Garage to ADU conversion?

Sacramento, California
House Hacking
1yFollow

Garage to ADU conversion?

Adam Watanabe
Member since 2023 · 7 posts · 4 votes

Hi there! My wife and I recently purchased a single family home with a detached ADU outside the Sacramento, CA area. We just started medium-term renting the ADU through Furnished Finder and it's been an incredible experience. We barely notice our tenant and his rent covers about half of our mortgage. You might say I'm a little hooked and am considering other real estate investments. One idea would be to convert our attached 450 sq ft garage into an ADU to rent. It would cost around $100-120K and could rent for around $2K a month. This would be nearing the 2% rule which seems pretty good especially in today's market. Not to mention, we would be building equity into our house and it would cover the other half of the mortgage.

The other option would be to look for a property to purchase out of state to BRRRR. I would most likely try to find a multi-family to update, then hire a property manager to takeover. I wouldn't get near the rate of return as I would on the ADU, but I would be diversifying my housing investments.

Thoughts and comments would be much appreciated. Thank you!

2Reply
103 views

Most Popular Reply

Dan H.Pro Member
Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
1y
Quote from @Bradley Buxton:

@Adam Watanabe

Converting a garage is not the best idea for the exit of a property. Many people still want garages for primary residences. By having a garage converted, you limit the value of the home and the buyer pool to investors. At 120k/2k that is 60 months or 5 years on the return. @Dan H. has some good insights on ADU conversions.
Generally, it would be better to put the $120k towards the down payment of another property so you can gain the equity even if the cashflow is breakeven. 


thanks for the tag.   To the OP, I regularly check ADU addition underwriting.  I encourage accurate and conservative underwriting.  On an ADU addition, the most important aspect of the underwriting is to KNOW the value that will be added by the ADU.  In the absence of sufficiently comps, expect a very poor valuation.  

I suspect the cost to convert an 450' garage to an ADU will approach $150k. The issue is it will likely add ~$75k of value resulting in an initial negative $75k (a value subtract). This initial negative position needs to be recovered before any cash flow is obtained.

I am also a bit skeptical that a 450’ unit can achieve $2k rent in Sacramento.

Using 50% rule (expenses other than mortgage is 50%) on a financed ADU, 8% 30 your loan at 80% LTV.

$2000 - $1000 (50% rule) - $881 (P&i) = $119/month
$75k/$119 = 630 months to recover the initial negative equity. This is 52.5 years.

Let’s use OP’s $120k with $45k initial negative position.
$2000 - $1000 - $704 (P&i) = $296/ month
$45k/$296 = 152 months or 12,7 years to recover the initial equity.

Building a single smal, unit is very expensive development.

Here is a list of why adding a single ADU in single family zoned areas in my CA market is typically a poor RE investment:
1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.

Good luck

7Reply
See this reply in the discussion

25 Replies

Jump to latestLatest
  • Bradley BuxtonBusiness Member
    Real Estate Agent · NV · Member since 2023 · 1k+ posts · 713 votes
    1y

    @Adam Watanabe

    Converting a garage is not the best idea for the exit of a property. Many people still want garages for primary residences. By having a garage converted, you limit the value of the home and the buyer pool to investors. At 120k/2k that is 60 months or 5 years on the return. @Dan H. has some good insights on ADU conversions.
    Generally, it would be better to put the $120k towards the down payment of another property so you can gain the equity even if the cashflow is breakeven. 

    2Reply
    • Dan H.Pro Member
      Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
      1y
      Quote from @Bradley Buxton:

      @Adam Watanabe

      Converting a garage is not the best idea for the exit of a property. Many people still want garages for primary residences. By having a garage converted, you limit the value of the home and the buyer pool to investors. At 120k/2k that is 60 months or 5 years on the return. @Dan H. has some good insights on ADU conversions.
      Generally, it would be better to put the $120k towards the down payment of another property so you can gain the equity even if the cashflow is breakeven. 


      thanks for the tag.   To the OP, I regularly check ADU addition underwriting.  I encourage accurate and conservative underwriting.  On an ADU addition, the most important aspect of the underwriting is to KNOW the value that will be added by the ADU.  In the absence of sufficiently comps, expect a very poor valuation.  

