Does it make sense to finish & legalise a basement as Additional residential units?

Question

Hello everyone,Me and my wife own a single detached bungalow (~1200 sq.ft) built in 1976 in Woodstock, ON. We have been living it for 2 years now. We purchased the house when the housing market was at its peak(high 700’s). We have 2 different entrances to get into our basement. The city of Woodstock has recently amended their by law that enables all the R1 zoning house to have 1 or 2 Additional residential units. We applied for a permit for 2 apartments in the basement (Unit 1:1 bed apartment & Unit 2: A 2 bed apartment ) The permit has been approved. We are also getting a forgiving loan of 30k for the duration of 10 years from the county for 1 unit if we rent out the 1-bed basement unit to a household with income less than 100k and at the rate defined by the city )(~1183+ utilities) for a 1 bed unit. I think the 2 bed can easily be rented out for $1450 + utilities in our area. About the basement: It's partially finished (drywalls and ceiling only) with no bathroom or kitchen.Since it's a considerably smaller house, I am not sure if this would add significant value to the house if we sell it say 5 years down the line. We will be landlords for the first time in our life. Estimates we are getting from the contractors to build in 2 legal units is between $110k-$150k. Given the scenario, does it make sense financially? My estimates say if I were to bring in the sub-trades myself I can get this project completed at about 80k. Seeking feedback from the experts in the group here. Thanks,Chirag

Abel Curiel · Answer

Do you have to get separate permits to be able to lease out those ADU spaces? Any other 'red tape' needed to get this space tenant occupied?The harder it is to do, the less people will do it. The less people do it, the more rare your property becomes. Rarity isn't always the best thing especially if demand for this property type is low in your market.The reason I am bullish on adding ADUs is because I don't think the increased demand for ADUs is unique to New York. I think overall, this current generation of homebuyers is very savvy. I speak to people less than 20 years old who are just starting to save $ for their first deal and so many of them want to buy properties such as the one you are describing here.Despite case studies (and possibly demand) being scarce in your market, the #s don't lie! You can still look at multifamily properties in your market or just outside your market to determine the local cap rate. Cap rate = NOI / Purchase PriceTotally guessing here but assuming you and your wife can rent your current unit aka the main unit for $1,800, that would make your total gross monthly income = $4,433 $4,433 x 12 = $53,196 Annual IncomeLets assume 30% annual operating expenses for taxes, maintenance, cap ex, property management, vacancy...$53,196 - 30% = $37,237.20 NOINow lets say you'd do this work to add the ADUs if you can get your property's value up to $800,000, that would mean your property is operating at roughly a 4.65% cap rate... is that good for your area? Is it just about right?... this will depend on your area's comps. I ran a quick Realtor.com search and found this recent multifamily sale in Ontario - https://www.realtor.com/realestateandhomes-detail/319-E-Park...If most properties are trading along this price range, you may want to run projections for future appreciation using conservative number. Since theses last few years have been statistical anomalies when it comes to home value surges, I wouldn't count on values growing at the same pace. Of course, please take this with a grain of salt since I do not operate in your market.

Abel Curiel · Answer

Hello Chirag!This is an excellent question. Although I am not in your market, I would say this could be worth it if the comparable sales support it. I'd recommend looking at similar nearby properties that have sold with 1 or 2 adu's. The best comparables will be the most recent but if this type of property is uncommon in your market, you can go back as far as 9-12 months in your 'past-sale' search. A local RE professional should be able to provide this information to you as well.In New York, we deal with this scenario frequently and oftentimes it does not make sense to legalize ADUs because the permit process is extremely lengthy, the cost is high (sometimes $150-300K for 1 ADU unit), and the potential increase in property valuable is not worth the risk.If you already have an approved permit/plan and can get your renovation down to $80K, you may want to consider this project if the ARV is say north of $800K.** You should also look into any potential property tax increases associated with this change. In some suburban counties here in NY, property taxes go up significantly when units are added to a property.All the best!Abel

Chirag Rathod · Answer

Hey Amadeusz,The numbers make sense to add ADUs. It would be worth it we were to keep the property for more than 5 years. However, if we were to sell it say within 3 years, things might be different or might be in negative. The reason is that it's very difficult to fetch 1mn for an old home in Woodstock.

Amadeusz Bialy · Answer

Hey Chirag,One key factor here to consider is your return on investment. Most of us investors use real estate as an investment vehicle due to the leverage. When buying a property with 20% down, your appreciation is based on 100% value. Due to this, it would be worth exploring what your return on investment would be to add 2 ADU's to your home OR simply buy another property as a rental, for example a duplex. The end result is 2 units added to your portfolio however you are now also exposed to the appreciation of the rental property at a 1 to 5 leverage.Of course that is assuming the property can also cash flow and service the debt of the new mortgage. If you need help running numbers to determine the return of both options, or simply chat further feel free to reach out.

Chirag Rathod · Answer

Hi Abel,Thanks for your reply. ADU concept is kind of new to our city and the bylaw was passed in December 2023. So getting the comparables of similar properties sold might be difficult. But yeah, I agree even if I can get ARV of 800K, I think it might be worth it.