Input on strategy to build ADU & rent house
New to Real Estate · Portland, OR · Member since 2018 · 15 posts · 11 votes
Hi all! I am new to the real estate investment game and am trying to find a way to house hack to start bringing in real estate cash flow. I live with my partner in a very small single family house in Portland, OR (2 bed/1 ba, 800 sq ft) that sits on a fairly large lot. We are thinking about constructing an ADU in the backyard (ADU <500 sq ft), and living in the ADU so we can rent out the house. I'm thinking we could rent the house for ~$1700/mo. Detached ADU construction costs in Portland seem to average around $150k, but I'm hoping to find ways to do it cheaper (maybe ~$120k).
I still need to run numbers on the specific expenses to confirm there would be positive cash flow, but am currently just feeling out the concept. Has anyone done a similar project or have any advice/input to share? One specific question I have is around financing- anyone have creative finance strategies for construction loans, or will I need 20% down?
I would appreciate any input on my proposed strategy. Thank you!
Morning Sarah!
The strategy itself is sound-with Portland having a housing shortage and no real signs of relief, I think that in the long-term, adding more housing to land you already control is a great idea. In the short-term, just be aware that there are likely some zoning changes coming down the pipe...I think they'll be favorable, just keep in mind they're coming.
There are banks that will loan on construction projects and different ways of financing that. Let me know if you need an introduction or two.
Mathew
@Sarah Szuhay if you are getting quotes from qualified GCs at $150k you are not likely going to get that down to less than $120k.
You should shop several banks for options. They will look at the cumulative LTV for the entire property so it all depends on the appraisal. Another scenario would be an equity line if you have enough equity in the property.
Morning Sarah!
The strategy itself is sound-with Portland having a housing shortage and no real signs of relief, I think that in the long-term, adding more housing to land you already control is a great idea. In the short-term, just be aware that there are likely some zoning changes coming down the pipe...I think they'll be favorable, just keep in mind they're coming.
There are banks that will loan on construction projects and different ways of financing that. Let me know if you need an introduction or two.
Mathew
@Sarah Szuhay it is not possible to get construction financing for an ADU. The property has one deed that the bank will loan on. If you don't have enough equity in your property it is a non-starter deal.
Another problem is while the ADU has value you lose value in the original home because the yard is less desirable to a renter, and for an appraisal.
From an income point of view it is a great idea.
At our Rental Housing Alliance meeting we just had a presentation from an outfit that uses a crane and drops it into your backyard. They are 130k and are prefab. They are built in Idaho. He has done quite a few.
@Mathew Wray what makes you say there is still a housing shortage other than that’s what city council and the activists keep saying here in Portland? I’ve seen 2019 as the softest rental market since I started in buying houses in 2011. I could be wrong but I’m interested and in your experienced opinion
@Steve B. Morning!
I think I agree in part with what you're saying...that the activists and city council are connecting housing and homelessness to a degree that isn't correct. Yes, there are people who are on the street who can't afford to live in the PDX metro area. And, I believe that is a much, much smaller percentage of the total homeless population when compared to those who can't find housing due to mental illness, addiction, etc. I feel like it's a shell game or three-card monte that the city/county/state leadership is playing-"look over here at the 'housing crisis' not at policies that have actually exacerbated the problem"
I totally agree in the short term that rents have softened (although I just finished a rehab in one of my rentals and went for $1,000/mo to $1,495 so I'm pretty happy there!!), especially at the higher end as the new condos that have been springing up come online. I do expect that flattening to continue for awhile. That top end dictates and caps what I can charge for my rentals and puts some downward pressure on rents across the whole metro area.
But I think that's temporary and that on the whole, the PDX metro area is still facing a housing shortage and here's why...
New construction permits are far out-paced by the influx of people to the Portland Metro area. To date in 2019, there have been 32 residential new-construction permits finalized, issued, or approved to issue in the city. There are about 400 in the pipeline for review/inspection. On the mixed-use/multifamily commercial side, I found just over 30 permits have been applied for in that same time span, with less than half since the rent control ordinance went into effect in Feb. Those numbers aren't outside the norm with what the last few years have brought. 1/2 of the 2018 new home permits are still under review and all together 2017 and 2018 saw under 1,500 total new home permits.
I'm not an economist so maybe I'm missing some numbers from somewhere. What I'm not missing is that forecasts put another 400,000 people in the Portland metro area in the next ten years. Where are they going to live? We're not building homes fast enough. Even the large Polygon developments like what's going in out off Roy Rogers road isn't going to put a dent in the housing we'll need in the next 10 years. Not everyone wants to live in a high-rise condo (nor can everyone afford to). Because of that, I'm saying we've got a housing shortage.
We're in this for the long-term and although it's soft now, I just don't see how the housing stock recovers, makes up ground, and gets ahead to a point where landlords don't win. To the original poster's point, I'd say build anything they can on land they own so they can be making money off of it. There are plenty of people who won't/can't/don't want to live in an apartment/condo building so a detached unit /ADU should be a great long-term play because people will pay more for that privacy.
Here's an interesting link to a Portland Business Alliance article with a great graph on Portland's housing, employment, and population growth:
https://portlandalliance.com/advocacy/2018-economic-check-up.html
And, none of this gets into existing home sales, which continue to decline year over year as I think people are priced out of the market/hole up in whatever home they've got rather than moving up and creating velocity in the market.
