Does Anyone have experience building a detached ADU in the backyard of their SFH

[Jackie Lin]

Wondering if there is anyone that has build a detached ADU in Fullerton, CA in the backyard of their single family home? Looking to learn how your experience was with going through the permitting process in the city and if you used any vendors that were a positive resource for the process. Any information would be much appreciated! Thank you!

[Dan H.]

How about some numbers derived from @Alan Asriants numbers. 

$200k fully financed with 8% heloc, 30 year term is $1468/month.  Using 50% rule (expenses excluding P&i is 50% of rent) here are the numbers;

1800 (rent) - $900 (expenses) - 1468 (heloc) = negative $568/month

At your rent point with that size unit, your expenses will ve less than depicted by the 50% rule, so let’s use a likely more accurate 40%

1800 - 720 (expenses) - 1468 = negative $388/month

Now let’s imagine you self manage and you time is not worth anything (I strongly recommend believing your time is worth less or worth less than a quality PM would charge) with 8% further reduction so expenses are down to 32%

1800 - 576 (expenses) - 1468 = negative $244/month. 

The cash flow does improve with the hold .   So let’s assume with realistic expense estimates over 1st 5 years you average $250 in today equivalent dollars (it will be a challenge at that starting point).

The ADUs are typically receiving valuations below $100k, but let’s be generous to show the scope of the people and say it adds $150k of value. 

Initial negative equity position is $50k. 

$50k / $250 (cash flow) = 200 months (16 years) to recover the negative position.  

but you will have appreciation and equity paydown, but so would any property you buy with financing. Add the primary structure will be rent controlled if over 15 years old. Add in the effort involved. If you want an ADU, purchase a property with an ADU.

The big issue is building a single small residential unit is the most expensive residential development.

Here is a list of why adding a single ADU in single family zoned areas in my CA market is typically a poor RE investment:
1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.

make sure you do accurate and conservative underwriting.   This includes knowing the value that will be added by the ADU.  If you cannot find comps to provide a clear valuation for the ADU addition, underwrite for a poor valuation (no more than 50% of the hands off ADU addition costs).  Understand the 50% expense rule especially as it relates to cap ex.

Good luck