      I suspect the cost to convert an 450' garage to an ADU will approach $150k. The issue is it will likely add ~$75k of value resulting in an initial negative $75k (a value subtract). This initial negative position needs to be recovered before any cash flow is obtained.

      I am also a bit skeptical that a 450’ unit can achieve $2k rent in Sacramento.

      Using 50% rule (expenses other than mortgage is 50%) on a financed ADU, 8% 30 your loan at 80% LTV.

      $2000 - $1000 (50% rule) - $881 (P&i) = $119/month
      $75k/$119 = 630 months to recover the initial negative equity. This is 52.5 years.

      Let’s use OP’s $120k with $45k initial negative position.
      $2000 - $1000 - $704 (P&i) = $296/ month
      $45k/$296 = 152 months or 12,7 years to recover the initial equity.

      Building a single smal, unit is very expensive development.

      Here is a list of why adding a single ADU in single family zoned areas in my CA market is typically a poor RE investment:
      1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
      2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
      3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
      4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
      5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
      6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
      7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
      8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
      9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
      10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
      11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
      12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.

      Good luck

      7Reply
    • Bruce WoodruffPro Member
      Contractor/Investor/Consultant · San Diego / Phoenix · Member since 2021 · 12k+ posts · 15k+ votes
      1y
      Quote from @Dan H.:
      Quote from @Bradley Buxton:

      @Adam Watanabe

      Converting a garage is not the best idea for the exit of a property. Many people still want garages for primary residences. By having a garage converted, you limit the value of the home and the buyer pool to investors. At 120k/2k that is 60 months or 5 years on the return. @Dan H. has some good insights on ADU conversions.
      Generally, it would be better to put the $120k towards the down payment of another property so you can gain the equity even if the cashflow is breakeven. 


      thanks for the tag.   To the OP, I regularly check ADU addition underwriting.  I encourage accurate and conservative underwriting.  On an ADU addition, the most important aspect of the underwriting is to KNOW the value that will be added by the ADU.  In the absence of sufficiently comps, expect a very poor valuation.  

      I suspect the cost to convert an 450' garage to an ADU will approach $150k. The issue is it will likely add ~$75k of value resulting in an initial negative $75k (a value subtract). This initial negative position needs to be recovered before any cash flow is obtained.

      I am also a bit skeptical that a 450’ unit can achieve $2k rent in Sacramento.

      Using 50% rule (expenses other than mortgage is 50%) on a financed ADU, 8% 30 your loan at 80% LTV.

      $2000 - $1000 (50% rule) - $881 (P&i) = $119/month
      $75k/$119 = 630 months to recover the initial negative equity. This is 52.5 years.

      Let’s use OP’s $120k with $45k initial negative position.
      $2000 - $1000 - $704 (P&i) = $296/ month
      $45k/$296 = 152 months or 12,7 years to recover the initial equity.

      Building a single smal, unit is very expensive development.

      Here is a list of why adding a single ADU in single family zoned areas in my CA market is typically a poor RE investment:
      1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
      2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
      3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
      4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
      5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
      6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
      7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
      8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
      9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
      10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
      11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
      12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.

      Good luck

       Dan is the expert on all of this, so I would take serious note of his opinions :-)

      As I am currently looking into doing an ADU in CA to have a home close to family, I would only add that, although CA is generally ADU friendly, the regulations that are attached to the building of them can add a lot of cost.

      For instance, if the ADU will be a detached unit, you are required to add a complete solar system. Also (depending on specific County/City location) you may have to use only a tankless water heater, add special costly insulation, and on and on....

      I would very carefully check out your building costs specific to your area.....do not just figure that it's X per Sq ft., you will be very surprised.

      Thoughts, @Dan H.? ^^^

      1Reply
    • Dan H.Pro Member
      Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
      1y
      Quote from @Bruce Woodruff:
      Quote from @Dan H.:
      Quote from @Bradley Buxton:

      @Adam Watanabe

      Converting a garage is not the best idea for the exit of a property. Many people still want garages for primary residences. By having a garage converted, you limit the value of the home and the buyer pool to investors. At 120k/2k that is 60 months or 5 years on the return. @Dan H. has some good insights on ADU conversions.
      Generally, it would be better to put the $120k towards the down payment of another property so you can gain the equity even if the cashflow is breakeven. 


      thanks for the tag.   To the OP, I regularly check ADU addition underwriting.  I encourage accurate and conservative underwriting.  On an ADU addition, the most important aspect of the underwriting is to KNOW the value that will be added by the ADU.  In the absence of sufficiently comps, expect a very poor valuation.  

