ADU Appraisal: Income-based, or....

Multi-Family and Apartment Investing
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ADU Appraisal: Income-based, or....

Jesse Aizenstat
Developer · Santa Barbara, CA · Member since 2019 · 10 posts · 2 votes

I live in a really expensive market, in Santa Barbara, CA. Buying a small 2/1 home starts at around 800k. Taking advantage of California's new ADU law, I decided to buy one of these small homes and permit an ADU. (A value-added play that I can control makes the most sense to me in this high market.)

My main house is 930 SF 2/1, and the ADU I want to build would be a 800 SF, 2/2. I estimated that this ADU would cost me $200k all in to build and generate $3,000 per month. That would be pretty good, considering how saturated multi-family is here in Santa Barbara. Most multi-family scores around a ".50" here: monthly rent / price * 100. Example: ($6,000 / $1.2M)100 = .50. These are the projected numbers on my deal and a ".50" is a typical score for multi-family here.

So, to mine the wisdom of the BP forum, what do you think this property would be worth when the ADU is completed? Can it be treated just like any other multi-family in my neighberhood, with an income-based approach?

I've read on another post that someone built a 2/2 in Portland that cost him 300k and the appraiser only added $75k worth of value. That seems crazy to me. But perhaps I'm just looking too hard at cash-flow and ROI. Since my property is in the multi-family zone, it does not need to be owner-occupied, so it really could be treated as a duplex to some investor if I decided to sell it. But I don't want to sell it. I want to eventually do a cash-out REFI, so what an appraiser thinks would be critical here.

Looking forward to hearing your thoughts in the comments section. Thank you.

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Cory CarlsonBusiness Member
Real Estate Broker · OR · Member since 2018 · 311 posts · 226 votes
7y

Looking at Comps on houses with ADU's in your area what is the market saying? Mr. Appraiser may just not know how to value it. Thats the issue with 4 and less units is the appraisers view it almost entirely on comps and not on the numbers. If you can find the added value that coincides with your end goal, you can provide that to the appraiser to hopefully get what you're shooting for. I had an awful appraisal on a four plex recently then we switched lenders, and got the appraisal that was more fair.

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  • Jeff S.
    Specialist · Portland, OR · Member since 2010 · 3k+ posts · 1k+ votes
    7y

    First of all congrats on being able to buy in Santa Barbara. Getting 3k for 200k is great too.

    In Portland what happens is when you add an adu you lose some quality of life to the original building which may have had a nice yard that is then compromised. This devalues the original house and cramps privacy. From an income point of view building an additional unit probably good.

    Can you build attached housing and add additional sf? Adding an adu for resale you would be lucky to break even on your investment in Portland IMO.

    Not sure how someone spent 300k on an adu.

    Not an appraiser just have same issues here in Portland.

    You might check in with Mike Nuss here in Portland. He is an appraiser.

    1Reply
  • Brian LarsonPro Member
    Investor · San Jose, CA · Member since 2018 · 313 posts · 230 votes
    7y

    @Jesse Aizenstat - I read that forum post too. I have had lots of conversations about this in the past few month because I am attempting to build an ADU in downtown SJ.

    My general comments are that Appraisers have not adjusted to this fundamental change in the California Real Estate market yet. I think it is possible for a higher appraisal but you need to work your lender and appraiser. Chances are stories like the $75K for a $300K investment are due to the appraisers methodology of treating ADU properties as SFH. These properties should really be appraised like a duplex. Not sure when the appraisal industry will address this issue but it needs to happen soon if local jurisdictions expect ADUs to solve the California Housing Crisis.

    1Reply
  • Cory CarlsonBusiness Member
    Real Estate Broker · OR · Member since 2018 · 311 posts · 226 votes
    7y

    Looking at Comps on houses with ADU's in your area what is the market saying? Mr. Appraiser may just not know how to value it. Thats the issue with 4 and less units is the appraisers view it almost entirely on comps and not on the numbers. If you can find the added value that coincides with your end goal, you can provide that to the appraiser to hopefully get what you're shooting for. I had an awful appraisal on a four plex recently then we switched lenders, and got the appraisal that was more fair.

    503-222-0282
    Constant Commercial Real Estate Inc543 Reviews
    WebsiteView Page
    2Reply
  • Michael T.
    Los Angeles, CA · Member since 2018 · 326 posts · 279 votes
    7y

    Jesse,

    As others have mentioned it definitely varies by market and if the market doesn't justify the value add then the appraisers won't appraise at too much of a higher value.

    As an example in the Los Angeles area if you add a $100K ADU typically an appraiser will only add an additional $50K-$75K to the value of the property. If there are multiple properties in your market that have ADU's and they have comps and the re-sell value is strong they will appraise it at the higher of the $75K range.

