Using a Construction Loan to Build New Garage with ADU on Top

Denver, Colorado
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Using a Construction Loan to Build New Garage with ADU on Top

Morgan Roddy
Investor · CO · Member since 2023 · 4 posts · 0 votes

Hello everyone! My name is Morgan and I am a Colorado Investor. I currently have 4 properties and am looking to expand. 

I am looking for ways to make my primary home cash flow and my favorite option would be to build a larger garage with an ADU on top to rent out long term or short term. I have gotten a few quotes for this and they are nearing 250-300k. I don't want to tie up all my cash in one project as I have other plans to continue growing my real estate portfolio. Because of this I am looking into financing options for this Garage ADU. Luckily, my home lot is zoned for 3 units. Because I would be building a separate residence do you think I could finance this via construction to traditional mortgage?

One thing to note is my neighbor a few doors down have the same zoning and they split the house up into 2 units and turned their garage into a third all with different addresses. My situation would be a bit different as I would like to use the garage personally and rent out the space above. If I ever sold my primary I would sell it as a package deal, but I don't plan on ever selling (buy and hold long term goals here).


Thank you in advance for your input. I greatly appreciate it. 

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Dan H.Pro Member
Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
2y
Quote from @Bruce Woodruff:

So you're in at $350k let's say.... Have you done the math? Does this give you the return you want? Let's say the ADU rents for $1500 a month (?).....that's 233 months to break even. Not incl interest. I know I'm over-simplifying this but it is a concept worth exploring....

I do not know the Colorado market, but I do know every market has expenses and vacancy.  

I am a fan of the 50% rule (expenses not including mortgage and vacancy is 50% of rent).  Using the 50% rule, this will take 466 months to break even if purchased with no financing.  The reality is financing is planned and the initial outlay is like 25% of the full cost.   However, at the current interest rates, this will be cash negative until rents increase enough to change that situation.  

in So Cal, most ADUs add less value than the cost of the ADU addition.  This implies that the ADU addition starts with an initial negative position.  The initial cash flow goes to recover the negative position.  I am unsure if this holds true for the Colorado markets.  

make sure you perform conservative underwriting and know the value that ADU addition will add to the property.  

good luck
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  • Jason WrayPro Member
    Banker · Nationwide · Member since 2020 · 2k+ posts · 1k+ votes
    2y

    Morgan,

    What we call it is a Renovation loan similar to construction but that is saved for "Ground Up" builds. Simple renovation loan would allow for you to convert a garage into a bedroom and allow to build up or build an ADU.

    It might make sense to look into simply buying an ADU from the vendor already built as a prefab/modular. That way they simply trailer the ADU you out and adhere it to a foundation/ground. There are some new companies out there called "Tiny home" you can pretty much call them and they deliver the home to your property and do whatever install is needed.

    This can save you a large amount of cash based on new construction and also reduce the timeframe from start to finish. You quoted above $250-300K that just seems like an overpriced bid to me but for what's it's worth check out the "Tiny Home" or ADU options where they trailer the unit out and complete/install. Either way you can use a Renovation loan for either of these options and they are generally easy to qualify for especially if it's a Primary or Secondary home.

    Last time I checked you can buy a an ADU aka tiny home in CO for starting at $39K upwards of $75K for a 3bed/1 bath. Try typing Colorado tiny home companies there are more than a few just vet them and compare prices. Nothing wrong with an ADU/tiny home not attached to the home. If anything it might offer more privacy and less noise for all parties.

    [email protected]727-637-4289
    1Reply
  • Bruce WoodruffPro Member
    Contractor/Investor/Consultant · San Diego / Phoenix · Member since 2021 · 12k+ posts · 15k+ votes
    2y

    So you're in at $350k let's say.... Have you done the math? Does this give you the return you want? Let's say the ADU rents for $1500 a month (?).....that's 233 months to break even. Not incl interest. I know I'm over-simplifying this but it is a concept worth exploring....

    1Reply
  • Morgan Roddy
    OP
    Investor · CO · Member since 2023 · 4 posts · 0 votes
    2y
    Quote from @Jason Wray:

    Morgan,

    What we call it is a Renovation loan similar to construction but that is saved for "Ground Up" builds. Simple renovation loan would allow for you to convert a garage into a bedroom and allow to build up or build an ADU.

    It might make sense to look into simply buying an ADU from the vendor already built as a prefab/modular. That way they simply trailer the ADU you out and adhere it to a foundation/ground. There are some new companies out there called "Tiny home" you can pretty much call them and they deliver the home to your property and do whatever install is needed.

    This can save you a large amount of cash based on new construction and also reduce the timeframe from start to finish. You quoted above $250-300K that just seems like an overpriced bid to me but for what's it's worth check out the "Tiny Home" or ADU options where they trailer the unit out and complete/install. Either way you can use a Renovation loan for either of these options and they are generally easy to qualify for especially if it's a Primary or Secondary home.

    Last time I checked you can buy a an ADU aka tiny home in CO for starting at $39K upwards of $75K for a 3bed/1 bath. Try typing Colorado tiny home companies there are more than a few just vet them and compare prices. Nothing wrong with an ADU/tiny home not attached to the home. If anything it might offer more privacy and less noise for all parties.