      I suspect the cost to convert an 450' garage to an ADU will approach $150k. The issue is it will likely add ~$75k of value resulting in an initial negative $75k (a value subtract). This initial negative position needs to be recovered before any cash flow is obtained.

      I am also a bit skeptical that a 450’ unit can achieve $2k rent in Sacramento.

      Using 50% rule (expenses other than mortgage is 50%) on a financed ADU, 8% 30 your loan at 80% LTV.

      $2000 - $1000 (50% rule) - $881 (P&i) = $119/month
      $75k/$119 = 630 months to recover the initial negative equity. This is 52.5 years.

      Let’s use OP’s $120k with $45k initial negative position.
      $2000 - $1000 - $704 (P&i) = $296/ month
      $45k/$296 = 152 months or 12,7 years to recover the initial equity.

      Building a single smal, unit is very expensive development.

      Here is a list of why adding a single ADU in single family zoned areas in my CA market is typically a poor RE investment:
      1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
      2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
      3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
      4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
      5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
      6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
      7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
      8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
      9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
      10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
      11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
      12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.

      Good luck

       Dan is the expert on all of this, so I would take serious note of his opinions :-)

      As I am currently looking into doing an ADU in CA to have a home close to family, I would only add that, although CA is generally ADU friendly, the regulations that are attached to the building of them can add a lot of cost.

      For instance, if the ADU will be a detached unit, you are required to add a complete solar system. Also (depending on specific County/City location) you may have to use only a tankless water heater, add special costly insulation, and on and on....

      I would very carefully check out your building costs specific to your area.....do not just figure that it's X per Sq ft., you will be very surprised.

      Thoughts, @Dan H.? ^^^


      In general the smaller the unit the higher the psf. There are other cost drivers like ease to build and finishes, but 2 different choices of ADU on a lot with same level of finishes and the smaller one will cost more per square foot. This likely makes sense to most people.

      In many CA markets, they are building multiple ADUs through bonus density and/or low cost housing options. For the low cost housing options, the jurisdiction approves addition units based on some being deed restricted to low cost housing for a certain amount of time. The low cost housing option has a risk in that jurisdictions are putting up more road blocks to transition to traditional housing at the end of the agreed upon duration. No one knows what will be in effect by the time the low cost housing committed time ends. Basically the jurisdictions seem to have no issue changing the rules mid game and are too ignorant to see how this discourages further low cost housing. The developers currently do not care because they typically do not hold the property, they sell it after development. However, they will when the value of affordable units falls further due to the risks involved.

      Developers make the most money on large number of large units. If you recognize rye reason for this, you get an understanding of the challenges building a single, small,unit on a property that already has a unit.

      One of my long ago protégés was the land provider on this effort. The property sold for ~$600k above its current use value (note he acquired it below market value so made more than this - A small 3/1/2 he sold for $1.5m about a year ago (you can see the original house in the video in the link)). My protege did well. I suspect everyone involved except the neighbors did well financially. The neighbors’ homes likely lost value and definitely lost convenience if for no other reason than the parking became awful.

      https://www.cbs8.com/article/news/local/working-for-you/new-...

      Good luck

      1Reply
    • Brian Larson
      Investor · San Jose, CA · Member since 2018 · 313 posts · 230 votes
      1y
      Quote from @Dan H.:
      Quote from @Bradley Buxton:

      @Adam Watanabe

      Converting a garage is not the best idea for the exit of a property. Many people still want garages for primary residences. By having a garage converted, you limit the value of the home and the buyer pool to investors. At 120k/2k that is 60 months or 5 years on the return. @Dan H. has some good insights on ADU conversions.
      Generally, it would be better to put the $120k towards the down payment of another property so you can gain the equity even if the cashflow is breakeven. 


      thanks for the tag.   To the OP, I regularly check ADU addition underwriting.  I encourage accurate and conservative underwriting.  On an ADU addition, the most important aspect of the underwriting is to KNOW the value that will be added by the ADU.  In the absence of sufficiently comps, expect a very poor valuation.  

