80k to Invest and Overwhelmed by Choices. Help!

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80k to Invest and Overwhelmed by Choices. Help!

Steven Henao
Investor · Member since 2021 · 8 posts · 1 vote

We have 80k to invest but feel paralyzed by the many directions to take! Please help!

Some background:

We bought our first property last year (2023) for $675k. A SFR 3/2 in Long Beach, CA that needed some work. It appraised for 725k at the time of purchase and has been holding steady since. Our plan was to do an ADU garage conversion (I know, super original), rent it out Short term / Med term, and then spruce up the main house after a couple of years of the ADU income.

So, we started the ADU permitting process right away…

The main house was livable but very old. It needed some TLC, and over the months of living there, we slowly started feeling claustrophobic. We couldn't hold it and decided to start on the renovations early while we waited for the ADU permit. Some of the work we did ourselves, but most of it we contracted out.

Fast forward to today, 

We spent about 70k on all new bathrooms, flooring, minor upgrades, and a badass kitchen. Our plan basically reversed, and we now have a beautiful main house but no ADU and no cashflow yet. We haven't received a new appraisal with the updated renovations, but we're estimating a solid chunk of equity has been added.

We'd like to invest the 80k in the ADU since that's a guaranteed >2k rent per month, but are feeling a bit doubtful in this moment. Do we really want to have all our eggs in one basket? It feels like a huge chunk has already been put into this property. Would it be better to invest it elsewhere? Should we consider different financing options? Did we chose the right location to have an ADU?

So BP, what do we do? 

Any tips, advice, thoughts appreciated!

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Dan H.Pro Member
Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
2y

$80k is way too low for a hands off garage conversion ADU in LA. It will have total costs approaching double that price unless you are planning on doing a significant amount of the work yourself.

In most areas ADUs cannot be used for STR (less than 30 days).

in general ADUs are one of the worse RE investments largely due to the cost of adding the ADU versus the value added by the ADU. The ADU can add value that is more than $100k below the cost of the ADU addition. Before you proceed with the ADU addition, make sure you understand the value that will be added by the ADU addition.

Here is a list of reasons that adding an ADU can be one of the worse RE investments:

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 acq
uisition or is often not leveraged (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 the value added by the ADU, 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 the value added by the ADU, 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) if CA an ADU and JADU can be added to virtually all homes. However, Freddie/Fannie will not finance a parcel with 2 ADUs. This lowers refinance options. It can potentially limit your buyers when/if you go to sell.
10) JADUs require OO. Note this is not only to rent the JADU, but in strictest interpretation to even have a legal JADU. This limits purchasers to house hackers significantly limiting the potential buyer. JADU are value subtract as they typically reduce the value of the RE and often best option at selling is to remove the JADU.
11) if the ADU is being added to a SFH, the ADU can make the house rent controlled (if it is over 15 years old). See AB1482.

ADU laws were added to add housing. However building small unit count, small units is very expensive housing. It is resulting in increase to housing costs and poor returns for the hands off investor. Some jurisdiction recognize this and allow large number of ADUs which compounds the NIMBY against ADUs. For example in city of San Diego you can designate a few units as affordable units and build 15 units in a single family zoned area. No one wants 15 unit apartments built next door to their SFH.  However, more than 4 units will be appraised on income approach and these can be very profitable.

Good luck

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  • Nathan M kiefer
    Rental Property Investor · south carolina and michigan · Member since 2023 · 348 posts · 226 votes
    2y

    If you know you can get 2k per month in a fixed up adu on average pull that trigger.

    otuerwise not sure what else you are going to put 70k into and get a consistent 2k per month return at this current market with where you are.

    2Reply
  • Dan H.Pro Member
    Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
    2y

    $80k is way too low for a hands off garage conversion ADU in LA. It will have total costs approaching double that price unless you are planning on doing a significant amount of the work yourself.

    In most areas ADUs cannot be used for STR (less than 30 days).

    in general ADUs are one of the worse RE investments largely due to the cost of adding the ADU versus the value added by the ADU. The ADU can add value that is more than $100k below the cost of the ADU addition. Before you proceed with the ADU addition, make sure you understand the value that will be added by the ADU addition.

