HELOC for ADU exit strategy
Member since 2020 · 10 posts · 5 votes
I am in the beginning stages of my first investment property. I am currently going through the planning of a garage conversion ADU. I live in the primary residence which is a 2 bedroom 1 bath 1000sqft. I have a HELOC in place for 45k along with some cash saved up to covert the garage into a 1 bedroom one bath ADU at just over 400sqft. Expecting 1200-1500/ month for the ADU and house hack. Current mortgage is 2,400.
My plan is to reappraise once ADU is complete and refi into a fixed rate to get out of HELOC. After doing some more reading I have seen people post about not getting much added value from ADU's due to lack of comps. I am looking for alternative exit strategies for HELOC. Thanks.
Thanks I will look into that. Added value would be great but it's not going to be a make or break for me due to the cash flow it will create. Correct me if I am overlooking something being a beginner. The current plan is to house hack and save up for a bigger house for my family as a primary residence and then use cash flow and hopefully by that time greater equity to continue my portfolio. If I didn't do the adu I would only be able to move on by selling the little equity I have now and have no portfolio started.
The issue is in many markets the value of the ADU addition is more than $50K less than the cost of the ADU addition. This is an issue for a few reasons: 1) The initial cash flow goes to recover the negative position. The negative position can consume years of cash flow before it is recovered and the first true return is achieved. 2) ADUs having value significantly below the hands on costs of the ADU addition means that there is no easy way to extract the value. Lets say that you can refi at 75% LTV and the ADU cost $100K (very cheap hands off ADU) but has a value of $50K as set by the appraiser. You get 75% of the $50K value or $37.5K. This implies $62.5K of value is trapped in the property. 3) the larger the trapped amount of investment, the lower the leverage and the lower the return. For example if I have $20K invested in a $200K property and it appreciates $10K, I have make 50% from that appreciation. But if instead I have $100K invested in the $200K property, I have made 10% from a $10K appreciation. The same thing happens with cash flow. Leverage can increase risk, but it provides the means to optimize the return from every dollar invested.
Do not discount the impacts of a negative position from an ADU addition. Make sure you have some idea of the value of the ADU versus the costs. Research Figure.com and see if it provides any benefit in the value of the ADU in your market. The research you are doing now will help you make an educated decision and hopefully avoid any significant surprises.
Good luck
I am in the beginning stages of my first investment property. I am currently going through the planning of a garage conversion ADU. I live in the primary residence which is a 2 bedroom 1 bath 1000sqft. I have a HELOC in place for 45k along with some cash saved up to covert the garage into a 1 bedroom one bath ADU at just over 400sqft. Expecting 1200-1500/ month for the ADU and house hack. Current mortgage is 2,400.
My plan is to reappraise once ADU is complete and refi into a fixed rate to get out of HELOC. After doing some more reading I have seen people post about not getting much added value from ADU's due to lack of comps. I am looking for alternative exit strategies for HELOC. Thanks.
I have not used it, but research Figure.com including searching BP. The claim is they treat ADU footage the same as the primary structure footage (same value for the footage). This likely will still place a value below hands off costs, but it likely is better than taking a chance on traditional appraisals that often value ADUs at least $50K below the hands off ADU addition costs.
My view is before proceeding with an ADU addition, get an understanding how it will be valued. I commend you for doing this. There are many posts on BP where the ADU addition is complete and the value given to the ADU is a complete surprise to the investor. How can it be valued so low?, unfair!, Can't they use the rents to set value?, etc. I have heard of many RE investors disappointed by the value of their ADU that if they had done better due diligence (like you are doing) would at least have been prepared and possibly have not added the ADU.
Good luck
Thanks I will look into that. Added value would be great but it's not going to be a make or break for me due to the cash flow it will create. Correct me if I am overlooking something being a beginner. The current plan is to house hack and save up for a bigger house for my family as a primary residence and then use cash flow and hopefully by that time greater equity to continue my portfolio. If I didn't do the adu I would only be able to move on by selling the little equity I have now and have no portfolio started.
Thanks I will look into that. Added value would be great but it's not going to be a make or break for me due to the cash flow it will create. Correct me if I am overlooking something being a beginner. The current plan is to house hack and save up for a bigger house for my family as a primary residence and then use cash flow and hopefully by that time greater equity to continue my portfolio. If I didn't do the adu I would only be able to move on by selling the little equity I have now and have no portfolio started.
The issue is in many markets the value of the ADU addition is more than $50K less than the cost of the ADU addition. This is an issue for a few reasons: 1) The initial cash flow goes to recover the negative position. The negative position can consume years of cash flow before it is recovered and the first true return is achieved. 2) ADUs having value significantly below the hands on costs of the ADU addition means that there is no easy way to extract the value. Lets say that you can refi at 75% LTV and the ADU cost $100K (very cheap hands off ADU) but has a value of $50K as set by the appraiser. You get 75% of the $50K value or $37.5K. This implies $62.5K of value is trapped in the property. 3) the larger the trapped amount of investment, the lower the leverage and the lower the return. For example if I have $20K invested in a $200K property and it appreciates $10K, I have make 50% from that appreciation. But if instead I have $100K invested in the $200K property, I have made 10% from a $10K appreciation. The same thing happens with cash flow. Leverage can increase risk, but it provides the means to optimize the return from every dollar invested.
