey all,

My name is Sean. I've been listening to the bigger pockets podcast for approx 3 years now, and was finally able to pull the trigger and finance my first multifamily property. The reason I am posting is because I've received some contradicting information about the ability to refi my property after adding ADU's. To provide some background here, my wife and i recently purchased a triplex that has an existing 500 sq.ft attached storage unit (conditioned space) and a detached 5-car garage. We purchased this property because of all the intrinsic potential it possesses. The intent is to convert the storage unit into a J-ADU, and the 5-car garage into two new detached ADU's. All three units will be funded by us - no loans. I was told by some of my clients that by adding these ADU's, my property value will not increase and I will not be able to get my money back out through a refi. I was also told by some of my clients that my property value will increase, and I will be able to get most of my money back out through a refi. So my questions to you all is as follows:

- By adding these ADU's to my property, will I be increasing my property value?

- Will I be able to pull my money back out after adding these units? (heloc or refi)

I am an engineer by trade, and own my own comapny (AHAE Designs Inc). I have designed many ADU's for many multifamily lots in the LA County area. I have a stong feeling that my clients would not be adding ADU's to their properties if they were not able to get their monies back out to keep investing. I look forward to your resonses. If you have any information that can potentially be useful to my case, please reach out to me directly. Thanks in advance experts.

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[Dan H.]

In general ADUs in single family zoned areas add less value than the hands off cost to add the ADU. This is not single family zoned.

If you add 2 ADUs traditional conventional F/F is typically not available but in this case the 2 units makes 5 unit.  5 unit s commercial MF with different rules and means to value. I am not sure how the owner occupancy requirement of the JADU impacts value, but is will impact value as there are many RE investors who do not want to owner occupy.

You should be able to determine the value by calculating NOI and knowing the market cap rate. You then need to adjust for the owner occupied requirement. This would allow you to calculate if the ADUs will add more value than the cost to add them.

I suspect that the value added will not be much higher than hands off cost because there is few development costs higher than small units in small counts.   

If you go through the exercise to determine a property value via NOI/cap rate adjusted for the mandated owner occupancy for what value is added by the ADUs it would be nice if you could post the results.

Good luck

[Andrew Postell]

@Sean A Lewis the only way to know if you can get your money back from a loan is by talking with a loan officer.  Now, it is possible that someone else might be right...but I would still say to confirm with a Loan Officer.  I'm saying this because later someone might give you tax advice - get with a CPA.  Or legal advice - get with an attorney.  It's impossible for us to keep up with EVERY industry out there.  So, even if you hear "something"...having a good network will allow you to verify what's possible.

Here's what you need to know based on what you asked above:

1. Refinancing - There's isn't enough information for me to provide specifics...so, I'll address it both ways. First, you won't be able to refinance with a traditional loan with multiple ADU's on your primary home. Traditional loans through Fannie/Freddie/Jumbo lenders won't allow multiple ADU's on a property. Their guidelines actually prohibit this. Which means you would need a "non-traditional" loan to even consider refinancing. That means a higher rate and less favorable terms. But finding such a loan on a primary home would be extremely challenging. It might even be impossible. Secondly though, if this is an investment property then you would have more options. Same types of rules apply in that this would not be a "traditional" style loan. It may not even be a 30 year, fixed rate loan. This might fall into the 20 year, ARM products. But you could find those on an investment property as opposed to not finding them on a primary home. There's over 8,000 lenders in the US...I can't speak for them all but this is what you should expect. Multiple ADU's on primary home - big challenges. On investment property - options, but less favorable terms. If you just have 1 ADU, then your options will be SIGNIFICANTLY more plentiful.

