Invest in single family home or convert backyard studio to ADU?

Question

Hi there-

I have two homes, one in the Bay Area (CA) and the one I currently inhabit in Boise, ID. We have some money in the bank and are trying to figure out how to best invest it. The CA home is soon to become an STR and there is a 200 square foot backyard studio in the backyard that is just basically a rectangular room room with electricity (no plumbing, no gas). I've had two contractors out and they quoted me between 100K-150K to convert the space into an ADU, with kitchen and bathroom. The down payment on a modest single family home here in the Boise area would be about the same amount. My question is, does it make more sense to invest in a single family home here in Boise that I can rent out, or convert the studio space in CA to then rent out? I'm brand new to real estate investing (as is probably obvious!). My husband and I are leaning toward the ADU option. Just wish it wasn't so darn pricey and wondering if we can play general contractor ourselves. Any advice appreciated!

Dan H. · Answer

Due to the high leverage, the boise investment is likely to produce the better COC and ROI.

In addition, I would have large concerns about STR regulations impacting your plans to STR in the Bay Area.  In San Diego we recently had one of our STRs that have operated 23 years by our family get regulated away.  We are still considering our plan of action and have contributed to a law suit that is fighting it.

In general ADUs additions in CA are one of the worse RE investments.  Here are some of the reasons:

1) The value added by the ADU addition is often significantly less than the cost of adding the ADU.  Search 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?

good luck

Nicole Reeder · Answer

Thank you for this very thoughtful reply. I will have to do more research and chew on each of your points. The structure is already there (I would never even consider building an ADU from scratch in my CA backyard) but lacks plumbing and gas. Not sure the windows are up to code. So it would take substantial funds to make it rentable. One idea we’ve had is just to use it ourselves when we come to visit and not use the main house we are trying to rent as an STR. Maybe less red tape if it won’t be used as an STR. But maybe not worth the money in that case. Thanks again.

Nicole Reeder · Answer

Maximizing ROI

Derek H. · Answer

More sense in what regards? Just money? Just stress? What are your goals?