Using a Construction Loan to Build New Garage with ADU on Top

[Morgan Roddy]

Hello everyone! My name is Morgan and I am a Colorado Investor. I currently have 4 properties and am looking to expand. 

I am looking for ways to make my primary home cash flow and my favorite option would be to build a larger garage with an ADU on top to rent out long term or short term. I have gotten a few quotes for this and they are nearing 250-300k. I don't want to tie up all my cash in one project as I have other plans to continue growing my real estate portfolio. Because of this I am looking into financing options for this Garage ADU. Luckily, my home lot is zoned for 3 units. Because I would be building a separate residence do you think I could finance this via construction to traditional mortgage?

One thing to note is my neighbor a few doors down have the same zoning and they split the house up into 2 units and turned their garage into a third all with different addresses. My situation would be a bit different as I would like to use the garage personally and rent out the space above. If I ever sold my primary I would sell it as a package deal, but I don't plan on ever selling (buy and hold long term goals here).

Thank you in advance for your input. I greatly appreciate it. 

[Dan H.]

Quote from @Bruce Woodruff:

So you're in at $350k let's say.... Have you done the math? Does this give you the return you want? Let's say the ADU rents for $1500 a month (?).....that's 233 months to break even. Not incl interest. I know I'm over-simplifying this but it is a concept worth exploring....

I do not know the Colorado market, but I do know every market has expenses and vacancy.  

I am a fan of the 50% rule (expenses not including mortgage and vacancy is 50% of rent).  Using the 50% rule, this will take 466 months to break even if purchased with no financing.  The reality is financing is planned and the initial outlay is like 25% of the full cost.   However, at the current interest rates, this will be cash negative until rents increase enough to change that situation.  

in So Cal, most ADUs add less value than the cost of the ADU addition.  This implies that the ADU addition starts with an initial negative position.  The initial cash flow goes to recover the negative position.  I am unsure if this holds true for the Colorado markets.  

make sure you perform conservative underwriting and know the value that ADU addition will add to the property.  

good luck