considering adding ADU's - will this affect my current loan?
I live in a 3 unit building and I have discovered it is possible to add two ADUs (Accessory Dwelling Units) to my property in California. I currently have a $1MM loan @ 2.25% fixed for 30 years so this is a keeper for a lifetime of a loan. If I add 2 additional ADU's my understanding is that this moves the property into a commercial 5 unit classification. What would that do to my existing loan if I did add 2 ADUs? And what if I just added 1 ADU to bring it up to only 4 units? Does my existing lender care that I added these 2 units? I would finance these units myself (about $400k each) so no loan required and I don't plan to ever refi. Each ADU would bring in at least $5k per month if I did Airbnb so it would be a big win for me. I don't want to mess with my existing loan however so I am not sure how to move forward.
Most Popular Reply
In virtually all areas of CA ADUs cannot legally be rented as STRs. Check your location regulations.
You current loan should be fine.
Current Freddie/Fannie rules do not allow multiplexes with ADUs. I have seen mixed enforcement on this. If it is enforced, the F/F loan is unavailable even if you add only one ADU. This would negatively impact the value and require alternate financing such as DSCR loan. Check with your favorite, trusted lender.
In most markets ADUs are being valued less than hand off ADU addition costs. This means they are a negative value add.
Self financing the ADUs at $400k each is not using the leverage that is one of the biggest advantages of real estate investing. The return generated by all sources is magnified with leverage.
To be blunt, $400k for $5k rent without leverage would not produce the type of return I seek from my RE investments. I suggest you rethink not using any financing for the ADUs.
Good luck
In virtually all areas of CA ADUs cannot legally be rented as STRs. Check your location regulations.
You current loan should be fine.
Current Freddie/Fannie rules do not allow multiplexes with ADUs. I have seen mixed enforcement on this. If it is enforced, the F/F loan is unavailable even if you add only one ADU. This would negatively impact the value and require alternate financing such as DSCR loan. Check with your favorite, trusted lender.
In most markets ADUs are being valued less than hand off ADU addition costs. This means they are a negative value add.
Self financing the ADUs at $400k each is not using the leverage that is one of the biggest advantages of real estate investing. The return generated by all sources is magnified with leverage.
To be blunt, $400k for $5k rent without leverage would not produce the type of return I seek from my RE investments. I suggest you rethink not using any financing for the ADUs.
Good luck
@David Isham - I share your concern.
Technically 5 units and above are considered commercial property (https://www.realized1031.com/b...) but if you are creating this situation on an existing property, you should be fine. But talk to some lenders and get their take.
Dang internet issues, Just lost my comment. Hope I get everything back in here for the second time.
SO, I would agree with @Dan H. in that if you add an ADU (even one) you would possibly and most likely paint yourself into all commercial loans including the DSCR loans. From a lenders prospective the only difference between a ADU and a Unit would be a separate power meter so I would push more in the direction to see if the city would let you add an additional unit to the property. If they are allowing the ADU and you have the space then that would be more ideal.
Otherwise, you want to keep your loan as long as possible so if you want more cash flow I would look at other means of increasing the income since your expenses may be as low as they can go. Have you looked at getting sheds or pavers and renting storage or parking (if there is a need). Just a thought. Interesting scenario.
Yes short term rental under 30 days would not be allowed in the ADU's but the 2 existing long term tenants I have in the 3 unit building could be moved into the ADU and those vacated units would be Airbnb'd which is why I mentioned the potential increase in cash flow as Airbnb pulls in at least 2x what I can collect for rent. Btw how do they legally enforce this requirement to not rent out the ADU's for under 30 days? Do they record something on your deed? @Dan H. I dont think I can use financing as I don't want to mess with my low fixed loan. Not sure how else I could finance the ADUs without messing with my existing loan? The beauty of doing Airbnb on my property is that I live here and it's easy to manage and clean the properties rather than having to drive somewhere. Dumpy condos here are $500k and any HOA would certainly not allow Airbnbing. I am open to other ideas on where to deploy my $800k. It would be VERY appealing to not have to deal with new construction as where I live it's a nightmare dealing with the planning department, contractors and all the other sharks that want a piece of me.
My investments are coastal Southern CA likely with similar price points are the those dumpy condos.
$800K at 80% LTV would purchase $4m of property or at 75% LTV $3.2m of property. The leverage alone makes this likely to produce a better return than all cash ADU construction that is likely to add a value less than the cost of the additions especially if it loses F/F financing. As for your current loan, they have construction loans, asset backed loans, personal loans, etc as options that would not affect your current loan.
Have you had an STR before? We have 3 (one is currently out of commission), they are a lot more effort than LTRs and we therefore use a professional PM. However, we are not happy with our current PM and so do not have a recommendation. Our professional PM has been both unresponsive and have very high rates (which would be more tolerable if they were more responsive). PM me if you have a referral for a licensed STR PM in San Diego.
As you noted the restriction on using the ADUs as STR is typically a deed restriction. I suspect it varies on the enforcement, but I would certainly not plan on using the ADUs for STR. Using the existing units should work. You then have to be cognizant of anti STR regulations. We have 3 STRs and our area passed STR quotas that restrict to 1% (30% in mission beach were 2 of our STRs are) and one per person(?). This regulation was to go into effect in July but due to not getting concurrence from the coastal commission is currently scheduled for next year. You should assess the STR sentiment in your areas and determine the associated risk. I would also have a plan B if STRs do end up getting restricted.
