So Cal ADU vs. Investing out of state

So Cal ADU vs. Investing out of state

Member since 2018 · 7 posts · 0 votes

We own a home in middle class neighborhood in a quiet residential neighborhood Los Angeles with a decent school district. Our lot size is about 6500 sq. ft., with a detached garage space which we are considering to covert to an ADU rental unit for extra income. We are going to be having a baby in 1.5 year and we would like to use the rental income so I can be home with the baby. We should preface it to say the home is near two small colleges, Google campus and near the shopping center (includes T-Joe).

This ADU will cost about $100k to $150K(cash) 400 sq. ft., from start to finish on the existing structure. I can rent out the unit for $1700 to $2200 a month which pays more than 60% of my mortgage, but I have so many questions that only gets me too scared to make the next move.

  1. My concern is what affects having the ADU will have on my home's resell value 10 years from now. In my neighborhood where homes are listed between $900k for a tiny fixer-upper to $1.8 for a decent size turnkey, I have seen smaller homes are so hot, high in demand by first time buyers where as larger homes go stagnant due to the higher pricing (due to the sq. ft. not because of the location)and targeting smaller audience group who can afford that higher price point. I have watched homes listed for $1.7m reduced down to $1.5 to sell. Home that sits on the market has to compromise in the sale price-that's the bottom line.
  2. To the contrary, one can argue that having the rental income is going to entice those first time buyers who may otherwise be priced out of that range but if I were a buyer I would first start to wonder how hard it is to keep the unit occupied throughout the year? Then my second question is the issue of privacy. I may even ask "Am I a chill, laid back landlord who is cool with living with a stranger?" How many of you would actually rather have a small fixer-upper than a large home where you have to share the space with a tenant?
  3. The alternative is to take that money and invest it in areas like Riverside, Inland Empire, Modesto etc, but that would require another loan and the money is getting more expensive as we know it. 
  4. The last option is to invest in another state, but this idea seems far fetched and risky especially that I am going to be home-bound with my baby. But if I were to do it I wouldn't want to leave the west coast.

At the end of the day, there is no risk free investment. Can all of you real estate experts shed some light on my dilemma. I would surely appreciate it.  

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Rental Property Investor · Los Angeles · Member since 2018 · 844 posts · 1k+ votes
7y

@Nikki O. I'm in a similar situation as you in the sense that my wife is really interested in building an ADU by converting our garage. Since we are within a half mile of public transportation, we are not constrained by the city requirement to have covered parking for your car.

Here are my thoughts when it comes to an ADU.

I hate ADU's that totally feel like garage conversions (although admittedly, they ARE garage conversions). In order to build it one so that it doesn't feel like you're living in a garage that's just been prettied up, you will spend a considerable amount of money..... probably more than whatever quote some of these local garage conversion specialists have told you. My wife's co-worker is in the process of building a 2br/1ba ADU ...they demo'd the existing garage and are building it from scratch from the foundation up and are almost done. So far, it looks beautiful....the type of property that I would love to live in if I were 10 years younger and single. However, it is costing them about $75K more and 6 months longer than initially estimated. But in the long run, it will be worth it because any hint of this structure being a garage has been completely eliminated, new utility meters have been done, and the property itself has its own address. Basically, his home was converted to a duplex that is perfect for house hacking. And I'm convinced that this structure will indeed substantially increase this property's market value.

You also must have a contractor that you know will do a good job. I have a person that I use all the time and 90% of his work consists of me and a few other of my closest friends. If I didn't have someone like him who I've used many times in the past with great results not only for me but also for everything he's done for my buddies, I'd be less confident about building an ADU.

With that said, there is no place in So Cal where you can spend 200K on a building and rent it for $2.5K. Although you will go through a lot of stress during the build process, the return on your capital will be hard to match.

Another option is to build the ADU and rent it as an Air BNB. We live in Wilshire Park, which is a very good place to run an Air BNB...and from what I can gather, you also live in a perfect place to run one as well. This will provide even better revenue, plus you get the flexibility to keep it vacant when you have out of town family visiting.

We looked at other places in CA that have higher cap rates, like Bakersfield and Fresno, but ultimately decided not to invest for reasons that are too long to list here. 

See this reply in the discussion

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  • Specialist · Riverside, CA · Member since 2015 · 6k+ posts · 3k+ votes
    7y

    If you spend $100k-$150k on an ADU it will likely have no effect positive or negative on the value of your home, some people would prefer the garage. However $100k + to convert a 400 sqft garage seems very excessive. Because the ADU is detached and small you probably won't be bothered by the tenant that much. Another way of looking at this is how many people would spend $100k to get a $1,700/ month rental in LA, and the answer is a lot of people would take that deal. However if you plan on selling in the near to medium term that may change the calculus.

