My First Deal: Analysis Advice (SF East Bay Area, ADU, HouseHack)

[Missy Longshore]

Hi,

I live in the San Francisco Bay Area (in El Cerrito, in the East Bay) and would like feedback on my plan to get started in real estate investing. I'm looking for a way to lower my housing costs with this plan.

The plan is to build an Accessory Dwelling Unit (ADU) in my basement, essentially turning my home into a duplex. I would move into the new, smaller unit in the basement (a studio) so I could rent out the 2 br/1 ba for maximum rent. Once the value of the home increases I could do a second cash out refinance and take that money to invest in my second property, likely an out of state or out of area rental.

Here are the numbers:

I currently owe $300k on the 2br/1ba

The current value is $645k (conservative estimate)

I'd cash out refinance a max of $200k to build the ADU and do repairs to get max rent for the 2br/1ba

New estimated value $900k

Cash out refinance rate: 5%

Current mortgage payment $2k (includes escrow account)

New payment: $2,750/mo

Rent for 2 br/1ba: $2,500

Rent for new studio: $1,750

50% rule analysis:

($2,500 in total income * .5) - $2,750 = ($1500)/mo

Obviously we want this to be a positive number, but is it fair to think of this as I'd be saving $500/mo over what I'm paying now ($2k)?

1% rule analysis:

Monthly rental income/Purchase Price

$1750/$150k=1.16% This is good, right?

This assumes 50k of 200k would go to upstairs/overall house repairs; I'm calculating it this way because there's no way I could purchase a studio home in the bay area for $150k.

Other questions:

Would this make me over-leveraged? What do I need to consider given that there is likely a recession coming in the next 24 months?

Thank you so much for your thoughts and advice!

Missy

[Amit M.]

Your idea is interesting, but I think you’re getting hung up on “rules” that don’t apply to Bay Area (i.e. expensive) real estate. Forget the 50% rule, as expenses are never close to 50% in expensive areas like the Bay Area. Also forget the 1% rule, as it mostly doesn’t apply here. 

I’d look at things more simply:

1- are there any comps that have SFH's with ADU's that have sold? Maybe not, as it's pretty new. So talk to some established brokers in your area. On one hand, you're adding value. On the other, for resale purposes, most buyers want SFH's. So you need to determine how desirebale a 2 unit bldg would be in your area, which I assume is mostly SFH. (If your area already has 2-4,s, like SF and OAKLAND do, then the decision is much easier.) My gut says that there will be multigenerational families, or singles/couples that would want the 2 units, to accommodate grandparents, etc., or to rent out for income, like your case. But I'd run this by some brokers, to make sure you don't end up with a white elephant when it comes time to sell it ;)

2- make sure that the $150k you spend will increase the property value by more than that. It should, but make sure #1 above checks out on a resale/desirability level. You only want to invest cash, time and effort if you clearly increase the property value!

3- from a cashflow perspective this is a no brained: your current housing expenses are $2k. Your new expenses (renting the main house) will be the difference between new mortgage of $2750 - $2500 rent income. You’re almost living the free! Of course, you need to be cool with the studio, or see if there is a way to make it a 1 BR. Not sure how many sq ft you have, if there is a garage in front. 

Since you want to invest in RE, this is a great way to start IMO. I wouldn't worry about a future recession, as you can always rent out a good unit in the Bay Area. And you shouldn't be over leveraged, as you *should* (confirm this) be adding more value than you borrow for the ADU. Just make sure your project will have solid resale appeal in the future!

Let us know what you decide, how you proceed on this post.