Best type of loan to build an ADU

[Tony Dinh]

I have an investment property that is fully paid off in garden grove California. I plan on doing some renovations to the main house and building an ADU.

I wanted to see what would be the best type of loan that I should be looking into. In terms of potential tax write offs and savings? HEL, HELOC?

[Dan H.]

Quote from @Alan Asriants:

Likely a home equity loan might be better since you dont have to worry about paying off the equity quickly and arent subject to higher rates and random rate changes which can destroy your cash flow.

Long term loans are best for long term projects

HELOC and lines of credit are good for get in and get out situations.

Its possible you can use a heloc to build the property as that can be cheaper for you and then you can do a cash out refi to pay off the heloc since your home is fully paid off. That might be cheaper and better bet than home equity loan. YOu need to reach out to local bank and see difference in rate and terms.

Also you need to know that investing 100k in an adu will not always increase your value by 100k. (Example)

if you need a solid contractor in the area for a bid, reach out anytime. my partner is a solid builder

 >you need to know that investing 100k in an adu will not always increase your value by 100k. (Example)

I would word this much stronger. It is rare for a single ADU addition in southern CA to add as much value as the hands cost of adding the ADU. This creates a negative position that needs to be recovered before sny cash flow is achieved. Search Bigger Pockets for posts on ADU valuation. Make sure before you add an ADU you know the value that will be added.

Here are reasons adding a single ADU to a single family home in Southern CA is typically a poor investment.
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.

Do accurate and conservative underwriting to include the likely initial negative position.  I have literally seen underwriting that depicts over a decade to recover the initial negative position.  

Good luck