investment advice on scaling current home

[Amanda Cano]

Hi y'all! My husband and I just discovered the BRRR method and have secretly and unknowingly been aiming to use it!

About us: we are late 20s young professionals who already are over working the 9-5 and looking to be full time investors. My husband is currently navigating his first year as a real estate agent while also teaching high school. I work in my field part time while also being a mom of 2.

In 2019 we bought a 2 bed 2 bath condo for 389k and sold it May 2021 for 499k after putting in 25k of renovations. We then bought our 2 bed 2 bath single family house in May of 2021 for 589k and put about 30k into it with a HELOC to pay for it. Both times we did 20% down payment. (Housing in extremely high on the central coast)

So, right now we have an appreciation value of 690-715k without appraisals on what we've done to it, purely appreciation value. We are considering taking out a larger loan to finish off renovations that would also absorb the current HELOC, about 137k at 6.8%. After absorbing the current HELOC that would be 107k leftover. We plan to use this money to renovate the 2 car garage into an ADU and then living in that while finishing the remodel of the main house. Afterwards we would Airbnb the ADU and live in the main house while we do a cash out refinance. Adding a 3rd bed and bath with upgrades should increase the value to about 900k.

My question is… should be do the BRRR method first before tackling a house hack? We were wanting to do the BRRR method after we do a cash out refi as to not feel overwhelmed with projects especially since we will be investing out of state. Does anyone have experience with ADUs? Long term goal will be to rent out both the main house and the ADU after some capitol gain. Looking at investing in Eastern Tennessee, North Carolina, or central Wisconsin. We are new to the investing game but interested in having a very large portfolio so advice is much appreciated - TIA!

[Janelle K. Eagle]

Hi Amanda! Love the brainstorm you are doing and congrats on getting connected to a spouse that is willing to support that vision with you!

In my opinion, as a fellow realtor/investor, it all comes down to the "cost of money." For every month that you have borrowed funds in use, you are obviously paying interest. I would do your best guess budget of what it would cost to do BOTH the ADU and the Main Home upgrades - and then add 20% contingency, and then ALSO calculate your carrying costs on the loan(s) over the period of time you think it's going to take. Factor in a 3month+ cushion as things always take longer than expected during construction and/or getting paying tenants placed.

In my personal opinion, I wouldn't do the cash out refi until you have ALL updated repairs and upgrades completed to maximize the valuation of the home and to pay yourselves back for as much as possible that you've already spent.

Keep records of the amount of income that is generated by the ADU (or the main home), and /or get your hands on similar listings in the area that can help quantify the potential income. All of that will be crucial for the valuation.

Hope this helps! 

[Dan H.]

In most jurisdictions, an ADU cannot be used as a STR. Check the rules for yr jurisdiction.

In general, adding an ADU is one of the worse RE investments. This is some of the 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?

if you still want to pursue the ADU, look into the $40k ADU grant. It helps slightly with item #1 above.

Good luck