    The best option is to add another separate unit and then the appraiser is able to justify the higher value due to comps.  

    I do agree with @Brian Larson that the appraisers have not adjusted to the new laws but it will still probably be a few years until we see the true appraisal value of an ADU in the California markets.

    2Reply
  • Mathew Wray
    Real Estate Agent · Portland, OR · Member since 2013 · 412 posts · 219 votes
    7y

    We've talked with appraisers about this very issue and the best of them have confirmed what others here have said: there is no universal guideline on valuing an ADU...yet.

    From a "next steps" standpoint, have you considered reaching out to a known appraiser and paying them to do a private appraisal? Tell them up front you've got an ADU situation and you want to pay for their time as a consultant. That way you can get on the phone or meet in person, talk through comps you've found, and have a conversation without it sounding like you're trying to tell them how to do their job.

    Then, assuming their report mirrors your goals, use that when going to a lender for a refi or a buyer’s lender is having an appraisal done. If the appraisal doesn’t match your target after all that then you may need to sit out as a rental for a few years until a standard is established. 

    Mathew

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  • Jesse Aizenstat
    OP
    Developer · Santa Barbara, CA · Member since 2019 · 10 posts · 2 votes
    7y

    Thank you @Mathew Wray for your response (and thank you everyone who has commented here). What a wealth of information. You know, I actually tried to get appraisers to come out previously, but all claimed to be "too busy" last time I checked. I just found someone in town who will be coming out this Friday. I'm going to present them with the facts, plans, but not "lead the witness" as they say. The value here is in letting him judge for himself and build his argument for price. Ultimately it will be his kin that presents to the bank. Not me. 

    There's also another detail that is largely overlooked in the appraising ADU's debate. There's a difference between a 4m house with a guesthouse that's built under the ADU law, and a small house in the multifamily zone that has an ADU that's about the same size, with the same amount of bedrooms and bathrooms. The 4m house is obviously not a typical rental and would be priced based on luxury comps. The small house with an ADU in the multifamily zone really is a rental, so an income approach is not just justified, it's completely designed around the idea of being an income property. So asking "how should an ADU be valued" might need a little more distinction before judgment.

    Another big component for me would be the owner-occupancy covenant with the City (as we have here in Santa Barbara). ADU's must be rented along with the house to the same person if the owner is not living at the residence. As an investor, this kills the "rental" idea of the ADU, and would cause me, if I were an appraiser, to look for comps on the ADU, perhaps mixed with some elements of an income approach. If this same house with an ADU was existing in the multi-family zone, it could be owned by whomever, rented like a duplex, and thus valued like a duplex.

    These two points really must be added to the ADU appraisal question. But it all seems pretty straight forward and will be interesting to see how the future of banks/appraisals shake out.

    1Reply
  • Mike NussPro Member
    Real Estate Entrepreneur · Portland, OR · Member since 2014 · 453 posts · 328 votes
    7y

    @Jesse Aizenstat that last paragraph you talked about was the most important part of your discussion and facts so far. I can talk a lot about how appraisers consider adus in Portland, but it sounds like it's a whole other ball game in Santa Barbara when it comes to the covenant. In my opinion, an owner occupied covenant should completely eliminate the income approach to value or using duplexes as comparables. Comparables are supposed to be properties that a potential buyer of the subject property would've considered purchasing as well, and vice versa. An investor who's looking at income property in Santa Barbara has no reason (unless for a specific investment niche) to be considering sfr w/adu properties as their main motivation is income stream. 

    In Portland, when I was appraising, I would consider duplexes. I have appraised a sfr w/adu as a single family home w/adu, utilizing a bank from for a single family home. I've also appraised a sfr w/adu on a 2-4 unit income property form as well. My reasoning for changing, was based on the specific context of the property that was being appraised. How would the market (potential buyers) look at the property? If that answer included, or was dominated by investors, I would really have to consider the income. ADUs are becoming much more common in our market, so it's possible now to complete an appraisal using strictly sfr w/adu properties as comparables. I had lunch with a realtor friend of mine today who lists a lot of infill new construction. We weren't talking about adus at all, but he said that he's seeing new construction with adus having the most success in the market right now. His thoughts are that the new construction market is completely flat and the adu gave builders an advantage on the market place. 

    Regarding your specific situation, as an investor minded person, 3K rent on 200K expense, in Santa Barbara seems really dang appealing. 

    Oh yeah, a little comment on the "0.50" comments about Santa Barbara....the reason your'e getting such a better return on your adu scenario versus a purchase scenario is because you're not factoring in land value. Land value for your adu is free as you already own the property.....purchases scenarios are having to buy the land as well as the income producing improvements. 

