How should I improve an SFH that I want to hold for 5 years?

Question

Background

- Location: Bay Area Peninsula

- House Price: ~$1M, Mortgage $700k

- Rent with similar square footage:  $4000/month

Running the number, it looks like it marginally break-even.

But I really wanted to have some cashflow during my holding years, so I am thinking to make an ADU. Here is my dilemma

- adding ADU itself cost money anyway (though a bit less than normal expanding?), but ADU won't add selling value as normal expanding

- doing normal expanding cost equal (if not more) money, but will add less cash-flow during my holding years

I wonder if there is a way for me to do ADU now, and later on convert ADU to normal square footage when I plan to sell.

Is this a good idea? (I am a new investor)

Bjorn Ahlblad · Answer

I had rental property in the Bay Area (San Mateo) for over 30 years. You have to change your investment expectations. Generally you will lose money every month and have a serious windfall on exit. Just never be forced to sell.

Spending 5-600k on an ADU won't CF either.......................but you will be able to cash out at some point in the future.

Gene Liang · Answer

@Sean YanI think the article is accurate. Although current law allows much easier permitting and building an ADU, ADU is still not very common. This makes valuating them difficult. An expansion is much more clear cut to valuate. When deciding if you want to build an ADU or do an expansion, I think you should consult a local real estate agent and maybe even a mortgage loan officer.

If this is house is anywhere desirable in the Bay Area, it's an entry level house. That means the person who is buying will be getting a loan. To qualify for a loan, the buyer need: 1) the house appraised significantly higher with the ADU/expansion and 2) income level is sufficiently high enough to qualify for the loan. The questions I would ask is 1) how much would an ADU add to the value of the house? Compare this to an expansion of the house. 2) Will the extra income coming from the ADU help that person qualify for the loan?

On the other hand, if the house is not entry level, the buyer is a wealthy, he will not need a loan and an expansion might make it more desirable.

One additional point which you alluded to. Yes, I believe an ADU doesn't have to be a stand alone. You can build it attached to the house and open it up when you want to sell it. Showing potential buyers that it can be used either way, allows you to capture both types of buyers.

Bjorn Ahlblad · Answer

@Sean Yan a nice 3 bed 2 bath home in, say San Mateo could be had for under 10k prior to 1960. Today that house is 1.75-2 mil or more. Crazy! Other places in the Bay Area were even crazier.

You can do the ADU with the tenant there but if it gets too disruptive they could leave. If you are in a tight budget don't forget the permits and architectural drawings will add considerably to the cost along with increases in material and labor, so examine all the numbers and consider markets outside of California if you want CF. All the best!

Steve Vaughan · Answer

A .4% purchase will pretty much never cash-flow. Even a large DP is just getting your own money back over time, not cf.

I'm in a .5% market and buy for the equity capture.  By buying off-market,  my avg equity capture at the buy is 12%. I don't buy if I'm not getting a deal.

I'm confused why an ADU wouldn't increase the value?  Seems like about the only way to cf a little bit with a hold in an expensive area.

Purchase below market value or pass I say. Buying in an expensive market is a balance sheet play.

Gene Liang · Answer

@Sean Yan

There is no reason why an ADU doesn’t add value to the property. If dine correctly, an ADU is completely legal and adds additional living space to the property. Giving the cost of Bay Area real estate, it might be worth $1000+ per square feet. Since ADU can be it’s own structure, sqft per sqft it might be worth more than an addition (expansion) to the house.

Nathan Gesner · Answer

I find it unlikely that your deal would ever cashflow, even after adding an ADU. After buying the property and building the ADU, you'll be $600,000 or more into the investment and maybe making $7,000 a month. I spent $100,000 to buy a storage facility that grosses almost $10,000 a month.

You're essentially betting on appreciation when the market is likely at or near it's peak, in a state that is losing businesses and a large number of upper-middle-class and wealthy people. That's not a bet I would make.

Sean Yan · Answer

@gene, here is the article I read and that's why I got impression that ADU does not add value like a regular expanded square footage.

https://abioproperties.com/do-..."While it’s difficult to quantify precisely how much resale value an ADU adds to a property, anecdotal evidence shows that homes sold with secondary units have a higher return on investment. "

From my own experience, when a potential buyer search on Redfin, she/he only sees the square footage of the normal structure -- the ADU square footage won't get counted. Even though you can add a note: hey, potential buyers, this house has a nice ADU, please come to see.Can you shed more light on this subject?

Sean Yan · Answer

Good to know that investing into non-CF property in Bay Area was the norm 30 years ago (I thought it was a last 15 yrs thing). thanks for sharing.

A separate topic (I ask it here because that’s something I am exploring to do for this property): can I do ADU project while I have a tenant inside the existing home? Is there any liability / legal issue that I need to care or is it too much a hassle that I should forget about this idea? (I am very tight on my budget, so having it vacant probably is what wanted to avoid if possible; but as I am a newbie investor, I don’t want myself get into hassle unnecessarily either)

How should I improve an SFH that I want to hold for 5 years?

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