Convert attached in-law suite to add sq.ft to main dwelling?

Question

Hi all,

Been a long time lurker on these forums and I’m happy to have closed on my first deal. I recently closed on a SFR in Concord,CA which I intend to house hack - thanks to all BP members, and podcasts, I was able to learn so much through these forums and was finally able to get past the analysis paralysis phase. The property has a 6bed 3bath main dwelling along with a studio with 1 bath which is attached to the main dwelling and is currently permitted as an in-law suite.

I got an appraisal done as a part of my loan process and realized the in-law suite is valued significantly lower than the main dwelling in the appraisal. I was originally planning on converting the in-law to a permitted ADU and add a full kitchen to rent out separately. But through a few posts on BP forums, I realized ADUs are valued significantly lower than the main dwelling when an appraisal is carried out. The appraisal report mentioned that the studio is not consistent with the main dwelling standards and hence given a separate valuation - about $180/sqft lesser than the main dwelling (building alone) discounting the value of the land (studio has peel and stick flooring with no heating or cooling). Comps with a fully finished ADUs were valued at $60k when building price per sqft in this area is around $250/sq.ft.

Question:

If I’m planning on refinancing in the next year or so, would it be worth converting the existing in-law to match the standards of the main dwelling and get permits to add it to main dwelling sq.ft? Any potential issues I should be aware of doing so other than potential for higher property taxes?

Brad S. · Answer

The quick and dirty answer is YES, based on what you describe it is possible and may make more sense. I am a CA based appraiser and broker, so here are my thoughts.

* The studio should be legally permitted as part of the main gross living area (gla), If it isn't, it will most likely be valued as an accessory structure (studio), even if it is contiguous and the same condition/quality as the main gla. I do see you mentioned having it permitted toward the main gla, so that's good.

* Functional - it should be functional as part of the main gla, or the valuation may not be maximized. One example is a tandem bedroom - where you need to walk through one bedroom to get to the other. That is called functional obsolescence and will be looked at negatively. That is only 1 example, so just keep in mind it should flow well and be functional with the rest of the house.

* I would think about remodeling the studio with the idea of easily converting it into a separate functional adu later. Some ideas are: make sure the bathroom is large enough and at least a 3/4 bath (with shower). do the rough work for a kitchenette - bring in plumbing, electrical, possibly gas hookup, etc. One way to do this is to put a wet bar and/or laundry in the existing studio. Those are ways to legally get the proper utilities for a future kitchenette, that can easily be converted later. You may want to also think about being able to easily cut off the studio area for a secure private adu later - by making the wall easy to replace (if you remove it) or put a solid door that you can put a double sided lock later, etc.

This way you are ready to readily convert the studio to a functional adu, should you choose to rent it out separately.

But, as to your original question, once you legally add the studio gla to the main gla, the appraiser should be comparing your house to other relatively similar sized comps. This should help raise the valuation.

Dan H. · Answer

If the conversion back to main house looks like it was part of the main house and not a poorly added on addition and there are comps of similar size that justify the value, then it should appraise as though it is the main house (as it will be the main house).  I suspect if it currently does not have heat and has lower quality finishes, this transition will be more costly than you may think.

In most markets an ADU studio will rent for quite a bit more than renting a BR by the room.  Your conversion back will negatively impact the cash flow.

Seeing you are already planning to house hack, I would first look into the cost of adding a kitchenette and resulting rent increase before looking to place a mother-in-law suite back to the main house.  Then look at the cost of reincorporating the mother-in-law suite into the main house including heating, making the layout natural, and upgrading the finishes.

I will give props to creativity on thinking of this value add as the typical direction is opposite of what you propose and the investor is often disappointed with the value associated with the ADU.  They often end up in an initial large negative position that can consume years of cash flow to recover.

Good luck

Dan H. · Answer

You purchased the property with a value associated with the mother-in-law suite that was significantly below the value associated with the main house.  This is common in many markets for both ADUs and mother-in-law suites.  It will likely continue to be the case regardless of trying to upgrade the finishes on the mother-in-law suite.

However, renting a mother-in-law suite without a kitchen will result in much lower rent than an ADU with a kitchen.

I do not expect that adding the kitchen and improving the finishes will help the appraisal significantly, but it will help the cash flow significantly.  If you want to rent the studio, I would add at least a kitchentte.

Good luck

Kimberly Peterson · Answer

Hi Aswin!  You'll want to review agency (Fannie/Freddie) guidelines for the way an ADU's value will be determined in an appraisal.  Appraisals are based on comparable values, so the appraiser will be looking for other homes with ADU's as comparable sales.  If your ADU is over-improved, you won't realize the value for it.

In other news, Freddie now allows the use of rental income from an ADU when qualifying for a mortgage, which can be helpful when qualifying.

You can read more about how an appraiser is to value an ADU at Freddie's site here, or please message me if you have more specific questions, I'm happy to help!

https://guide.freddiemac.com/a...

Joel Forsythe · Answer

Whip smart. Phased improvement. All legitimate, and wise knowing the roughed-in mechanical locations for future phase 2 conversion. Design your phase 2 completely, highly detail all your future mechanical locations, strip the floor plan/finishes back to phase one needs, but keep the mech rough in walls, underfloor, and even attic with easily accessible junctions and tie-ins- phase 2 ready to move forward way faster. That could be electrical, plumbing, and even ductwork. This is if you are highly confident and committed to doing phase 2.

Aswin Easwaran · Answer

Thanks for your inputs on this @Dan Heuschele. My plan is to eventually have it permitted as an ADU and hold it long term, but trying to squeeze as much value as I can out of the property before doing so. Thanks for the heads up on the cost aspect, didn’t realize it might be a lot more expensive than converting it to ADU, so have to run a cost vs value comparison before making this decision.

Aswin Easwaran · Answer

Thanks for your inputs @Brad Sand. My plan resonates with the steps you outlined- have accessory structure gla added to main gla through city permits, refinance, add a full kitchen to the studio,pull permits as ADU and hold. This is going to be a long term hold so the permitted ADU should get better cash flow than a studio with no kitchen. The studio is around 850sqft standalone, so there is a possibility to add a bedroom to it as well (already has a walk in closet plus 72sqft full bath).

I might have to consult an appraiser to look at functional obsolescence as you’ll have to walk through the kitchen to get to the studio, so thanks for pointing it out.

Really glad you were able to chime in - thank you so much for your time in looking at this.

Aswin Easwaran · Answer

@Kimberly Peterson@Dan Heuschele Thanks for your response. My question was more geared toward getting most value out of the additional square footage. I realize ADUs or in-law units won’t necessarily get the bang for their buck from an appraiser standpoint. The in-law is connected to the main dwelling through a door and I was wondering if I could open up the wall, make improvements to the in-law to conform with main dwelling standards and have this added to the square footage of the main dwelling, something very similar to the process of adding square footage to the house. Is this possible to do and get it refinanced for a better valuation, considering there are reasonable comps around? I’m planning on using rent by room strategy to house hack, so having the in-law connected to the main dwelling with a single kitchen should not significantly affect the strategy.

Convert attached in-law suite to add sq.ft to main dwelling?

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