  • Palo Alto, CA · Member since 2017 · 230 posts · 200 votes
    7y

    Spend $100-150k to build this in-law unit probably is not the best of return.  It does not add much value to your home as people mostly care about the size and condition of your primary house.  Investors are not going to buy in your neighborhood due to negative return.  Biggest value add for your home is to add 1 bedroom and 1 bathroom to the main house (especially if your home is 2 bedroom in an expensive neighborhood).

    If you have the cash (I am from CA also), invest out of state (without moving). with 25% down, you can buy rental properties (try buy more than 1 to spread the risk) worth at least $500k. Even at 5 CAP, your return is better than $1700 per months gross (not net profit).

  • Rental Property Investor · Los Angeles · Member since 2018 · 844 posts · 1k+ votes
    7y
    Originally posted by @Edward Liu:

    If you have the cash (I am from CA also), invest out of state (without moving). with 25% down, you can buy rental properties (try buy more than 1 to spread the risk) worth at least $500k. Even at 5 CAP, your return is better than $1700 per months gross (not net profit).

     500,000 at 5 cap will be 2,083 per month. Are you ignoring cost to carry debt?

  • Member since 2018 · 7 posts · 0 votes
    7y

    If I am not building ADU my down payment will be more like $80k for a starter, but that amount will hardly be enough to get me a multiple units let alone a single condominium in SoCal.

    I have also entertained working with a partner to increase my capital but a partnership with a stranger sounds like more risk than I can bargain for. 

    So where should I put my money? I have been looking for pockets with rank 8+ schools,  Lancaster, Palmdale, Riverside, Glendora under $250k (25%-30% down)SoCal market. What other qualities in the city or indicators should I be looking for in the city with growth potential? 

    The out of the state market as the next “pot of gold”; What are the cities in or out of CA that seem intact from market crash and still affordable for a small timer like me? If so I would surely appreciate a pointer. 

  • Rental Property Investor · Los Angeles · Member since 2018 · 844 posts · 1k+ votes
    7y

    @Nikki O. I'm in a similar situation as you in the sense that my wife is really interested in building an ADU by converting our garage. Since we are within a half mile of public transportation, we are not constrained by the city requirement to have covered parking for your car.

    Here are my thoughts when it comes to an ADU.

    I hate ADU's that totally feel like garage conversions (although admittedly, they ARE garage conversions). In order to build it one so that it doesn't feel like you're living in a garage that's just been prettied up, you will spend a considerable amount of money..... probably more than whatever quote some of these local garage conversion specialists have told you. My wife's co-worker is in the process of building a 2br/1ba ADU ...they demo'd the existing garage and are building it from scratch from the foundation up and are almost done. So far, it looks beautiful....the type of property that I would love to live in if I were 10 years younger and single. However, it is costing them about $75K more and 6 months longer than initially estimated. But in the long run, it will be worth it because any hint of this structure being a garage has been completely eliminated, new utility meters have been done, and the property itself has its own address. Basically, his home was converted to a duplex that is perfect for house hacking. And I'm convinced that this structure will indeed substantially increase this property's market value.

    You also must have a contractor that you know will do a good job. I have a person that I use all the time and 90% of his work consists of me and a few other of my closest friends. If I didn't have someone like him who I've used many times in the past with great results not only for me but also for everything he's done for my buddies, I'd be less confident about building an ADU.

    With that said, there is no place in So Cal where you can spend 200K on a building and rent it for $2.5K. Although you will go through a lot of stress during the build process, the return on your capital will be hard to match.

    Another option is to build the ADU and rent it as an Air BNB. We live in Wilshire Park, which is a very good place to run an Air BNB...and from what I can gather, you also live in a perfect place to run one as well. This will provide even better revenue, plus you get the flexibility to keep it vacant when you have out of town family visiting.

    We looked at other places in CA that have higher cap rates, like Bakersfield and Fresno, but ultimately decided not to invest for reasons that are too long to list here. 

  • Architect · Los Angeles, CA · Member since 2018 · 27 posts · 20 votes
    7y

    Nikki & Tony,

    Adding an ADU will add a tremendous amount of value to your property. I am not sure why there are those that are stating that having an ADU could potentially have a negative effect on your home's market value. I am actually taken aback at the fact that not many are taking advantage of the city wide ADU ordinance. For every conditioned occupiable SF added to your property, whether it be added space to the existing primary house or as a detached secondary unit, it will (at a minimum) add about $400 per added SF to your market value. I will say this though you should strive to built the ADU under 100k. I have assisted a number of clients with their ADU projects and have seen first hand the benefits of having an ADU. Not only will you add instant value but you will generate rental income on a month to month basis. I just bought a house about 6 months ago in the Inglewood area and I as well plan to convert my detached garage. Anyhow, If either of you have any questions please do not hesitate in messaging me via BP. Good luck!

    -Salvador

  • Specialist · Riverside, CA · Member since 2015 · 6k+ posts · 3k+ votes
    7y

    @Salvador Jimenez even if an ADU adds value it will be nowhere near the cost to build it.