    I hope this helps

    Oh yeah, @Mathew Wray gave a great recommendation to just contact an appraiser. I would go a step further and say you don't really need to get them out to your property. A good appraiser will know your location and zoning designation in their head and can probably just have a 5 minute conversation of how they would "pull comps" in your given scenario, which would give you a good idea of how they'll be considering the adu's income as it pertains to value adding potential. 

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  • Mathew Wray
    Real Estate Agent · Portland, OR · Member since 2013 · 412 posts · 219 votes
    7y

    @Mike Nuss thanks for lending your appraiser knowledge to the conversation!! 

    A quick clarifying question-when you said you'd look at the context from how the market looks at the property are you talking about how an individual buyer under contract is assessing the property or the market in aggregate? I'm assuming you don't know whether the buyer is buying a property with an ADU for an investment or as a SFR to offset the cost of the purchase/family reasons. Do you just look at the proportion of multifamily sales to sfrs to gauge that specific area?

    Would love to know more here to help educate my buyers. Appraiser’s we've spoken to at brokerage meetings and for listings tell us there are no hard and fast guidelines which is about as frustrating an answer as possible!

    Mathew 

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  • Adam Mayberry
    Architect · San Jose, CA · Member since 2014 · 90 posts · 57 votes
    7y

    I think more and more, especially in the Bay Area where housing is expensive and Baby Boomers have VERY low tax basis in their homes, ADUs will be very common place for sales of properties. There is a financial benefit for young families looking to buy a home to also look for an ADU for a mother/father or both to live in during retirement and or as a home base when they sell the "family home" and buy in a cheaper retirement area. The ADU is a way to downside, without incurring the costs of purchasing a new smaller single family home, or condo with HOAs....

    Comp's haven't caught up yet, but if you can build for $300-400/sf and homes in your are sell for $700-$1500/sf - there has to be value in building that ADU square foot when you do go to sell, let alone collect the income for ongoing rental basis. It's a long term gain as an investor - not a get rich quick flip / flip / flip type scheme.

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  • Mike NussPro Member
    Real Estate Entrepreneur · Portland, OR · Member since 2014 · 453 posts · 328 votes
    7y

    @Mathew Wray kind of both actually. Not the specific buyer that is in contract, but how the "typical" buyer in the market place would consider that property. Some properties will be looked at both by owner occupants and by investors. Some just by owner occ and some just by investors. 

    It is frustating that there are no hard guidelines, which is actually a good thing in my opinion as it actually allows for some "art" as context varies. For example, I appraised a sfr w/adu that was right off of mississippi. There was a lot of interest from investors. The actual buyer was an owner occ that was going to rent the adu, but because so many investors were interested, I actually appraised that like a duplex. There were no good "comps" at the time (this was back in 2009 or 2010) so a duplex made much more sense. A contrasting example would be a sfr w/adu further from the city core and in a less walkable part of time. The rent value from the adu isn't nearly as much so the adu is much more of a "mortgage cost offset" than a real "marketability increaser" where it increasd the pool of buyers simply by being there (where as Mississippi's location grew the pool of buyers dramatically). 

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  • Mathew Wray
    Real Estate Agent · Portland, OR · Member since 2013 · 412 posts · 219 votes
    7y

    Got it! That makes perfect sense! 

    I do appreciate the art form and fluidity of a lack of guidelines...and all things being equal would prefer a human touch vs. a checklist, even if it does make it more nuanced to explain to clients! 

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  • Chen Zhou
    Rental Property Investor · Santa Clara, CA · Member since 2019 · 160 posts · 156 votes
    5y

    Hi everyone, wanted to share with you a great way to tap into the equity built from your ADU.

    The problem today: most appraisers used by traditional lenders would give ADU square footage a second-class treatment than the main house (as some of your mentioned above) since there aren't that many comps and they're trying to be conservative.

    However, you can consider taking out a HELOC/doing cash-out refi through Figure.com (HELOC up to $250k, Cash-out refi up to $1M). I just took out a 30-year fixed-rate HELOC through Figure from my San Jose property that has an ADU on it. Unlike the other lenders, Figure.com does automatic appraisal (without a human involved) based on public data and they treat ADU square footage the same as the main house square footage. Because their generous appraisal value, I was able to take out all the cash I invested into the ADU (plus some more). The whole process only took 2 weeks and I'm really happy about it. In fact, you can check your property's appraised value by simply filing out the questions on their website. If you have an ADU on your property, it's super easy to find out approximately how much you can take out through just a few clicks with only a soft credit pull...

    A side note: the founder of Figure.com Mike Cagney also founded Sofi and they got pretty some impressive investors. I think they really did a great job simplifying the process and removing all the inefficiencies in mortgage industry today...

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