    Thank you for this insight. I would need the garage for personal use, parking is bad in my neighborhood and snow, so I like the idea of a tiny home or ADU but don't think that would suit my overall needs. I wish quotes were cheaper but these were from 3 different reputable contractors here in Denver. I will look into prefab options though that is a great idea. 

    In regards to the recommendation of a renovation loan, I am hesitant since my current loan rate is very low. I would like to fund this project without impacting my current primary loan as it would greatly decrease my monthly cash flow.
    0Reply
  • Morgan Roddy
    OP
    Investor · CO · Member since 2023 · 4 posts · 0 votes
    2y
    Quote from @Bruce Woodruff:

    So you're in at $350k let's say.... Have you done the math? Does this give you the return you want? Let's say the ADU rents for $1500 a month (?).....that's 233 months to break even. Not incl interest. I know I'm over-simplifying this but it is a concept worth exploring....


    Yeah, this is good to look into more. I would get a lot of use out of the garage and it would make my primary home value jump signifigantly. I like Jason's idea of finding a prefab option and just prepping the site for a building to be dropped off.

    0Reply
  • Bruce WoodruffPro Member
    Contractor/Investor/Consultant · San Diego / Phoenix · Member since 2021 · 12k+ posts · 15k+ votes
    2y
    Quote from @Morgan Roddy:
    Quote from @Bruce Woodruff:

    So you're in at $350k let's say.... Have you done the math? Does this give you the return you want? Let's say the ADU rents for $1500 a month (?).....that's 233 months to break even. Not incl interest. I know I'm over-simplifying this but it is a concept worth exploring....


    Yeah, this is good to look into more. I would get a lot of use out of the garage and it would make my primary home value jump signifigantly. I like Jason's idea of finding a prefab option and just prepping the site for a building to be dropped off.


    That might be better...or not do it at all, spend your hard-earned dollars somewhere else. The ADU thing is really big right now, kinda like a fad.....I used to bid on a lot of these when they first hit the scene in San Diego and the numbers usually did not work, people just did it because it was a 'cool' thing to do...Don't do that...make the numbers work first.

    0Reply
  • Dan H.Pro Member
    Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
    2y
    Quote from @Bruce Woodruff:

    So you're in at $350k let's say.... Have you done the math? Does this give you the return you want? Let's say the ADU rents for $1500 a month (?).....that's 233 months to break even. Not incl interest. I know I'm over-simplifying this but it is a concept worth exploring....

    I do not know the Colorado market, but I do know every market has expenses and vacancy.  

    I am a fan of the 50% rule (expenses not including mortgage and vacancy is 50% of rent).  Using the 50% rule, this will take 466 months to break even if purchased with no financing.  The reality is financing is planned and the initial outlay is like 25% of the full cost.   However, at the current interest rates, this will be cash negative until rents increase enough to change that situation.  

    in So Cal, most ADUs add less value than the cost of the ADU addition.  This implies that the ADU addition starts with an initial negative position.  The initial cash flow goes to recover the negative position.  I am unsure if this holds true for the Colorado markets.  

    make sure you perform conservative underwriting and know the value that ADU addition will add to the property.  

    good luck
    1Reply
  • Weronika JedrakPro Member
    Investor · NJ · Member since 2023 · 26 posts · 11 votes
    2y

    Hi Morgan, 

    Funny enough, my husband and I are in the exact situation! We have a detached 3 car garage in our primary residence. The garage needs new roof and we have been considering popping the top and building an apartment above the garage to rent it as MTR. However, we had an engineer come out and the foundation of the garage cannot support second floor. So, we have been looking at different options as rebuild can be costly. I came across a small pole barn idea. They usually are cheaper, and they can make them to suits your needs aka garage at the bottom, apartment at the top. I didn't get any quotes yet, but it mostly likely would be cheaper than 300K, and more durable, so that is another way to go about it. 

    0Reply
  • Jason WrayPro Member
    Banker · Nationwide · Member since 2020 · 2k+ posts · 1k+ votes
    2y
    Quote from @Morgan Roddy:
    Quote from @Jason Wray:

    Morgan,

    What we call it is a Renovation loan similar to construction but that is saved for "Ground Up" builds. Simple renovation loan would allow for you to convert a garage into a bedroom and allow to build up or build an ADU.

    It might make sense to look into simply buying an ADU from the vendor already built as a prefab/modular. That way they simply trailer the ADU you out and adhere it to a foundation/ground. There are some new companies out there called "Tiny home" you can pretty much call them and they deliver the home to your property and do whatever install is needed.

    This can save you a large amount of cash based on new construction and also reduce the timeframe from start to finish. You quoted above $250-300K that just seems like an overpriced bid to me but for what's it's worth check out the "Tiny Home" or ADU options where they trailer the unit out and complete/install. Either way you can use a Renovation loan for either of these options and they are generally easy to qualify for especially if it's a Primary or Secondary home.