Do not discount the impacts of a negative position from an ADU addition. Make sure you have some idea of the value of the ADU versus the costs. Research Figure.com and see if it provides any benefit in the value of the ADU in your market. The research you are doing now will help you make an educated decision and hopefully avoid any significant surprises.
Good luck
Well put. I thank you for lending this vital knowledge. This will definitely help moving forward. Thank you.
Another note from what Dan has already said, appraisals are going to be your biggest hurdle but it helps to live in an area where ADUs, granny flats, etc are more common. If your garage is attached I don't think this applies much. But I do know that where I live (20 minutes south of Dan in central San Diego) that ADUs are less of a white elephant and a few investor friends have had no trouble getting them to appraise. Other people have experienced what Dan has said with little to no appraisal value.
Other quick question, are you sure you will be able to refinance with a HELOC in place and a balance? I am under the assumption a refinance can only happen with no liens on the property.
Another note from what Dan has already said, appraisals are going to be your biggest hurdle but it helps to live in an area where ADUs, granny flats, etc are more common. If your garage is attached I don't think this applies much. But I do know that where I live (20 minutes south of Dan in central San Diego) that ADUs are less of a white elephant and a few investor friends have had no trouble getting them to appraise. Other people have experienced what Dan has said with little to no appraisal value.
Other quick question, are you sure you will be able to refinance with a HELOC in place and a balance? I am under the assumption a refinance can only happen with no liens on the property.
Yea I may have some trouble getting the added value. My buddy is doing his ADU currently and his is costing 55K. I am hoping to do mine for about the same. If this is the case I think I will be able to capture that in added value. I have about 70% of that saved up in cash so now I might be thinking to use more cash to pay for the ADU to help keep my HELOC debt low. As far as refi with a HELOC you are able to do it. My creditor stated the only penalty for closing the account early was a $350 fee which was waived when opening the account. This is the method I got from Kol Petersons book called backdoor revolution.
@Dan H. is 100% right correct with his comments. I jumped fully into the ADU route but I have serious reservations about decision. I am anxiously awaiting my appraisal now but given the comments here, I seriously doubt that I will see a huge boost in value to our property.
Regardless, I am really banking on reducing cost of living to accumulate investment funds faster and do some OOS investing in the future.
As far as refi with a HELOC you are able to do it. My creditor stated the only penalty for closing the account early was a $350 fee which was waived when opening the account.
I am still wanting to clarify, you said refi with a HELOC and then said "closing the account early". So, are you able to refi with a HELOC open and in place, or do you have to close the HELOC first before you refi? I am still under the assumption that you will have to completely pay off the HELOC first to close the account before you can refinance.
As far as refi with a HELOC you are able to do it. My creditor stated the only penalty for closing the account early was a $350 fee which was waived when opening the account.
I am still wanting to clarify, you said refi with a HELOC and then said "closing the account early". So, are you able to refi with a HELOC open and in place, or do you have to close the HELOC first before you refi? I am still under the assumption that you will have to completely pay off the HELOC first to close the account before you can refinance.
I don't believe that is true. The method I am trying to execute would be to use HELOC based on current equity to pay for ADU. Once ADU is complete refi out of the HELOC into a new 30 year fixed based upon the new value of the home. This of course all relies on capturing enough of that added value once the ADU is complete and keeping cost of ADU build under budget.
I would really double check on being able to refi out of the HELOC into a new 30 year fixed with a balance on the HELOC. If you are able to do that and keep the open balance on the HELOC I would be interested in which lender you are using as that would be useful for my situation as well!
The HELCO is treated as just another loan. During a cash-out refinance, the original loan is paid off and then the HELCO is paid off. This only works for folks who have the equity. I'm my case, I had loads of equity so it should not be an issue to pay all of this off and restructure with a new fixed 30 year loan.
A homeowner in San Jose had good success with figure.com in getting a nice appraisal on their ADU for a HELOC after a project. It may be dependent in how the additional square footage is recorded but a helpful option as @Dan H. mentioned. Here's the thread:
@Michael Ramos
I added an adu to an existing single family in LA and just finished this year. I’m in the process of refinancing now and it’s been disappointing to say the least. There are no comps in our area and the appraiser basically just found single family properties with similar square footage and then added $15,000 for the adu. We are challenging the appraisal now.
I think the bigger concern may need to be cost estimates. We broke ground just as covid was hitting last year and it more than doubled our budget and timeline. Feel free to message me and I can tell you my particular story, but you’ll just want to make sure your estimates are realistic and you know how to get through the permit process.