All Forum Posts by: Adam Watanabe

@Adam Watanabe

Are you aware that 2 ADUs excludes the use of conventional (Fannie/freddie (f/f)) financing?   The loss of conventional financing will negatively affect the valuation.   

Not eligible for conventional residential financing

- multiple ADUs

- ADU added to a quad

Make sure you are aware of the impacts of adding a second ADU.

Good luck

Is the $2k/month as an STR or LTR? STRs and MTRs are more work and have more expenses.

if you are planning on adding a second ADU, is one a JADU? JADU in general lower the value of the property and require owner occupancy. If i is not a JADU, are you relying on a local ADU law?

my wife has an acquaintance that adds ADUs in some of her OC coastal flips.  She only does this if she can find comps that show a valuation noticeably above her development cost (her ADU development costs are significantly lower than a non developer hands off ADU).  Note because she has her own development team, this is not a hands off ADU addition. Even with having her own development team, having the ADU add more than the cost of the addition  is an exception and not the normal.  Most flippers are not adding ADUs because even acting as GC the value added is typically less than the cost of the addition.

In addition, if there are local laws that permit the addition of multiple ADUs, then it could be worth adding. The link i provided had the land provided by one of my protégés.  I suspect everyone will make money on that development but for sure my protege did well and has already exited (so even if it goes south, he has made his money). I am a partner on an effort that leverages San Diego rule that allows as many ADUs as desired to be converted from permitted space   The plan is to add 8 studio ADUs out of garage.  It seems like a good investment, but I fear I will lose money on this effort due to the hit in valuation of commercial MF.  Hopefully I am mistaken and I can get some profit.

I agree RE investing is challenging at this time. However the large initial negative position and the other items I listed make adding an ADU typically a particularly poor investment. The ADU addition making the primary rent controlled (assuming more than 15 years old) can make LL more challenging (currently SFH are exempt from rent controlled state wide - Costa Hawkins).

Make sure you know the value the ADU addition will add. Make sure you know the ramifications of adding an ADU. Make sure you understand the work involved and how the ADU addition will be financed.

Good luck

@Adam Watanabe

The idea of an ADU might make sense in Sacramento but it would depend on where this property is located. Is it in a trendy downtown place with lots of renters (i.e. Midtown, Land Park, Curtis Park, Tahoe Park, etc.)? If so, then I might consider it.

Also, are you certain about the conversion costs?  How many contractors have you spoken with?  Do you know what plans and permits will cost?  You should probably do more research and maybe find some local people in Sacramento that have ADUs to get advice.

Many of the people above are from out-of-state (OOS) so they don't understand all the rules in California or Sacramento. Sacramento is an ADU-friendly city so I would not be concerned about the city approving your conversion.

I suspect the cost to convert an 450' garage to an ADU will approach $150k. The issue is it will likely add ~$75k of value resulting in an initial negative $75k (a value subtract). This initial negative position needs to be recovered before any cash flow is obtained.

I am also a bit skeptical that a 450’ unit can achieve $2k rent in Sacramento.

Using 50% rule (expenses other than mortgage is 50%) on a financed ADU, 8% 30 your loan at 80% LTV.

$2000 - $1000 (50% rule) - $881 (P&i) = $119/month
$75k/$119 = 630 months to recover the initial negative equity. This is 52.5 years.

Let’s use OP’s $120k with $45k initial negative position.
$2000 - $1000 - $704 (P&i) = $296/ month
$45k/$296 = 152 months or 12,7 years to recover the initial equity.

Building a single smal, unit is very expensive 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.

Good luck

@Adam Watanabe

Converting a garage is not the best idea for the exit of a property. Many people still want garages for primary residences. By having a garage converted, you limit the value of the home and the buyer pool to investors. At 120k/2k that is 60 months or 5 years on the return. @Dan H. has some good insights on ADU conversions.
Generally, it would be better to put the $120k towards the down payment of another property so you can gain the equity even if the cashflow is breakeven.