2. Value - How do we know what your value will be here? We must consult our comps. How many triplexes have ADU's in your neighborhood? And this goes for ANY renovation that we do. What will my value be if I finish a basement? What do your comps show? What about with adding granite countertops? What do the comps say? Adding a pool? Comps! We MUST analyze comparable properties with determining future value. So, if no comps have pools...then adding one may carry ZERO value. That doesn't mean we shouldn't add a pool though. If adding a pool provides a happier family...what's that worth? That's priceless. There might be reasons for us to do these types of renovations still but you need to know that your comps determine the value. And if there aren't any comps, then no value might be something that occurs. Maybe adding the ADU's will give us more rental income and that's good enough. But keep in mind that resale in the future. So, just like it might be hard for you to get financing...same for any future buyer too. Keep the current market in mind but also consider the future too.

Hope all of that makes sense.

[Dan H.]

Quote from @Andrew Postell:

@Sean A Lewis the only way to know if you can get your money back from a loan is by talking with a loan officer.  Now, it is possible that someone else might be right...but I would still say to confirm with a Loan Officer.  I'm saying this because later someone might give you tax advice - get with a CPA.  Or legal advice - get with an attorney.  It's impossible for us to keep up with EVERY industry out there.  So, even if you hear "something"...having a good network will allow you to verify what's possible.

Here's what you need to know based on what you asked above:

1. Refinancing - There's isn't enough information for me to provide specifics...so, I'll address it both ways. First, you won't be able to refinance with a traditional loan with multiple ADU's on your primary home. Traditional loans through Fannie/Freddie/Jumbo lenders won't allow multiple ADU's on a property. Their guidelines actually prohibit this. Which means you would need a "non-traditional" loan to even consider refinancing. That means a higher rate and less favorable terms. But finding such a loan on a primary home would be extremely challenging. It might even be impossible. Secondly though, if this is an investment property then you would have more options. Same types of rules apply in that this would not be a "traditional" style loan. It may not even be a 30 year, fixed rate loan. This might fall into the 20 year, ARM products. But you could find those on an investment property as opposed to not finding them on a primary home. There's over 8,000 lenders in the US...I can't speak for them all but this is what you should expect. Multiple ADU's on primary home - big challenges. On investment property - options, but less favorable terms. If you just have 1 ADU, then your options will be SIGNIFICANTLY more plentiful.

2. Value - How do we know what your value will be here? We must consult our comps. How many triplexes have ADU's in your neighborhood? And this goes for ANY renovation that we do. What will my value be if I finish a basement? What do your comps show? What about with adding granite countertops? What do the comps say? Adding a pool? Comps! We MUST analyze comparable properties with determining future value. So, if no comps have pools...then adding one may carry ZERO value. That doesn't mean we shouldn't add a pool though. If adding a pool provides a happier family...what's that worth? That's priceless. There might be reasons for us to do these types of renovations still but you need to know that your comps determine the value. And if there aren't any comps, then no value might be something that occurs. Maybe adding the ADU's will give us more rental income and that's good enough. But keep in mind that resale in the future. So, just like it might be hard for you to get financing...same for any future buyer too. Keep the current market in mind but also consider the future too.

Hope all of that makes sense.

I was of the belief 5 units (triplex plus 2 ADUs) would make it commercial MF and valued on NOI and cap rate, not comps. is this not the case for some reason? Can you explain why it would not be commercial MF?

We are in full agreement that 2 ADUs means traditional conventional loan (meaning not commercial MF loan) is explicitly prohibited.   However, I have seen cases where it is not enforced on zoned MF.   For me to take that risk, the upside would need to be high or I have a solid plan B.

I am unsure you know this nuance, but JADUs in the state of CA require owner occupancy in every jurisdiction that I am aware of.   This complicates the valuation regardless if via comps as you indicated or via noi and cap rates.   The buyer pool shrinks significantly.   I suspect less than 10% of MF buyers are owner occupied in my area and I would not surprised if it is less than 5%.   Reduce the buyer pool to that extent and it has to negatively effect valuation.  