  • Palo Alto, CA · Member since 2017 · 230 posts · 200 votes
    7y

    I am not sure where you got the idea that convert a SFH to 2 units will drastically increase value. Buyers for SFH and multiple units on very different. Most SFH buyers will skip duplexes or other types of multiplexes as they are looking for a home to live in, not for investment. In some markets, it will increase value of the home, but in higher cost areas of CA, it will reduce foot traffic whenever you put on the market due to its classification. In many cities, SFH cost a lot more than multi-units. For example, I just put in an offer for 3 plex in this college town about 0.3 miles from the university on the east coast for $185k. Medium price for SFH in the area is $235k. This is quite common in many cities that multiplex is cheaper vs. SFH.

  • Karen MargraveBusiness Member
    Moderator
    Realtor, General Contractor, and Developer · Redding, CA · Member since 2009 · 7k+ posts · 4k+ votes
    7y

    @Nikki O. ADUs in southern CA make a lot of sense. There's a huge demand for affordable housing, as well as in law suites. Your lot will easily handle it. What are the fees and permits, because $100k seems kind of high. I cannot see any negatives of doing it. Curious, what are min lot sizes? You may be able to actually split lot in 2 and do an actual house instead of ADU.

  • Rental Property Investor · Los Angeles · Member since 2018 · 844 posts · 1k+ votes
    7y
    Originally posted by @Edward Liu:

    I am not sure where you got the idea that convert a SFH to 2 units will drastically increase value. Buyers for SFH and multiple units on very different. Most SFH buyers will skip duplexes or other types of multiplexes as they are looking for a home to live in, not for investment. In some markets, it will increase value of the home, but in higher cost areas of CA, it will reduce foot traffic whenever you put on the market due to its classification. In many cities, SFH cost a lot more than multi-units. For example, I just put in an offer for 3 plex in this college town about 0.3 miles from the university on the east coast for $185k. Medium price for SFH in the area is $235k. This is quite common in many cities that multiplex is cheaper vs. SFH.

    I agree with your reasoning but there's a big difference between multiplexes and a house that has a nice ADU attached. I'm not saying an ADU will drastically increase the market value, because the data on that so far has been inconclusive. I'm just pointing out that you're making an observation on traditional multiplexes whereas the original poster is talking about simply adding an ADU to the house.

  • Andy BrohardPro Member
    Los Angeles, CA · Member since 2017 · 78 posts · 82 votes
    7y

    Hey @Nikki O.

    I converted my garage to an ADU and love it. If you plan on being in the house for 10 years I wouldn't worry too much about the effect on your home value. Personally, I see it as a selling point, even in higher end markets because you're adding more beds/baths and it can be advertised as a separate office or a way for someone to offset their mortgage. Especially if it has a good rental history.

    I think your second point is the real question. Can you live with someone else on your property? It definitely took me some getting used to having other people walk down the driveway past my kitchen and hearing other voices in the backyard. We also didn't build an extra fence line which I know a lot of people are doing now. I'd make sure you have a great lease and do some good tenant screening.  That being said, my tenant is fantastic. It's also giving me good practice being a LL/manager literally in my own backyard. (which helps with my out of state properties) 

    Feel free to PM me if you want to chat more about the process etc. 

  • Rental Property Investor · Culver City, CA · Member since 2014 · 222 posts · 79 votes
    7y
    @Andy Brohard @Nikki O. I agree with Andy, in densely populated Los Angeles, even if you don't want to rent out the ADU, it makes a great office space or guest house or bedroom for older kids, or even live in nanny or au pair. I've seen some of these conversions, even unpermitted (but nice) ones increase the value of properties. I'm not suggesting at all that you dont permit it. Just an observation. It gives you additional space that has the option of giving you income. However, building something a finding and managing out of state properties have their own separate challenges. Definitely do whatever you will do before you have kids, because everything is 10 times as hard after. I like the idea of an ADU, but don't want other people on the property and don't want to give up my garage space or backyard at the moment. I think it's a possibility in the future though.
  • Member since 2018 · 24 posts · 10 votes
    7y

    @Nikki O.

    Reading your post and I'm in same boat. Did you push thru with your ADU project?

  • Real Estate Agent · Diamond Bar, CA · Member since 2016 · 112 posts · 29 votes
    6y

    @Nikki O.

    how is the ADU coming along?

  • Rental Property Investor · Hawthorne, CA · Member since 2018 · 655 posts · 900 votes
    6y

    @Nikki O.

    I think many people in So Cal are thinking about this.

    The way I see to truly get the most out of the investment in an ADU is to move into it and rent out the main house. You will live for free and if you save right you can use those funds to continue down the road of progress.

    In today's society with the tiny home fascination moving out of your 3000 sq ft home and into a 600 sq ft ADU would be a novelty.

    I haven’t convinced my wife yet but I’m still working on it.

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