    Here is a list of reasons that adding an ADU can be one of the worse RE investments:

    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 acq
    uisition or is often not leveraged (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 the value added by the ADU, 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 the value added by the ADU, 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) if CA an ADU and JADU can be added to virtually all homes. However, Freddie/Fannie will not finance a parcel with 2 ADUs. This lowers refinance options. It can potentially limit your buyers when/if you go to sell.
    10) JADUs require OO. Note this is not only to rent the JADU, but in strictest interpretation to even have a legal JADU. This limits purchasers to house hackers significantly limiting the potential buyer. JADU are value subtract as they typically reduce the value of the RE and often best option at selling is to remove the JADU.
    11) if the ADU is being added to a SFH, the ADU can make the house rent controlled (if it is over 15 years old). See AB1482.

    ADU laws were added to add housing. However building small unit count, small units is very expensive housing. It is resulting in increase to housing costs and poor returns for the hands off investor. Some jurisdiction recognize this and allow large number of ADUs which compounds the NIMBY against ADUs. For example in city of San Diego you can designate a few units as affordable units and build 15 units in a single family zoned area. No one wants 15 unit apartments built next door to their SFH.  However, more than 4 units will be appraised on income approach and these can be very profitable.

    Good luck

    3Reply
  • Steven Henao
    OP
    Investor · Member since 2021 · 8 posts · 1 vote
    2y

    @Dan H. Thanks for the detailed reply! Your points are really interesting, especially about Rent Control – that's new to us!

    Could you explain more about the benefits and downsides of classifying our property as a duplex versus a single-family home with an ADU?

    Also, I want to mention that we don't plan on selling unless it's smarter to use our current equity to invest in other properties. Our long term goal is accumulating rental properties and holding. Right now, our mortgage costs us about $4800 a month. In our area, renting out 3bd/2ba usually go for $4-5k. If we moved out and rented the main house as-is, we'd barely break even or even potentially enter negative cashflow.

    That's why the idea of renting out the ADU for extra income sounds appealing. Any thoughts on that?

    0Reply
  • Andrew SteffensBusiness Member
    Tampa, FL · Member since 2022 · 3k+ posts · 3k+ votes
    2y

    What about getting a 10% second home loan and investing in a solid market where you can purchase a $750k+ house that can make $2k per month and then you will have a second appreciating asset?

    This is not for everybody, but figured it could be given consideration!

    [email protected]813-563-0877
    Vacation Rentals of Florida53 Reviews
    WebsiteView Page
    1Reply
  • Dan H.Pro Member
    Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
    2y
    Quote from @Steven Henao:

    @Dan H. Thanks for the detailed reply! Your points are really interesting, especially about Rent Control – that's new to us!

    Could you explain more about the benefits and downsides of classifying our property as a duplex versus a single-family home with an ADU?

    Also, I want to mention that we don't plan on selling unless it's smarter to use our current equity to invest in other properties. Our long term goal is accumulating rental properties and holding. Right now, our mortgage costs us about $4800 a month. In our area, renting out 3bd/2ba usually go for $4-5k. If we moved out and rented the main house as-is, we'd barely break even or even potentially enter negative cashflow.

    That's why the idea of renting out the ADU for extra income sounds appealing. Any thoughts on that?

    An SFH with ADU is not a duplex. Duplex can add ADUs, do not have extra STR restrictions, etc Duplexes usually are comped with duplexes. SFH with ADU if in a MF area can be comped with duplexes but in most areas they are comped using SFH with ADU and in the absence of appropriate comps, the appraisal will be via adjustments and the adjustments associated with ADUs have horrendous valuations.

    I do not sell but virtually all my loans have been less than 5 years.   With the recent appreciation, it made sense to refi back to a highly leveraged position and redeploy that capital to where it can produce higher return than it was achieving trapped in a property which was reducing the leverage.  The poor valuations will be reflected in your appraisal which impacts what you can leverage elsewhere.  In addition, from an accounting perspective there is no return until negative position has been recovered regardless if you sell or refi.

    If Piti is $4800 and rent is $4k to $5k, you would bleed negative cash flow.  In my underwriting, I would always use the lower rent value as I desire conservative underwriting.    Your maintenance/cap ex will be greater than $400/month.  Vacancy at 5% is $200 to $250.   PM is ~$320/month.  Even if you self manage your underwriting should include this as it is effort and takes time.

