Adu Conversion in Los Angeles

[Robert Reynolds]

I currently own a home in Los Angeles and would like to purchase my first investment property but would have to go out of state to do so, because Los Angeles seems to expensive. I was looking in Texas and other states where you could buy a house for about $150k, and rent out for less than $1,500. My buddy recently introduced me to the idea of turning my garage into an asset by converting it to an ADU. I could convert my garage for about 60k to a studio that would rent for about $1,200, or tear down my garage and build a two story 2 bed/1 bath rental that could rent for $2,500-$3,000 for about $150,000. To pay for this I would take out a HELOC loan, just quoted at 3.5% for up to 200k. Would appreciate any comments and advice.

[Dan H.]

First HELOC vs refi (even though you did not ask): I choose HELOC for loans that I expect to be short in duration and refi for longer duration loans. This is because I like the security of a fixed rate loan for a long duration loan. You have no idea where rates will be in 10 years. There is a lot more room for rates to go up than to go down. We are currently near historically low rates. The owner occupied 30 year fixed rate loan is as close to free money as you may ever find. Therefore, I personally would not choose a HELOC for this loan.

OOS (not limited to Texas) investing is full of perils. No local knowledge. Have to build and maintain a team. Cannot self manage. Non-owner occupied means lower LTV (75% LTV is common for non owner occupied). Depending on where in Texas, there can be any of the following: storm issues, foundation issues, property tax issues. We had an OOS duplex once that I loved (Gulf Shores, Alabama) but we sold it shortly after it got hit by a second hurricane not long after getting hit by the first hurricane. Both were very hard to get repairs performed being OOS. I believe it has not been hit by a hurricane since we sold.

ADU conversions are not cheap to build. They also appraise significantly below the costs of the ADU build. It is cheaper to buy a property with an existing ADU than to build an ADU. However, you already own the property and seem like you would not miss the garage. If you have run the numbers and the return meets your expectation, I am confident this is the lowest risk approach.

Good luck