My First Deal: Analysis Advice (SF East Bay Area, ADU, HouseHack)

Real Estate Deal Analysis & Advice
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My First Deal: Analysis Advice (SF East Bay Area, ADU, HouseHack)

Missy Longshore
San Francisco Bay Area California, USA · Member since 2018 · 14 posts · 3 votes

Hi,

I live in the San Francisco Bay Area (in El Cerrito, in the East Bay) and would like feedback on my plan to get started in real estate investing. I'm looking for a way to lower my housing costs with this plan.

The plan is to build an Accessory Dwelling Unit (ADU) in my basement, essentially turning my home into a duplex. I would move into the new, smaller unit in the basement (a studio) so I could rent out the 2 br/1 ba for maximum rent. Once the value of the home increases I could do a second cash out refinance and take that money to invest in my second property, likely an out of state or out of area rental.

Here are the numbers:

I currently owe $300k on the 2br/1ba

The current value is $645k (conservative estimate)

I'd cash out refinance a max of $200k to build the ADU and do repairs to get max rent for the 2br/1ba

New estimated value $900k

Cash out refinance rate: 5%

Current mortgage payment $2k (includes escrow account)

New payment: $2,750/mo

Rent for 2 br/1ba: $2,500

Rent for new studio: $1,750

50% rule analysis:

($2,500 in total income * .5) - $2,750 = ($1500)/mo

Obviously we want this to be a positive number, but is it fair to think of this as I'd be saving $500/mo over what I'm paying now ($2k)?

1% rule analysis:

Monthly rental income/Purchase Price

$1750/$150k=1.16% This is good, right?

This assumes 50k of 200k would go to upstairs/overall house repairs; I'm calculating it this way because there's no way I could purchase a studio home in the bay area for $150k.

Other questions:

Would this make me over-leveraged? What do I need to consider given that there is likely a recession coming in the next 24 months?

Thank you so much for your thoughts and advice!

Missy

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Amit M.
Rental Property Investor · San Francisco, CA · Member since 2013 · 1k+ posts · 1k+ votes
7y

Your idea is interesting, but I think you’re getting hung up on “rules” that don’t apply to Bay Area (i.e. expensive) real estate. Forget the 50% rule, as expenses are never close to 50% in expensive areas like the Bay Area. Also forget the 1% rule, as it mostly doesn’t apply here. 

I’d look at things more simply:

1- are there any comps that have SFH's with ADU's that have sold? Maybe not, as it's pretty new. So talk to some established brokers in your area. On one hand, you're adding value. On the other, for resale purposes, most buyers want SFH's. So you need to determine how desirebale a 2 unit bldg would be in your area, which I assume is mostly SFH. (If your area already has 2-4,s, like SF and OAKLAND do, then the decision is much easier.) My gut says that there will be multigenerational families, or singles/couples that would want the 2 units, to accommodate grandparents, etc., or to rent out for income, like your case. But I'd run this by some brokers, to make sure you don't end up with a white elephant when it comes time to sell it ;)

2- make sure that the $150k you spend will increase the property value by more than that. It should, but make sure #1 above checks out on a resale/desirability level. You only want to invest cash, time and effort if you clearly increase the property value!

3- from a cashflow perspective this is a no brained: your current housing expenses are $2k. Your new expenses (renting the main house) will be the difference between new mortgage of $2750 - $2500 rent income. You’re almost living the free! Of course, you need to be cool with the studio, or see if there is a way to make it a 1 BR. Not sure how many sq ft you have, if there is a garage in front. 

Since you want to invest in RE, this is a great way to start IMO. I wouldn't worry about a future recession, as you can always rent out a good unit in the Bay Area. And you shouldn't be over leveraged, as you *should* (confirm this) be adding more value than you borrow for the ADU. Just make sure your project will have solid resale appeal in the future!

Let us know what you decide, how you proceed on this post. 

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  • Amit M.
    Rental Property Investor · San Francisco, CA · Member since 2013 · 1k+ posts · 1k+ votes
    7y

    Your idea is interesting, but I think you’re getting hung up on “rules” that don’t apply to Bay Area (i.e. expensive) real estate. Forget the 50% rule, as expenses are never close to 50% in expensive areas like the Bay Area. Also forget the 1% rule, as it mostly doesn’t apply here. 

    I’d look at things more simply:

    1- are there any comps that have SFH's with ADU's that have sold? Maybe not, as it's pretty new. So talk to some established brokers in your area. On one hand, you're adding value. On the other, for resale purposes, most buyers want SFH's. So you need to determine how desirebale a 2 unit bldg would be in your area, which I assume is mostly SFH. (If your area already has 2-4,s, like SF and OAKLAND do, then the decision is much easier.) My gut says that there will be multigenerational families, or singles/couples that would want the 2 units, to accommodate grandparents, etc., or to rent out for income, like your case. But I'd run this by some brokers, to make sure you don't end up with a white elephant when it comes time to sell it ;)

    2- make sure that the $150k you spend will increase the property value by more than that. It should, but make sure #1 above checks out on a resale/desirability level. You only want to invest cash, time and effort if you clearly increase the property value!

    3- from a cashflow perspective this is a no brained: your current housing expenses are $2k. Your new expenses (renting the main house) will be the difference between new mortgage of $2750 - $2500 rent income. You’re almost living the free! Of course, you need to be cool with the studio, or see if there is a way to make it a 1 BR. Not sure how many sq ft you have, if there is a garage in front. 