      I suspect the cost to convert an 450' garage to an ADU will approach $150k. The issue is it will likely add ~$75k of value resulting in an initial negative $75k (a value subtract). This initial negative position needs to be recovered before any cash flow is obtained.

      I am also a bit skeptical that a 450’ unit can achieve $2k rent in Sacramento.

      Using 50% rule (expenses other than mortgage is 50%) on a financed ADU, 8% 30 your loan at 80% LTV.

      $2000 - $1000 (50% rule) - $881 (P&i) = $119/month
      $75k/$119 = 630 months to recover the initial negative equity. This is 52.5 years.

      Let’s use OP’s $120k with $45k initial negative position.
      $2000 - $1000 - $704 (P&i) = $296/ month
      $45k/$296 = 152 months or 12,7 years to recover the initial equity.

      Building a single smal, unit is very expensive development.

      Here is a list of why adding a single ADU in single family zoned areas in my CA market is typically a poor RE investment:
      1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
      2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
      3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
      4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
      5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
      6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
      7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
      8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
      9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
      10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
      11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
      12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.

      Good luck

       Wow @Dan H. this is a crazy story.  I had no idea that someone could even do this.

      0Reply
    • Dan H.Pro Member
      Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
      1y
      Quote from @Brian Larson:
      Quote from @Dan H.:
      Quote from @Bradley Buxton:

      @Adam Watanabe

      Converting a garage is not the best idea for the exit of a property. Many people still want garages for primary residences. By having a garage converted, you limit the value of the home and the buyer pool to investors. At 120k/2k that is 60 months or 5 years on the return. @Dan H. has some good insights on ADU conversions.
      Generally, it would be better to put the $120k towards the down payment of another property so you can gain the equity even if the cashflow is breakeven. 


      thanks for the tag.   To the OP, I regularly check ADU addition underwriting.  I encourage accurate and conservative underwriting.  On an ADU addition, the most important aspect of the underwriting is to KNOW the value that will be added by the ADU.  In the absence of sufficiently comps, expect a very poor valuation.  

      I suspect the cost to convert an 450' garage to an ADU will approach $150k. The issue is it will likely add ~$75k of value resulting in an initial negative $75k (a value subtract). This initial negative position needs to be recovered before any cash flow is obtained.

      I am also a bit skeptical that a 450’ unit can achieve $2k rent in Sacramento.

      Using 50% rule (expenses other than mortgage is 50%) on a financed ADU, 8% 30 your loan at 80% LTV.

      $2000 - $1000 (50% rule) - $881 (P&i) = $119/month
      $75k/$119 = 630 months to recover the initial negative equity. This is 52.5 years.

      Let’s use OP’s $120k with $45k initial negative position.
      $2000 - $1000 - $704 (P&i) = $296/ month
      $45k/$296 = 152 months or 12,7 years to recover the initial equity.

      Building a single smal, unit is very expensive development.

      Here is a list of why adding a single ADU in single family zoned areas in my CA market is typically a poor RE investment:
      1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
      2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
      3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
      4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
      5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
      6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
      7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
      8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
      9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
      10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
      11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
      12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.

      Good luck

       Wow @Dan H. this is a crazy story.  I had no idea that someone could even do this.


      In San Diego, there is starting to be legit push back to these types of developments but the state has mandated affordable housing quotas. The jurisdictions need to comply to these requirements. Their solution of discarding the zoning rules for a commitment of low cost units is a poor solution. It would be better if they mandated new development to provide low cost units at part of the approval process but this has issues when the development as proposed meets the current rules. But they change the rules (increasing allowed density) for affordable ADU units added. I see little difference in changing rules in the new development except new developers likely have more resources to fight the rule change.

      If you believe affordable housing should be provided in all areas, the solutions are not trivial. So we end up with 18 units (17 ADU units plus the original unit) on a lot that was zoned for a single family home (by the way single family zoning no longer exists in CA).

      Note, I am not claiming there are easy solutions to the housing crisis.  I do claim the existing solutions seem extreme especially if it happens next door to you.

      0Reply
    • Adam Watanabe
      OP
      Member since 2023 · 7 posts · 4 votes
      1y
      Quote from @Bradley Buxton:

      @Adam Watanabe

      Converting a garage is not the best idea for the exit of a property. Many people still want garages for primary residences. By having a garage converted, you limit the value of the home and the buyer pool to investors. At 120k/2k that is 60 months or 5 years on the return. @Dan H. has some good insights on ADU conversions.
      Generally, it would be better to put the $120k towards the down payment of another property so you can gain the equity even if the cashflow is breakeven. 

