Backyard ADU is $300k+ in Denver... Any way it financially makes sense? Modular ADU?

[Spencer Holland]

I just bought a home in a walkable & higher rent neighborhood in Denver (LoHi), so I want to utilize the land to it's fullest rental potential. The backyard is already divided into 2 parts and has plenty of space for an ADU. I'm hoping for 600 - 800 sq feet. After calling the city, zoning doesn't seem to be an issue. I'm beginning to get high-level quotes from builders & even modular companies (which I thought would be cheaper) and they are all $300k+.

Is there a less expensive route that I'm missing? Is there a way with creative financing to make this make sense? I would assume the small ADU would get $1700 - $1800 per month in rent.

[Dan H.]

According to NAR data from Nov 2021 an ADU in Denver added $170k. If an ADU addition in fact costs $300k+ to build, you are likely starting with over $100k of negative equity. There is no cash flow until the negative equity position is recovered. At that cost and rent point, it will take many years to recover the negative equity position.

https://www.nar.realtor/magazine/real-estate-news/study-adus...

Here is a list of why adding a single ADU in single family zoned areas in my CA market is typically a poor RE investment (some of these may not apply in Denver, especially I do not know the rent control rules in Denver):
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 by the ADU (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?
9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.

good luck