Los Angeles ADU/Duplex Appraisal Issues

9 Replies

I'm looking into buying a single family residence and building a second unit as a duplex or ADU, but my lender and other posts online say that is very difficult to get a correct appraisal done for a 2 unit home. In some cases, the ADU isn't considered at all in the ARV for a property.

does anyone have any tips on how to get the appraisal to come in correctly ? This is the only thing preventing me from moving forward with this duplex/ADU plan

@Fahad Masud "Correctly" is subjective. Right now homes that are zoned as SFH or R1 are appraised based on comps (from what I am told). When you have a house with an ADU and there are no comps in the area that also have an ADU, what you have in the appraisers mind is a unique SFH with what could be considered an over-improvement for the area no different from say, a $200,000 fancy swimming pool. It brings some additional value, but not what its "worth". My SFH with ADU ($2000/mo in rent) was compared to a SFH that had a workshop attached to the garage, so the appraiser gave the ADU a $40,000 value... which was generous.

I suspect ADUs will always add less value per the appraisal than the hands off cost of construction. Here is why: If I have a home without an ADU I can choose to build an ADU or not. If I build the ADU, I can build it for the hands off construction cost and I can build exactly what I desire. However, if I purchase an RE with an ADU, I have someone else's ADU goal.

This does not fully explain the low ADU appraisals. A protégé of mine recently sold a SFR with a nice (but with a strange entrance - entrance was through the BR) 1 BR, 1 BA ADU with laundry/storage room. The appraisal basically gave value for footage, BR, and BA but no value for the kitchen other than for the footage. Also the laundry/storage room was consider non-living space (footage not counted) which was borderline (human entrance was from outside the unit). The ADU was valued by the appraisal way below hands off construction costs.

@Fahad Masud

The interesting concept with ADU should not necessarily be used to refinance cash out, but to increase potential cash flow. ADU's are great for the latter but not great for the first concept. If you want to utilize a BRRR strategy, then you need a small, cruddy SFH on a large lot hopefully in an up and coming or quickly appreciating neighborhood with a detached garage... take that home, add square footage to the front house so your comps are now in the maybe a 3/2 or 3/3 arena. Convert the garage into the ADU and now you have a recipe for an nice forced appreciation in comparison to other SFH in the neighborhood and the ADU can be used as a cherry on top for whatever the appraiser decides to add. If you are using large lenders like Wells, B of A etc etc, you should factor in 0 value for the appraisal because they are the worst, but if you have a private broker and they understand the area, and understand the appraisers standards in how to value ADU's (yes they exist) then you can have some value considered for it, but again.. don't rely on it, because a lot of appraisers dont put in the extra work to educate themselves on the ongoing ambiguity in our quickly changing market.

Anyways... Just my two cents. 

@Dan Heuschele I agree with your suspicion that "ADUs will always add less value per the appraisal than the hands off cost of construction," but how does logic of purchasing a house with someone else's "ADU goal" differ from purchasing a how with someones "addition goal" like in @Nabil Suleiman 's value add example?

Houses with additions that bring square footage to the market norm are probably more desirable at this time, but I can see a scenario where there is significant demand for ADUs. Maybe in the future lenders allow people to take credit for ADU income when applying for a mortgage and that allows lower end homebuyers to get into previously inaccessible areas. Obviously a stretch, but if there's demand, there should be sales, with sales we get comps, and with comps we get value. Is my logic wrong?

Originally posted by @Matthew Forrest :

@Dan Heuschele I agree with your suspicion that "ADUs will always add less value per the appraisal than the hands off cost of construction," but how does logic of purchasing a house with someone else's "ADU goal" differ from purchasing a how with someones "addition goal" like in @Nabil Suleiman 's value add example?

Houses with additions that bring square footage to the market norm are probably more desirable at this time, but I can see a scenario where there is significant demand for ADUs. Maybe in the future lenders allow people to take credit for ADU income when applying for a mortgage and that allows lower end homebuyers to get into previously inaccessible areas. Obviously a stretch, but if there's demand, there should be sales, with sales we get comps, and with comps we get value. Is my logic wrong?