I think this property would be a challenging one to appraise even if value is based on noi and cap rate because of the OO requirement. That has to significantly impact the cap rate.

thanks

[Alecia Loveless]

@Sean A Lewis I have a loft I was considering converting to an ADU. The estimate I got for the renovation of the space was $110,000. Mostly because we have to add roof dormers and also for the expense of running the plumbing.

My realtor said that initially he thought the ARV for my building would only increase by about $60K but that if I held over the long term eventually I would get the value.

So you might look into this factor as well of cost to build vs. after build value.

It may be slightly different for a commercial 5 unit property but the last appraisal I had done focused more on the property value than the rent value. Maybe that was my location but it provided very disappointing results in terms of the value I had been hoping for.

[Brad S.]

Ok, so, if I understand correctly, the property is currently a triplex and you want to add/convert 2 adu's to make it a 5-plex and also add/convert a jadu. Firstly, that will probably cause the appraiser's head to spin.  :P 

As an appraiser myself, I would probably charge a very high fee for this assignment, since it is pretty unique and complex. Anyway, here's my thinking. In CA what you are talking about, is now legally possible, due to the adu laws, which supercede zoning. So, the property would essentially be a commercial property now (5+ units) and would essentially have the same use and rights as a traditional 5-unit commercially zoned property. I am assuming the Subject property is not currently zoned commercial and cannot legally have 5 units, except for the adu laws? If that is the case and other 5-unit comps used are on traditionally commercially zoned properties, there might be a value difference for that, since the highest and best use may differ. Since it may be possible, the commercially zoned property may legally have more units than the Subject, etc.

So, my guess is the newly created 5-unit property would be valued as such and comped to similar 5-unit properties, as well as utilizing cap rates and income, etc. 

The jadu would most likely have minimal value or be discounted since of it's owner occupied requirement and therefore, not having the same rights as a traditional 6-unit property.

As to the lending part - I am not sure how lenders are going to look at this, since it does now fall under the commercial definition.

As to your specific question: 
It might increase the property value. My guess is that it should. Remember, the value is just what a buyer would be willing to pay for it and technically, there is no way of knowing that for any property, unless it is for sale on the market. But, if you want to get an idea, you should find similar 5-unit sales and derive a cap rate for the market, estimate your projected NOI, and derive your estimated value range. Or, you can pay me a lot of money to do it. :)

It is these kind of situations that create opportunity and value since many people don't have the resources or knowledge to see the potential and take advantage of it. But, that is also why it is not straight forward and sometimes a little bit of a crapshoot. But, it sounds like there is a lot of potential.  Good luck!

[Bill B.]

People have converted 5 unit buildings to 4 units buildings and increased the value because of the value of residential lending. MAKE SURE you aren’t going to be forced in to commercial lending. You get worse terms, worse rates, and you you get moved from comps to income based. Many small multi sell for higher “cap rates” because they are being owner occupied by emotional people. 

Could you convert just the garages in to a massive “owner’s suite” convert e small building into a garage or workshop and create the ideal 4 unit for an owner occupant? You might save money and increase value while rducing headaches. 

You could also try leaving 1 garage and making less massive master suite but check local code on shard wall with garage. 

[Sean A Lewis]

@Dan H. Thank you much for the amazing reply. This was super helpful.

[Sean A Lewis]

@Andrew Postell Thank you much for the amazing reply. This was super helpful. I will definitely be looking into this one the remodeling completes.

[Sean A Lewis]

@Andrew Postell Thank you much for the amazing reply. This was super helpful. I will definitely be looking into this once the remodeling completes.

[Sean A Lewis]

@Alecia Loveless Thank you much for the amazing reply. This was super helpful.

[Sean A Lewis]

@Brad S. Thank you much for the amazing reply. This was super helpful. This was super insightful, and most of all makes the most sense. I will be doing this before talking to the bank. We are on a 2 year time frame to complete these two ADU's and move on to a new property so the JADU is no longer an option. I still have a 400 - 500 sq.ft open conditioned space at the bottom of one of my units. Any ideas on what would bring the most value from an appraisal standpoint?