ADU appraisal and valuation on BRRRR Questions

BRRRR - Buy, Rehab, Rent, Refinance, Repeat
3yFollow

ADU appraisal and valuation on BRRRR Questions

Nicholas Spinazze
Investor · Fayetteville, AR · Member since 2022 · 31 posts · 7 votes

Hey there Bigger Pockets community! My wife and I have plans to build to build a 3BR single family and an 2BR Accessory Dwelling Unit(ADU) on one of the lots we split recently. Our plan is to use the ADU as a short term rental and the single family as a long term rental. We had planned something similar to a BRRRR except we are creating value by building as opposed to creating value by rehabbing.

The trouble is the way lenders in this area value ADUs. They value them at a flat 90k regardless of the condition or rentability of the unit. The ADU we are building costs approximately 150k to build and has a significantly higher cost per square foot for construction than our single family unit. Our lender said that after a year of seasoning we could come back and they would evaluate the value of the ADU based on the cashflow it generates.

So it would take approximately 2 years to get the total amount of our initial investment back and I don't have any guarantees that they will even value it at its cost of construction. We are also concerned about how the buyer's appraiser is going to value the ADU if and when we choose to sell the property. As having the ADU is taking our value per square foot down from $235 psqft (which is what the single family appraised at by itself) down to $189 psqft.

Do other areas value ADUs the same way? Given all this does it make sense to build an ADU still? We haven't broken ground yet so can we go back to the bank and tell them we just want to build a single family now? Greatly appreciate any thoughts/advise/opinions!

0Reply
24 views

4 Replies

Jump to latestLatest
  • Jaron WallingPro Member
    Rental Property Investor · Indianapolis, IN · Member since 2018 · 4k+ posts · 4k+ votes
    3y

    @Nicholas Spinazze "we are creating value by building as opposed to creating value by rehabbing." - This statement is part of the problem for your strategy. The classic "BRRRR" method works better with distressed, older properties, bought under market value. The numbers generally pencil out better. You're doing new construction. From an outsiders prospective this isn't a cash-flow play. It's an equity play with a little icing on top from the ADU. I doubt the income from a STR covers the entire mortgage payment. I could be wrong. Either way the lender probably views the ADU as risk and priced the value accordingly even though you know the market value would command more. Build a cheaper ADU?...

    The risk is more trapped $$$ upfront. Is this trapped money worth the investment for the STR income? Unless the location, amenities, and demand is high I'd probably bail on the ADU. Just depends on your market and rental demand. Big fan of Fayetteville, AK! Huge cycling and gravel riding scene there! I think it's a great place to build or buy property.

    1Reply
  • Dan H.Pro Member
    Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
    3y

    >Our lender said that after a year of seasoning we could come back and they would evaluate the value of the ADU based on the cashflow it generates.

    Traditional residential Fannie/Freddie loans value on comps and not cash flow.  The type of loans that will value on cash flow have worse terms than if you valued the property on comps.

    >Do other areas value ADUs the same way?

    In the absence of comp data to show differently, ADUs in my market (San Diego) are being valued like accessories and can come in even lower than the $90K that you state they are valued in your market. In virtually all cases, they are being valued less than the hands off cost to add the ADU. This evaluation seems to be supported by the selling data I am seeing. In vast majority of the cases, you can purchase a property with an existing ADU for less than purchasing a similar property without the ADU and then adding the ADU (hiring out all of the construction).

    In my market there are many reasons that adding an ADU is one of the worse RE investments. They include: The negative initial position resulting from the ADU value being less than the cost to add (in your case you are starting negative $60K) can consume years of cash flow. There is no income until project completion versus most RE investments have income starting at acquisition. The effort is similar to doing a BRRRR, but the return is far worse. It is cheaper to purchase a property with an ADU than to purchase property without an ADU and add one. It detracts from exiting property whether it is a garage or just yard space. The interest rates of ADU construction loans are typically do not have terms as good as Fannie/Freddie residential acquisition loans.

    There is no way that I would choose to assume a negative $60K position.  The lower your investment amount the better the return.  The negative $60K position is worse than bringing an additional $60K to the investment because bringing an additional $60K typically is associated with $60k of value.  In this cast the $60K has zero value.

    Good luck

    2Reply
  • Nicholas Spinazze
    OP
    Investor · Fayetteville, AR · Member since 2022 · 31 posts · 7 votes
    3y

    Thanks so much for your prompt reply Jaron! The Razorback greenway is definitely something we make full use of here! At any rate, using AirDNA average data we are expecting roughly 3k per month in revenue, we feel this is actually pretty conservative as we have an excellent location walking distance from baseball stadium and easy bike trail access. We expect the single family to rent out for 2400 a month. So all in all we would hope to generate 5400 a month for each of the 2 lots we have with mortgage of 2500 roughly on each depending on the interest rate when we complete construction including taxes and insurance. 

    0Reply
  • Nicholas Spinazze
    OP
    Investor · Fayetteville, AR · Member since 2022 · 31 posts · 7 votes
    3y
    Quote from @Dan H.:

    >Our lender said that after a year of seasoning we could come back and they would evaluate the value of the ADU based on the cashflow it generates.

    Traditional residential Fannie/Freddie loans value on comps and not cash flow.  The type of loans that will value on cash flow have worse terms than if you valued the property on comps.

    >Do other areas value ADUs the same way?

    In the absence of comp data to show differently, ADUs in my market (San Diego) are being valued like accessories and can come in even lower than the $90K that you state they are valued in your market. In virtually all cases, they are being valued less than the hands off cost to add the ADU. This evaluation seems to be supported by the selling data I am seeing. In vast majority of the cases, you can purchase a property with an existing ADU for less than purchasing a similar property without the ADU and then adding the ADU (hiring out all of the construction).

    In my market there are many reasons that adding an ADU is one of the worse RE investments. They include: The negative initial position resulting from the ADU value being less than the cost to add (in your case you are starting negative $60K) can consume years of cash flow. There is no income until project completion versus most RE investments have income starting at acquisition. The effort is similar to doing a BRRRR, but the return is far worse. It is cheaper to purchase a property with an ADU than to purchase property without an ADU and add one. It detracts from exiting property whether it is a garage or just yard space. The interest rates of ADU construction loans are typically do not have terms as good as Fannie/Freddie residential acquisition loans.

    There is no way that I would choose to assume a negative $60K position.  The lower your investment amount the better the return.  The negative $60K position is worse than bringing an additional $60K to the investment because bringing an additional $60K typically is associated with $60k of value.  In this cast the $60K has zero value.

    Good luck


    Thanks so much for the feedback Dan! Definitely seems like from an equity perspective that ADUs don't really make sense. Which is a real shame because the laws as they stand in the area, its much easier to get an STR license on an ADU than on a normal property and they do tend to cashflow very well around here if you're close to the university for sporting events.

    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free