      @Bradley Buxton

      Appreciate the advice Bradley! I have a feeling we'll be here for the next 7-10 years so exit strategy is always important. From what I've researched, it seems as though living space is generally more desirable than a garage although the lack of one can deter many. You're right about the equity in another property yielding better return. Will definitely keep this in mind and keep doing my research. Thanks for your time!  

      0Reply
    • Adam Watanabe
      OP
      Member since 2023 · 7 posts · 4 votes
      1y
      Quote from @Dan H.:
      Quote from @Bradley Buxton:

      @Adam Watanabe

      Converting a garage is not the best idea for the exit of a property. Many people still want garages for primary residences. By having a garage converted, you limit the value of the home and the buyer pool to investors. At 120k/2k that is 60 months or 5 years on the return. @Dan H. has some good insights on ADU conversions.
      Generally, it would be better to put the $120k towards the down payment of another property so you can gain the equity even if the cashflow is breakeven. 


      thanks for the tag.   To the OP, I regularly check ADU addition underwriting.  I encourage accurate and conservative underwriting.  On an ADU addition, the most important aspect of the underwriting is to KNOW the value that will be added by the ADU.  In the absence of sufficiently comps, expect a very poor valuation.  

      I suspect the cost to convert an 450' garage to an ADU will approach $150k. The issue is it will likely add ~$75k of value resulting in an initial negative $75k (a value subtract). This initial negative position needs to be recovered before any cash flow is obtained.

      I am also a bit skeptical that a 450’ unit can achieve $2k rent in Sacramento.

      Using 50% rule (expenses other than mortgage is 50%) on a financed ADU, 8% 30 your loan at 80% LTV.

      $2000 - $1000 (50% rule) - $881 (P&i) = $119/month
      $75k/$119 = 630 months to recover the initial negative equity. This is 52.5 years.

      Let’s use OP’s $120k with $45k initial negative position.
      $2000 - $1000 - $704 (P&i) = $296/ month
      $45k/$296 = 152 months or 12,7 years to recover the initial equity.

      Building a single smal, unit is very expensive development.

      Here is a list of why adding a single ADU in single family zoned areas in my CA market is typically a poor RE investment:
      1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
      2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
      3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
      4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
      5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
      6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
      7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
      8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
      9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
      10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
      11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
      12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.

      Good luck

       @Dan H.

      Thanks for the thoughtful break-down, Dan! It's really helpful seeing all the numbers and you also raised some really good points that I'll need to further investigate. We're closer to Davis, CA and we have various acquaintances who are renting their attached ADUs for at least $2K a month. One of our friends is even getting close to $2,250 (Airbnb fees deducted) for his 350ft attached ADU (which doesn't even have a stove!).

      Other than purchasing a property with an ADU, it seems like an attached garage conversion is one of the more cost-friendly ways to go. Are there ever situations when you would support building an ADU for rental income? If so, what would that look like? We'll most likely stay in the home anywhere from 7-10 years. If we converted the garage to an ADU, that would allow for eventually 3 rentals on the property (Main house, 1 detached ADU, 1 attached ADU) which would incentivize holding onto the property even if we move out. I've already looked at the local codes and we don't need to live in one of the units to rent medium/long term.

      Curious to know what your thoughts are and if you would ever encourage ADU development for rental income. It gets harder and harder to find good deals out there which is why I've been lately hearing more about ADUs and the need to "build a good deal."

      Thanks in advance!

      1Reply
    • Dan H.Pro Member
      Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
      1y
      Quote from @Adam Watanabe:
      Quote from @Dan H.:
      Quote from @Bradley Buxton:

      @Adam Watanabe

      Converting a garage is not the best idea for the exit of a property. Many people still want garages for primary residences. By having a garage converted, you limit the value of the home and the buyer pool to investors. At 120k/2k that is 60 months or 5 years on the return. @Dan H. has some good insights on ADU conversions.
      Generally, it would be better to put the $120k towards the down payment of another property so you can gain the equity even if the cashflow is breakeven. 


      thanks for the tag.   To the OP, I regularly check ADU addition underwriting.  I encourage accurate and conservative underwriting.  On an ADU addition, the most important aspect of the underwriting is to KNOW the value that will be added by the ADU.  In the absence of sufficiently comps, expect a very poor valuation.  