    Last time I checked you can buy a an ADU aka tiny home in CO for starting at $39K upwards of $75K for a 3bed/1 bath. Try typing Colorado tiny home companies there are more than a few just vet them and compare prices. Nothing wrong with an ADU/tiny home not attached to the home. If anything it might offer more privacy and less noise for all parties.

    Thank you for this insight. I would need the garage for personal use, parking is bad in my neighborhood and snow, so I like the idea of a tiny home or ADU but don't think that would suit my overall needs. I wish quotes were cheaper but these were from 3 different reputable contractors here in Denver. I will look into prefab options though that is a great idea. 

    In regards to the recommendation of a renovation loan, I am hesitant since my current loan rate is very low. I would like to fund this project without impacting my current primary loan as it would greatly decrease my monthly cash flow.
    You might be surprised mortgage rates are coming down and the renovation loan is I/O interest only until you need to go to Perm.  In most cases when you calcualate the overall cost between a HELOC, or other loans, the renovation loan followed by the refinance to perm save the most money.  While trying to expand and grow you cannot let a lower rate hold you hostage you can always refinance down the road and even opt for a rate buy down on a LTR situation so the burn rates makes sense.
    [email protected]727-637-4289
    0Reply
  • Brittany Guimond
    Realtor · New Castle, CO · Member since 2022 · 93 posts · 58 votes
    2y

    @Morgan Roddy — your quotes are right on with current pricing, the cost to build an ADU is at least $250K, throw a garage in and you're right there. If it were me, I'd likely go HELOC on my primary (if you aren't leveraging one already) but this renovation loan then refinance to perm that Jason mentioned sounds interesting! I would shop both options. I like Security Services Federal Credit Union for HELOCs, they tend to have the best terms from what I've found for myself and clients.

    What Bruce says here is also on point -- your payback period would be soooo long, unless you plan to do a cash out refinance after the project is complete and your property value has increased. In my experience, adding an income unit to a property increases its value, but not by a whole lot, and I assume whatever rate you have locked in is better than the rates we have today. You might be better off buying another primary with costs as high as they are right now, just my two cents. I'm interested to hear what you do -- good luck!

    1Reply
  • RJ Molitor
    Member since 2023 · 4 posts · 2 votes
    2y

    Morgan,

    I am a General Contractor here in Denver. I am happy to help on this. I have good contacts to pre-fab factories here in Colorado - if that is the route you are looking to go. Feel free to private message me and connect. Thanks

    0Reply
  • David HolcombeBusiness Member
    Real Estate Agent · Atlanta, GA · Member since 2016 · 35 posts · 25 votes
    2y

    Hi Morgan!

    I'm an ADU nerd and building one myself right now also. Financing is tough but getting easier. The most common options are renovations loans or Heloc's. You mentioned not wanting to disturb your current low interest rate loan. Either a HELOC or Renovation loan would leave the primary loan intact, they would be secondary loans. Renofi is very active with ADU renovation loans and seems to be a good option. Also, there's a wonderful Facebook group called How to ADU that has 50,000 members all interested in ADU's. I've posted questions on there and gotten some great responses.    You asked about whether the cost is worth it. To answer that question, I would look at what the cost psf is for similar sized properties in your area. If they're selling for $600 psf and your cost to build is $250 psf, then you're almost definitely adding value to your property.  (This is why ADU's are so popular in expensive markets but not less expensive suburban markets). My other rule of thumb is looking at the 1% rule. Good MTR's can get to the 1% rule now. It's difficult to get to the 1% for a standard unfurnished rental in most markets.  So go look on Furnished Finder. If 1 bedroom garage ADU's are renting for $3,500/month and your cost is $350k, then you've hit your 1% rule. If you can get more rent than that, great.  Your situation is a little different because you're not only building a garage, you're also building an apartment above it, so when thinking through these "rules of thumb", be sure to keep in mind your build cost isn't $350k for an ADU, it's probably more like $200k for the ADU portion and $150k for your garage.  Generally, the more the ADU can feel separate from the main house, the more value you can add. If you can fence a private entry or outdoor for the ADU, that will help. Corner lots are ADU gold for this reason.  Good luck with your project!

    David Holcombe - Holcombe Real Estate53 Reviews
    WebsiteView Page
    1Reply
  • Stephanie Nichols
    Rental Property Investor · Charleston, SC · Member since 2024 · 1 post · 0 votes
    2y

    Hi Morgan!

    Is your garage attached to your house? I'm not sure if this is common elsewhere, I had never heard of it until I moved to Charleston, but FROGs (finished room over garage) are extremely popular here! I'm not sure if that would be easier with zoning purposes too. This way you're basically adding an additional bedroom and square footage to your home which would also significantly increase its value and would probably be a lot cheaper than building a whole mother in law suite or apartment above your garage? If you would like more insight on that let me know! I know here they're great for renting purposes and would probably give you the cash flow you wanted! Maybe even make room for a bathroom up there? Most people who rent rooms around here will pay extra for a private bath.

    0Reply
  • Matt M.
    Realtor · Denver, CO · Member since 2013 · 2k+ posts · 1k+ votes
    2y

    ADUs as investments don't pencil. Your money is better spent elsewhere. 

    0Reply
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