Good luck
I am in San Rafael in unincorporated Marin County. Because my house is currently multi-family I would be allowed to build up to 1200 sq feet per unit. Both units have to be attached to each other. I don't really know right now what the costs might be other than anecdotal wide ranging estimates from contractors of $400k to $500k per unit. I would need fire sprinklers and solar etc and contractor costs are astronomical here. I have to talk to the water district to see if my current meter is big enough to handle an additional 2400 sq feet units. Same with PG&E and Sanitation to confirm my electrical service and sewer line is big enough. Lots of factors. Airbnb is very strong and consistent here since we are so close to SF and Muir woods and Napa Valley etc. I currently do airbnb in another property in this town which is why I am salivating at putting more airbnb units into service. To live onsite and have airbnb on the same property is a huge benefit as you can keep an eye on things and help guests when they need something. I am fortunate to have a relatively large lot (28k sqft) so there's plenty of space to build and plenty of parking.
@David Isham $500k isn’t getting you anything in Santa Barbara, unless you mean North County like Santa Maria and Lompoc…but that’s a very different ballgame and doesn’t have the same appreciation value as Santa Barbara proper.
- Lucas Martinez
Yes I'm talking Santa Maria (Northern Santa Barbara County). The last 10 years Santa Maria has outperformed Santa Barbara in home price appreciation (146% vs. 113%). That area is the last affordable place near water in California as you are only 15 minutes away from Pismo beach. As an investor I would rather buy 5 homes for $200k each than 1 home for $1MM. I was buying new construction 4 bed, 2000 sq ft homes there in 2000 for $200k. I can still buy 3 bedroom homes for $500k there which is appealing as I still see sustained growth. In the SF bay area that $500k will get me a 2 bed new construction unit and the Airbnb'ing of units here will produce 2-3x more cash flow vs. a long term rental in santa maria. Santa Maria = slow steady growth + leverage (I can buy 4 homes w/ $500k) vs. Bay Area new construction = 2-3x more cash flow but lots of cash tied up since I most likely won't be able to refi.
David -
I'll offer a different viewpoint. I think the returns you will get on short term renting from an ADU in San Rafael (assuming that you aren't restricted by the local government as mentioned in the other posts) very well might beat the cashflow you will get, even when using leverage, of investing the $800k in purchasing another property in Marin or the surrounding area. Of course, you could take that money an invest in the mid-west and get much better returns, but that's a whole other discourse. I agree that running a STR is a whole different game than long term rentals, but also agree with you that if you are living on the property it will make it much easier and more likely to succeed. If you set up a good system, and have someone reliable to do the cleaning, and you are prepared to do a little extra work, then it can pay off very nicely.
Regarding the line of credit. Some banks allow you to get a HELOC or LOC and then fix the rate for a number of years. I just saw one offer that allowed a LOC to be fixed for 10 years (I'll see if I can find which bank that was). So that might be a good solution for you.
IMHO, the big wrench in your plans is your estimated cost of construction. I'm a general contractor and have a good sense of building costs in the Bay Area. $400k for 1200 square foot new build that requires sprinklers is not realistic. I would budget a minimum of $400/sqft and more likely $450+/sqft. For your underwriting I would be conservative and make sure that the numbers work even with the top end of construction costs.
The 3 unit building I live in right now is 4500 sq feet and is a 100 year old mansion. I bought the house 20 years ago with fire damage and I completely gutted it down to the studs and did a very high end remodel and added sprinklers. I remember at the time I was told it would cost me $500/sq ft to do a high end remodel. I did a lot of the design work myself designing the kitchens and picking out and buying all the materials myself. There's so many ways to save on costs like using those $100 per slab granite counter top places you find in the industrial areas of the bay instead of walking into a showroom and buying overpriced granite. I was able to do the whole job for $800k instead of the $2MM everyone kept telling me. If I just hired a GC to do the whole thing I might have paid double. I know things have changed in the past 20 years so maybe there's not as many areas to save. I did get all my grey hairs from that renovation project so while I did save a lot of money it was at a cost. I am not looking forward to dealing with all this again but life is hard whether you are working in a cubicle or dealing with construction projects so we have to pick our hard.
If you can do some of the work yourself then more power to you! FYI: an average price for an 8-foot granite slab at Granite Expo today is $450. ;) Good luck whichever you go.
Oh wow you are right. I just checked with my go to place Sincere hardware and the granite is crazy expensive now. There is still the Tiger Skin White for $99 but it's so ugly it would never be under consideration. ugh.
Is Poway coastal So Cal? That depends on the perspective. From a national perspective yes it is coastal (san Diego is coastal), from a local perspective no. From a local perspective I consider North of Hwy 5 is coastal. All 3 of our STRs are west of Hwy 5 and therefore coastal from a local perspective (and national perspective). Our Mission Beach units are ~100' from the sand. The Pt loma unit is ~5 blocks from the ocean and ~5 blocks from the bay.
I really do not know what a $4m property would bring in as an STR, but 2 of our STR units are a duplex in Mission Beach that is worth ~$1.6M. In 2019 these units had rents of ~$160k. In 2020 (Covid impacted) they had rents under $100k. In 2021 (still covid impacted as January was unrented and rest of year had lower rate and higher vacancy than 2019) had rents of ~$125K. Our PM charges a lot, but the units are small so have low maintenance/cap ex costs.
Note these are long established STRs that in 2019 had very few days vacant.
Good luck