Quote from @Dan H.:
ADU in sf areas of San Diego are seldom getting values from appraisers over $100k. This is n spite of it costing much more than that to add an ADU.
Look for comps of properties sold with an ADU then look for comps comparable to the house without the ADU. That will show you how the market values the ADU. If you cannot find at least 3 comp properties with an ADU, then be prepared for a horrendous valuation (<=$100k).
It s my view ADU additions in So Cal are one of the worse RE investments especially in SF areas. Here is a list of reasons:
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 (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.
Good luck
Thanks so much for the thoughtful post!
Reactions to your points - would love your feedback given you are clearly very experienced in this.
1. There are properties in the direct area where the ADU sqft was simply added to the total sqft and was sold with a similar price per sqft to other properties in the area (ranging in the $700-800 ppsf). Actually, I haven't found a single one where the ADU lead to a meaningful discount.
2. The bank I am working with would provide a construction loan with 3/8 points higher than the original mortgage to buy the property. So very attractive financing? I would then refi after construction is complete to a "regular" loan.
3 + 4. I think these are the biggest risks I am facing since there are powerlines in the proximity.
5. / 6. / 7. The property is already a duplex (i.e., it has 2 units). The ADU would be the 3rd unit and the largest and most attractive one out of the 3 (also preserving the 2 garage spots). To be clear, this is not a single-family home which would lose its benefit of being a single-family home)
8. If I could find a good one I would ;) but havent found anything that is cheaper since the sqft of building is much lower than what it sells for (at least what I have seen in the areas I am looking).
9. It's a duplex so dont think this applies here.
10. Probably right, aiming for 1000 sqft livable space so not super tiny but still your point probably holds.
Steady state, the property should generate about $12-13K in rental income monthly (I will likely live in the ADU to begin with, which would reduce the income of course). At a ticket price of $2M (purchase + ADU build). Doesn't look terrible for one of the more attractive neighborhoods in LA?
Would love your thoughts!