    My thought on the ADU is before you proceed be sure that you understand the value that will be added by the ADU. I suspect once you determine this value, you will decide adding the ADU is not the best option for your investment dollars.

    Good luck

    1Reply
  • Steven Henao
    OP
    Investor · Member since 2021 · 8 posts · 1 vote
    2y

    @Andrew Steffens 
    That would help ease our fear of putting all our money in one place forsure

    Are 10% down investment loans a thing??? Our loan officer has only given us quotes for a minimum of 25% down.

    0Reply
  • Dan H.Pro Member
    Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
    2y
    Quote from @Steven Henao:

    @Andrew Steffens 
    That would help ease our fear of putting all our money in one place forsure

    Are 10% down investment loans a thing??? Our loan officer has only given us quotes for a minimum of 25% down.

    Common max LTV

    - 95% LTV on owner occupied (96.5% with FHA)
    - 90% LTV on 2nd home.  
    - 80% LTV on investment SFR

    - 75% LTV on investment MF (used to be able to get 80% LTV, but those are becoming unicorns)

    Good luck

    1Reply
  • Steven Henao
    OP
    Investor · Member since 2021 · 8 posts · 1 vote
    2y

    Currently reading about second home qualifications. Never knew this existed, thank you both! 

    Honestly surprised my loan officer never mentioned this as an option. 

    0Reply
  • Rick Albert
    Real Estate Agent · Los Angeles, CA · Member since 2018 · 2k+ posts · 1k+ votes
    2y

    A couple of things:

    1. You cannot do STR with ADUs. I'm pretty sure that is a statewide regulation since the whole point of ADUs was to build affordable housing.

    2. There is something to be said to have two units on a lot. One insurance, one property tax, diversify vacancies (50% if one unit is vacant versus 100% for a single family).

    3. I agree, the costs right now are likely around $125K plus for a garage conversion. 

    4. From a cash flow perspective, I don't know anywhere in the country where you can get $2K a month in rent and invest $80K. Otherwise I would be all over it.

    5. I have sold ADU properties, it has been a major selling point in a positive way. There are buyers looking for multigenerational living in addition to house hackers and investors. The last ADU property I sold, we had a lot of buyers come through looking to house their parents, uncles, etc. We sold with multiple offers and over asking. I will say it would have sold for more if we didn't sell it with a tenant in place in the ADU. We rent out our ADU, but you can design it for ultimate privacy, we did on our property. The only push back tends to be lack of storage and parking. We put plywood down in our attic and built a shed on the side of the house to compensate.

    6. Statewide rent control isn't as bad as say Los Angeles Rent Control. If you plan for it, have strict rental criteria, vetting, etc, you will likely be fine. Plus it is 15 years down the road. You will be halfway through your mortgage, rents will hopefully have increased, and hopefully so will your property. You could always sell and do a 1031 Exchange elsewhere. Also (need to confirm) for Statewide Rent Control, just the ADU would be subject, not the house. In Los Angeles, the house will be subject to LA Rent Control if built prior to 1978.

    7. JADUs are somewhat useless in my opinion. Go full board ADU.

    1Reply
  • Steven Henao
    OP
    Investor · Member since 2021 · 8 posts · 1 vote
    2y

    @Rick Albert I'm totally on the same page regarding the cash flow perspective. If our estimates hold up, it just seems like the obvious choice.

    I get what you're saying about the storage and parking challenges too. Our current setup is pretty tight. The driveway's narrow and only has about 4 feet of space next to our neighbors, which can be a bit of a squeeze when there are cars parked. I don't think it'd be practical for both the main house and the ADU to share the driveway. Which only would leave street parking for the ADU.

    I wonder how much of an issue this would be for potential renters in LA? It seems like parking is always a big deal around here. What do you think?

    0Reply
  • Rick Albert
    Real Estate Agent · Los Angeles, CA · Member since 2018 · 2k+ posts · 1k+ votes
    2y

    My tenants park on the street and are fine with it. When we lived in the ADU we parked on the street.

    Once we move out, I will likely pave the front of the house to create a Y-shaped driveway. The main house can park in front and the ADU tenants and park tandem down the driveway.

    1Reply
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