Seeking Advice: ADU in Berkeley vs. Property in the Midwest

[Adam Sha]

I'm facing a bit of a dilemma and could use some advice from this knowledgeable community. I'm considering two investment options and am torn between them:

1. Building an ADU in Berkeley: I have the opportunity to build a 316 sqft ADU in Berkeley, CA, which I could rent out for around $2,000 a month. The construction cost is estimated to be around $180,000.
2. Buying a Property in the Midwest: Alternatively, I could take the $180,000 and buy a property (or properties) in the Midwest, where the rental market is more affordable. The monthly rent would likely be lower, but the entry costs and potential regulatory hurdles might also be less.

Here are my main considerations:

• Rental Income: Higher in Berkeley ($2k/month) vs. potentially lower in the Midwest.
• Appreciation: Likely higher in Berkeley.
• Management: Easier to manage the ADU since it's close to home, but more regulatory headaches.
• Diversification and Simplicity: Potentially less hassle with a property in the Midwest.

Given these factors, what would you recommend? Has anyone had experience with either option and can share insights on rental yields, appreciation, management challenges, or any other considerations I might be missing? Thanks in advance for your thoughts!

[Greg San Martin]

Maybe best to wait to see whether Berkeley's brain damaged voters pass anti homeowner ballot measures.  State propositions could undermine new real estate investments too.  And the state supreme court just illegally invalidated the will of the voters.  If rates remain higher for longer or go up, then maybe best to wait.  Oversubsidized overbuilt apartment buildings may continue to keep rent levels fixed or declining.  Look at Berkeley rent trends for the past 4 years. Insane shelter in place rules have resulted in an $80 billion state budget deficit.  Entire industries have left the state due to inept state and local regulators.  Good luck finding a reputable entity for home insurance. Berkeley will increasingly be sought after as temperatures rise and inland metros become uninhabitable.  So it is a good long term bet (provided the socialists do not bankrupt you first).

[Adam Sha]

Thanks Greg. this is helpful! 

[Becca F.]

I'm also considering building an ADU in a very large downstairs unit (in. S.F.) but it would change my SFH into a 2 unit and be under rent control. The main part of house is renovated and rented out. Does Berkeley have similar laws as S.F. with regards to a property being under rent control if your ADU would make it a multi-unit?

I invest in the Indianapolis metro area. It's affordable but $180,000 (move in ready) will buy you a Class C to maybe B area. I have 3 SFHs, one in a great suburb, Class A, which has appreciated (doubled in value in 10 years so not bad for the Midwest). The other two are Class C on the East side of Indy bought in 2023 at $130,000 and $132,600.  Sounds great price wise but these are older renovated homes (renovated by the seller). Too many headaches for cash flow on paper (which is actually negative in reality) : stolen AC unit (thieves climbed a 7 ft fence), attempted break in (alarm scared intruder away), repair issues, winter weather (make sure someone turns up the heat on a vacant property). The path of gentrification is difficult to predict. It's block by block in many Midwest cities: Detroit, Cleveland etc. If I were do it over again, I wouldn't buy Class C and go Class A nice suburb (prices will be in $270,000  and up) and wait for appreciation. 

I lived in Indy then moved back to the Bay Area (long story) so I knew the area, much more now down to a detailed level now. The property tax rates are 2.72% and 2.78% in Indy and my last increase was 17%. I think the property tax rates are high. If I wind up selling off my Indy properties, I'd go buy in Reno or Vegas - Nevada has low property tax rates and appreciation is higher. Typical Indiana appreciation is 3% a year (aside from 2019-2022). 

If you're considering the Midwest, I'd suggest flying there and getting to know the area really well. if you have friends or family in the Midwest, that would help since they could check out a neighborhood or  homes for you. Don't pick a random city far away. 

You won't get $2000 rent on a $180,000 property in the Midwest now with 7% interest rates.  Can you talk to other Berkeley landlords doing ADUs to get their feedback? 

[Michael Smythe]

@Adam Sha as @Becca F. mentioned, Class C isn't for everyone.

Traditionally, going back 30 years, investors bought Class B properties as rentals and held them to gentrify.

It's only in the last 5-6 years we've seen investors buying Class C - and many unfortunately, don't know what they are doing.

With $180k you could buy a nice Class B rental in Metro Detroit. It may not cashflow from Day 1, but will in 1-3 years and you'll have nice appreciation.

That's how my manager started out and what he still tries to do.

DM us if you'd like to chat more.

[Travis Biziorek]

Adam, if those were my only two options I would build the ADU.

This is coming from someone down on the Central Coast that has 12-doors in Detroit... but I'm currently building an ADU & addition of 2,060 sq ft total at my primary residence. The ADU will be a 2/1 and 1,000 sq ft.

We plan to rent the ADU as a short-term rental and expect to get $4,000 - $5,000 gross/month. This is largely all profit since we're doing the build all-cash and no plans to refi.

You may not have STR options in Berkeley but could you run it as a mi-term rental? If so, you may be able to get north of $2,000/mo.

Creating more value at your primary would also give you more options down the road. You could utilize a HELOC and do flips or BRRRR's, etc.

[Greg San Martin]

Adam,

In Berkeley, my recollection is that under Measure Q, if a single family homeowner builds an ADU AND occupies one of the two units, then the homeowner will be exempt from rent board regulations. Despite losing an attack on this rule two years ago, the rent board is trying again to regulate everyone that invests their nesteggs to expand the housing supply. So, if their measure fails in November, your ADU investment would probably make a lot more sense.

Recognize that in California, single family homes can add one detached ADU and one attached ADU or junior ADU. In some cases, JADUs can be done for under $50K.

Lastly, recognize that it may be possible for you to condo and sell the ADUs separate from the original unit.  Berkeley is among the first cities to claim that it wants to allow housing developers to use this new provision in state law.  We'll see.

if you live in the main unit while the ADUs are built, then when AND IF the condos are established, you could presumably sell the main unit right away and claim the "2 in 5" tax writeoff. You could then move into one of the ADUs and live there for two years before selling it. If you were careful about who you rented the other ADU to, then you might be able to move into the other ADU and live there for another two years before selling. So, over 4 years, you could conceivably sell three condos. If married, that would be a $1.5 million writeoff against your overall gains.

Lots of big IFS here. Obviously this is not investment advice.  Always seek strategic advice from a professional. 

[Mike Paolucci]

Quote from @Adam Sha:

I'm facing a bit of a dilemma and could use some advice from this knowledgeable community. I'm considering two investment options and am torn between them:

Don't forget to take future legislation into account. This is what I'm referring to --> "Justice for Renters Act" This is coming up on this year's November ballot for the entire state. 

As a bay area native (born an raised in SF), I personally prefer to stay away from legislation that will handcuff me as a landlord moving into the future, which is why I started investing in the Midwest back in 2021. Columbus, OH is landlord friendly and the term "landlord rights" is a real thing. 

Happy to answer any questions you might have about OOS investing or Ohio Markets. 

[Adam Sha]

Thanks everyone! those are all awesome tips.