    Since you want to invest in RE, this is a great way to start IMO. I wouldn't worry about a future recession, as you can always rent out a good unit in the Bay Area. And you shouldn't be over leveraged, as you *should* (confirm this) be adding more value than you borrow for the ADU. Just make sure your project will have solid resale appeal in the future!

    Let us know what you decide, how you proceed on this post. 

    2Reply
  • Missy Longshore
    OP
    San Francisco Bay Area California, USA · Member since 2018 · 14 posts · 3 votes
    7y

    Hi Amit, 

    Thank you so much, this is a huge help! 

    I spoke with my realtor who sold me this home in 2010 and she did say she thought the resale value would be higher if it was a larger home vs. a 2 unit, so I'm having the architect look at an option where I expand it to a 3/2 by putting a staircase in to go to the basement. I wouldn't love giving up my privacy (in this scenario I'd move into the new downstairs master suite, sharing the kitchen with a renter; my other concern is just renting a room would max out at close to $1,000 month) but if the renovation costs are way cheaper and the resale price would be that much higher I might consider it - I'd love your thoughts on that.

    FYI the home is small at 869 sf so the max the ADU could be is about 425sf, so I wouldn't add the staircase to downstairs if I build the ADU since that would take up too many square feet.

    I did a quick search in El Cerrito and didn't find any recently sold homes with ADUs but interestingly enough there are 3 listings that include 'potential for ADU!' as a selling point.

    One other concern is the rising interest rates - does that mean I should rush to try to get my cash out refinance to start the project? My contractor isn't available until the spring.

    Thanks!

    Missy

    0Reply
  • Mark Hogan
    Specialist · San Francisco, CA · Member since 2018 · 19 posts · 13 votes
    7y

    Have you spoken with a contractor about your construction cost estimate for the ADU + remodel work? All in, including hard and soft costs, I think it's going to be more expensive than you have indicated. I'm an architect and am working on literally dozens of ADUs in the Bay Area and have not seen any recent construction project come in at under $350-$400/SF in hard costs alone. On top of that you will have permit fees, utility connection fees, you may have to rent an apartment during construction etc. Just make sure it's a real number before you get too far in. Overall though your plan sounds pretty solid!

    0Reply
  • Missy Longshore
    OP
    San Francisco Bay Area California, USA · Member since 2018 · 14 posts · 3 votes
    7y

    Hi @Mark Hogan, thanks for your reply! I have been talking with several contractors and architects and the most I've been quoted is between $150-200k, but this is very helpful info for comparison purposes and a reality check. I'm curious, have most of these been detached ADUs? I originally looked at a detached ADU but it was at least $10-25k more even when I include the french drain, foundation work, and plumbing pump needed since it's in my existing basement. Thank you again!

    0Reply
  • Mark Hogan
    Specialist · San Francisco, CA · Member since 2018 · 19 posts · 13 votes
    7y

    The ones we have been working on have been inside existing buildings (garage conversions, basements, storage rooms etc.). It sounds like you are already accounting for some foundation work in that number and have talked with professionals, so that is a good start. I'd definitely get it designed as soon as possible so you can get a few real bids off a set of plans. 

    1Reply
  • Amit M.
    Rental Property Investor · San Francisco, CA · Member since 2013 · 1k+ posts · 1k+ votes
    7y

    Yeah usually in better neighborhoods adding sq ft to the home is highest and best value appreciation wise. But you need to keep in mind that the ADU phenomena is very new. 10 years from now there will be more of these in suburban neighborhoods, and we will get a batter idea of the value vs traditional SFHs.

    This endeavor is very nuanced. For instance, in SF, adding an ADU to an SFH puts both under rent control, so that's a big negative. Not sure if El Cerrito has rent control, but check the implications.

    Another alternative is a best of both worlds approach: add a master suite downstairs, but include “were bar.” also include a separate enterance to the downstairs. You’d still need the staircase connecting the 2 floors, but that can easily be closed and locked off. Presto, instant “informal” second unit! I’m not sure how El Cerrito’s planning dept would handle this, but in SF this has been done. You basically want to make it look and feel like an addition, so planning accepts it. Btw you can get clever with the wet bar- no stove is allowed, but if you happen to leave space for a future stove, well that’s up to you!

    0Reply
  • Mark Hogan
    Specialist · San Francisco, CA · Member since 2018 · 19 posts · 13 votes
    7y

    @Amit M. that is good advice, but if you are in San Francisco (specifically) there is what Planning calls a "rooms down" analysis that is done. They often will not let you have a wet bar and a full bathroom downstairs because they think you're trying to create an illegal rental unit. It's somewhat subjective because it depends on the type of connection to the main living space upstairs. It's an easier strategy in El Cerrito. 

    0Reply
  • Missy Longshore
    OP
    San Francisco Bay Area California, USA · Member since 2018 · 14 posts · 3 votes
    7y

    Thank you both so much, this is very helpful! Since my strategy is to live in the ADU myself so I can rent out the larger space, I would definitely want it to be fully functional with a kitchen so I can feed myself = ). There is something called a junior ADU in El Cerrito which is basically a spare bedroom but that's really designed for an existing space to be modified, not my case where I have a raw basement space (dirt floor, foundation work needed, etc, etc).

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