Mathew
*I know some of the numbers I used are Portland specific and some are metro area-It's not ideal and at the same time, they still illustrate my point :)
While I agree with Jeff that there are some value concerns associated with adding an ADU to a home that people should include in their calculations, I do have to politely disagree on the lending. There are banks that will lend on ADU construction. 100%. Yes. You may not meet their terms, that would have to be discussed directly with them, but there are construction loans available for ADUs.
Mathew
@Mathew Wray why would someone go through the grief of getting a construction loan when HELOCs and refinancing is available? ADU's are not separate properties .
Just trying to put options on the table!
Maybe not enough equity for a HELOC but extra cash for enough to offset the down on a construction loan? Maybe wrapping it all up in one loan is easier for them? In my mind, it's better to have extra options than only 1...
And then one needs to consider and qualify for the additional payment. Let's say 130k at 6% interest only is $650.
But then you could spend 200k+/- on a stick built. Same terms $1,000 pm. Unfortunately HELOC's are generally adjustable so can go up.
Getting fixed rate probably better but payment higher. Locking in a great low rate now a good idea IMO.
Seems to me @Mathew Wray that a loan with a draw system, if contractor needs payment along the way, would be costly. Not familiar with those but maybe good? Don't know. Is this a credit union product that you are referring to?
It's been about a year since I went over the program with her before referring a client, so forgive me if I'm a little fuzzy on the exact terms. But, as I remember, the loan has a variable rate during the construction process and then converts to a permanent fixed rate mortgage at the end of construction automatically. All of the underwriting is done up front and the loan is based in off of the future value of the property. There are draws baked in which you're right, will likely add to cost. I think it's just running the numbers both ways and seeing if the fixed rate of the construction loan beats out the flexibility of the HELOC.
After that conversation, I looked at using the same product to redevelop a duplex in NE of mine into a four-plex using the equity in the property as my down. The numbers didn't quite pencil out for me at that time, but I'm confident they will in the future.
It's a product through Umpqua. I know some RE brokers have differing opinions over direct bank financing vs. going through a mortgage broker. In fairness to Umpqua, I've got a client just wrapping up a commercial multi-family transaction with their lending and it's been a really easy, quick process so I've been impressed.
That is cool and creative on Umpqua’s part. Thanks for the info @Mathew Wray.
Thank you both for the wonderful insights. It's really great to hear from folks in the Portland area. I still need to do more research on my financing options, but it seems like the main (conventional at least) options are a construction loan or a HELOC. I have heard great things about working with Umpqua, so I will definitely be checking out what they offer. I do not have a ton of liquid cash or equity in my house, so I will need to get creative with financing :)
Another option I'm considering, instead of a detached ADU, is converting my house to a duplex by adding a second story. I'm not sure yet how much this would cost or if I could afford it, but I'm curious if you have any thoughts. I have an assumption that a duplex would be more appealing to an eventual buyer than having someone in the backyard in an ADU, but I'm not sure. I also need to see if a second story could qualify as an "ADU", which get many fee exemptions, or if it would be considered a standard multi-family by the city (read: more expensive).
@Jeff S. By the way- I actually toured one of those pre-fab ADUs on the Portland ADU tour a couple weeks ago, assuming it was the same company. They're pretty cool! I thought they were a bit pricey though. I have family in both architecture and construction so I am optimistic (or maybe naive) that we can cut costs by doing some of the project ourselves!
@Sarah Szuhay how big is your large lot and what is the zoning? An ADU may not be the best financial play on that property, depending on those two factors. I'm happy to help you brainstorm highest and best for your property if you'd like. I've seen homeowners make financial mistakes by building an adu on the wrong property. An adu is great if you don't have additional density. It could easily become an "under improvement" and not the best financial move if you do.
@Steve B. we definitely have a housing shortage. @Mathew Wray was spot on that it's like a trick card game, the way the city skews their #'s, especially when they through out rent burden #'s without considering other subsidies for those income brackets. However, we truly have more house holds than housing and that's getting worse by the year. We were behind in housing before the crash, built nothing during the crash and not enough since. I'm seeing softening in my urban core portfolio as well, especially for my higher end remodeled units, but it is unit type specific. I'm not seeing softening in single family at all. Also, when you go past 82nd ave, competition is stiff. I've purchased out there recently and have had clients purchase out their recently.....that submarket is entirely different than inner submarkets. Supply and demand is way out of whack out there (not enough supply given the demand increase) where as it's the opposite in the urban core (too much new one/studio supply, more supply in general, higher pricing, more options for renters, etc..). The underlying population patterns and income are huge factors. The migration east of 82nd is pretty strong right now due to pricing west of 82nd and the household growth in the 100K+ households that can afford the inner markets (forcing lower income households east or out of Portland).
@Mike Nuss My lot is ~5000 sq ft and is in an R2 zone. I have talked to the city and understand that my lot can have up two units on it, unless I pursue affordable housing, then I could have three units. I really appreciate your insights and would love to take you up on your offer to help brainstorm the best solution for my property. Let me know the best way to get in touch. Thank you!