>how does logic of purchasing a house with someone else's "ADU goal" differ from purchasing a how with someones "addition goal" …

My view is that, in general, it is not.  Most additions will not appraise as high as the hands off construction costs, but the right additions can.  

Right additions include adding a bathroom to an older home that was built in a era when families managed fine with a single bathroom.  Or adding an extra BR to 2 BR homes in a family neighborhood where 3 BR is the expected minimum.  Extending the size of a small kitchen from a era when 60' enclosed kitchen was fine

Those additions unlikely to produce appraisals that match the hands off costs are Pools, patios, extra BR that bring the count above 4, a Living room or family room where there is already one or the other. 

There are exceptions to both, just as I believe an ADU in a high enough land cost areas (super high rent areas) on the right lot may be able to get an appraisal to match the hands off cost due to a better use of the land. Such an ADU would have an end result that would look to a casual observer to be 2 separate properties each with own access (cannot go through one unit's yard to access the other unit) and separate yards. The rent on the ADU would far exceed the 1% rule.

I had a property under contract as Covid hit that we pulled out of during DD (not due to covid) that I had allocated $275k to $300K mostly hands off for the ADU construction (3/2 with garage and high end interior with small amount of hardscape) that I believe would have rented for ~$3.5 to $3.7K. I was expecting the appraisal to come close to ADU construction costs because both units (existing and ADU) would have had own yard (with a shard pool) and it was in location that RE sells for over $1M.

Most ADU projects will not get appraised at the hands off construction costs, but there will be some exceptions.

@Fahad Masud

Wanted to share with you a great way to tap into the equity built from your ADU.

The problem today: most appraisers used by traditional lenders would give ADU square footage a second-class treatment than the main house (as some of your mentioned above) since there aren't that many comps and they're trying to be conservative.

However, you can consider taking out a HELOC/doing cash-out refi through Figure.com (HELOC up to $250k, Cash-out refi up to $1M). I just took out a 30-year fixed-rate HELOC through Figure from my San Jose property that has an ADU on it. Unlike the other lenders, Figure.com does automatic appraisal (without a human involved) based on public data and they treat ADU square footage the same as the main house square footage. Because their generous appraisal value, I was able to take out all the cash I invested into the ADU (plus some more). The whole process only took 2 weeks and I'm really happy about it. In fact, you can check your property's appraised value by simply filing out the questions on their website. If you have an ADU on your property, it's super easy to find out approximately how much you can take out through just a few clicks with only a soft credit pull...

A side note: the founder of Figure.com Mike Cagney also founded Sofi and they got pretty some impressive investors. I think they really did a great job simplifying the process and removing all the inefficiencies in mortgage industry today...

On all of my and my clients' ADUs, we have to essentially do the appraisers job. Look for comparable homes with ADUs and show the appraiser. During my refinance here in Los Angeles, I had to give him 3 or 4 sales. This is especially true because some agents when listing properties with ADUs combine the total square footage (for example will advertise 2,500 square feet with 2,000 for the house and 500 for the ADU), so some appraisers miss it completely.

@Fahad Masud I agree to most of what was said here and the ADU landscape is too new to answer with confidence. I am currently converting my garage to an ADU with permits. My property is zoned RD3 so I can have 3 units. The appraisers that I know from my clients say the same thing, ADUs are not given full value due to zoning. My property, when the ADU is complete, will be a triplex with an ADU not a four unit property. If I want to use the income from this property to refinance, I cannot use the ADU income. As far as value, I was given a standard 20k increase in value, which is on the low end but what I have seen is 20-50k range. So building as ADU is only for cash flow at this stage. As more properties with ADUs are being sold, then the valuation landscape will change but as of now, basing your strategy solely on the perceived increase in value of an ADU is setting youself up for failure.