Flip After Building an ADU

[Jonathan Clarkson]

Hi everyone! I’m new here and looking for some guidance. I’m thinking of pursuing flipping homes full time - specifically around flipping properties after building an ADU (in an ADU friendly market, and where building one makes sense from an ROI perspective). Does anyone do this for a living? If so, are you open to mentoring? I'm a very handy guy, and have built houses and additions in the past. I'm detail oriented and very organized. I've been working in the AEC industry for a long time and always thought about pulling the trigger starting my own business, but don't know where to start. I'm also open to relocating to where the best market is for better opportunities. My thought was be the GC and sub-out the trades I'm not good at, then scale from there. Thank you!

[Dan H.]

Quote from @Peter Mckernan:

This is a good model if you know the area and it is a longer term play. There are many outfits that do this raising money for the build out and buy, and then exit with giving investors back money on the sale. I know investors that do this on places in LA and San Diego while raising money to get a bigger value. There are some added things in there to get the value even higher as a couple of the responses mentioned. 

One guy I know raises money in San Diego and they do max units on a lot and then sell in student housing areas next to the colleges. The other guy does this up in LA, and he adds square footage to the livable space on the SFR and adds the max ADUs. This has worked for both of them and not worked on a higher ROI stand point. I have seen some investors doing it really successfully in the south LA County cities like Long Beach and Lakewood. The point here is that it is harder to get a value for the out price and flipping since this not a duplex, triplex or four unit. This is a single family with an ADU. Even though this law went into effect in 2017, and that is almost 10 years ago, there is still so many investors that are looking for the traditional investment, or there is not comps that support the out price.

The properties I have that I end up adding an ADU on ones that are not flips but long term buy and holds. They have large lots so tenants are not on top of each other, and there are comps that comp out so that I know the value even though I am not selling for a long time. If I wanted to refinance out then there is something there that will provide that appraiser with a base value.

The point is, this ADU add can be used for flips or long term value add too. Like anything, you need to have the values there in the comps to really be able to give a solid out price to investors, or yourself to say this is an option to do. That is not in all communities, for example any construction that is 1990 and newer would not be a good move, and any city built in the 1900-1970 (conventional construction) is easier to do this model, if there are comps to show a solid value to sell for a profit. So, do your homework on the area(s) you are looking and make that choice on that and really evaluating what that area along with investors are getting after purchase, units added, and value after ADU.

I am a partner on a multi ADU add (8 ADUs added, plus the value add to the existing units) in San Diego. It has not performed near expectations and I expect to not recover my full investment. we are looking at exit options, but making a profit seems very unlikely (commercial MF values have declined significantly). It is NOT near a college. I do think areas near the colleges are more likely to give better value for an ADU addition than most areas of San Diego.

I know someone in San Diego with the same MO as you describe (adds ADUs to SFH near SDSU). He is a smaller operator (he and his brother are the two primaries), so may not be the same person you describe. The person I know has small margins. His last exit he was about to take off market and rent himself when he found a buyer. Literally if the offer had not come that week, he would have reluctantly held it. Note his small margin is with him having done this already quite a few times and having a preferred contractor team. I do not take efforts of that size for the margins he does (at least not intentionally).

Adding small units in small counts is the most expensive residential RE development. Adding them to in general older SFH development areas where most buyers are OO who have no interest in house hacking significantly reduces the buyer pool which reflects why ADUs have such low valuations at resale.

NAR pulled their ADU data about a month ago on the premise that it was dated. I believe the real reason the data was pulled is that the data did not support a narrative that was favorable to NAR. The data showed that in virtually all markets the ADU addition added less value than the hands off cost to add the ADU. San Diego was particularly poor (but there were some markets (including some in Southern California) that adding an ADU resulted in a value decline) and properties with ADU sold for less than $20k more than properties without an ADU on average in San Diego.

If you are adding an ADU as an investment, it is imperative to understand the value that will be added by the ADU and understand operating costs. Note at a 1% monthly rent ratio, the property tax is a ~10% expense. Example $250k spent on ADU addition that rents at $2.5k, prop tax will be ~$250/month. Sustained expense/vacancy ratio below 40% accounting for all costs (including PM) is a fantasy. $50k initial negative position will take many years to recover via the cash flow on high leverage ADU.

Good luck