How to maximize rental income, include adu or not

Question

I have a 1000 sf 2br/1ba house that needs serious tlc in upscale neighborhood. I'm interested in maximizing rental income and would like to know if rebuilding the existing house to 2 story 3br 3ba 2000sf and adding 800sf adu in the back would be a good approach. Concern is that renters in the main house may balk at having people walking through 'their' yard. Or do I go all in and build the biggest possible main house? Neighborhood has a good mix of old and new, and the new ones are trending BIG. This is in Palos Verdes area. Your thoughts are appreciated.

Ricardo Paredes · Answer

@Nick Larsson I would tend to agree with posters above that an ADU might not be as popular in PV, Rancho PV as a value add if you're selling the property, but it might make sense for you as the landlord. We just finished an ADU on a detached garage in southbay and are happy with the results. Feel free to message me if you have questions about process or want a contractor recommendation.

Ashley Undercuffler · Answer

Really good questions! Typically adding a second floor to existing home is extremely expensive and difficult structurally. Adding an ADU would be much easier (assuming you have enough square footage). It is a very popular and typically rents very fast. It all depends on what your goal is. If you were going to occupy the front unit and build a back unit, you just need to be clear on how much time you want it to take. Know that before talking to a contractor. There's also a special loan program called homestyle loans. This is where the bank will give you money based on the expected value of the ADUs. I'm happy to talk more about it if you're curious. Have a good day!

Eliott Elias · Answer

If there are no comparables in the neighborhood like this it is impossible to give you an answer. The amount of cash you will spend to do this can be put towards other properties. You may inhibit its value.

Monica Der · Answer

I grew up in Palos Verdes Estates, and as a local I think most people who live there are looking for a SFR, so the ADU would fit the location, older, quieter and more conservative tenants. My parents house on Chelsea Road was built in 1953, in quite a state of disrepair and only 1776 square ft. You should increase the size of the lot if permissable by local zoning and building codes. Then add a swimming pool for value add. Depending on the location in Palos Verdes, you can get about $6500 per month for a smaller, older SFR

Matt Giacinto · Answer

Hey @Nick Larsson, I agree with Alex here with bringing up SB-8 and how it'd make things really difficult for you to remodel and redevelop the main house. However, an ADU is definitely possible and could make some sense depending on the construction costs and potential rent it could generate. I work with a construction company and we can help analyze what makes sense for you, if anything.

Alex Otto · Answer

Hey @Nick Larsson! As you're thinking through options, if any of them involve demolishing an existing residence, I would be mindful of SB-8 and how it's being applied by whichever jurisdiction you're in.

For example, if you were in Los Angeles City, SB-8 would say that if you demolish the existing SFR as part of your redevelopment, you need to verify the income of whoever has lived in the house for the last 5 years. Then, if any of their income levels were "low" or "very low" (or if you just can't get the income level from any past tenants/occupants), you would have to replace it with an affordable unit. Now, LA City's documents are conflicting on whether or not this applies to owner-occupants or just tenants, but the CA Gov't Code says just renters.

Note that the Gov't code says that the affordability requirements don't apply to a project that just demolishes and replaces an SFR ("for purposes of a development project that consists of a single residential unit on a site with a single protected unit, “replace” shall mean that the protected unit is replaced with a unit of any size at any income level."), but LA City is less clear on that...

Anyways, that example above hopefully illustrates that, depending on who has lived in your property and how your jurisdiction is implementing SB-8, you may prefer to choose one development option over the other, and you may want to phase any multi-unit development rather than do it all at once. Thinking again about the example of LA City above, if it were me, I might try and permit any work on the existing house as an alteration or addition, which would mean that SB-8 would never be triggered. Alternatively, I would permit the demo/rebuild of the SFR first, then separately permit any additional development.

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As for the concerns regarding ADUs (or any other SFRs on the lot) and access/privacy, I would argue that the job of any good designer would be to make both units feel like they had clear, private access, great outdoor space, no/minimal windows staring from one unit to the other, etc. Depending on your lot size/shape, that might be difficult, but it's definitely an achievable design goal for many projects.

Dan H. · Answer

Adding ADUs is typically one of the worse RE investments contrary to what ADU developers may claim. This is especially true if hiring out all the work.

The best rents for ADUs is achieved for ADUs that have an appearance of being a separate property.  This would not be the case if the ADU occupants need to walk through the primary unit’s yard to access.

Here is why adding an ADU hands off is often a poor investment especially if compared to other RE investment options. 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?

Good luck