      I suspect the cost to convert an 450' garage to an ADU will approach $150k. The issue is it will likely add ~$75k of value resulting in an initial negative $75k (a value subtract). This initial negative position needs to be recovered before any cash flow is obtained.

      I am also a bit skeptical that a 450’ unit can achieve $2k rent in Sacramento.

      Using 50% rule (expenses other than mortgage is 50%) on a financed ADU, 8% 30 your loan at 80% LTV.

      $2000 - $1000 (50% rule) - $881 (P&i) = $119/month
      $75k/$119 = 630 months to recover the initial negative equity. This is 52.5 years.

      Let’s use OP’s $120k with $45k initial negative position.
      $2000 - $1000 - $704 (P&i) = $296/ month
      $45k/$296 = 152 months or 12,7 years to recover the initial equity.

      Building a single smal, unit is very expensive development.

      Here is a list of why adding a single ADU in single family zoned areas in my CA market is typically a poor RE investment:
      1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
      2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
      3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
      4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
      5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
      6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
      7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
      8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
      9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
      10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
      11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
      12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.

      Good luck

       @Dan H.

      Thanks for the thoughtful break-down, Dan! It's really helpful seeing all the numbers and you also raised some really good points that I'll need to further investigate. We're closer to Davis, CA and we have various acquaintances who are renting their attached ADUs for at least $2K a month. One of our friends is even getting close to $2,250 (Airbnb fees deducted) for his 350ft attached ADU (which doesn't even have a stove!).

      Other than purchasing a property with an ADU, it seems like an attached garage conversion is one of the more cost-friendly ways to go. Are there ever situations when you would support building an ADU for rental income? If so, what would that look like? We'll most likely stay in the home anywhere from 7-10 years. If we converted the garage to an ADU, that would allow for eventually 3 rentals on the property (Main house, 1 detached ADU, 1 attached ADU) which would incentivize holding onto the property even if we move out. I've already looked at the local codes and we don't need to live in one of the units to rent medium/long term.

      Curious to know what your thoughts are and if you would ever encourage ADU development for rental income. It gets harder and harder to find good deals out there which is why I've been lately hearing more about ADUs and the need to "build a good deal."

      Thanks in advance!


      Is the $2k/month as an STR or LTR? STRs and MTRs are more work and have more expenses.

      if you are planning on adding a second ADU, is one a JADU? JADU in general lower the value of the property and require owner occupancy. If i is not a JADU, are you relying on a local ADU law?

      my wife has an acquaintance that adds ADUs in some of her OC coastal flips.  She only does this if she can find comps that show a valuation noticeably above her development cost (her ADU development costs are significantly lower than a non developer hands off ADU).  Note because she has her own development team, this is not a hands off ADU addition. Even with having her own development team, having the ADU add more than the cost of the addition  is an exception and not the normal.  Most flippers are not adding ADUs because even acting as GC the value added is typically less than the cost of the addition.

      In addition, if there are local laws that permit the addition of multiple ADUs, then it could be worth adding. The link i provided had the land provided by one of my protégés.  I suspect everyone will make money on that development but for sure my protege did well and has already exited (so even if it goes south, he has made his money). I am a partner on an effort that leverages San Diego rule that allows as many ADUs as desired to be converted from permitted space   The plan is to add 8 studio ADUs out of garage.  It seems like a good investment, but I fear I will lose money on this effort due to the hit in valuation of commercial MF.  Hopefully I am mistaken and I can get some profit.

      I agree RE investing is challenging at this time. However the large initial negative position and the other items I listed make adding an ADU typically a particularly poor investment. The ADU addition making the primary rent controlled (assuming more than 15 years old) can make LL more challenging (currently SFH are exempt from rent controlled state wide - Costa Hawkins).

      Make sure you know the value the ADU addition will add. Make sure you know the ramifications of adding an ADU. Make sure you understand the work involved and how the ADU addition will be financed.

      Good luck

      0Reply
    • Bruce WoodruffPro Member
      Contractor/Investor/Consultant · San Diego / Phoenix · Member since 2021 · 12k+ posts · 15k+ votes
      1y
      Quote from @Adam Watanabe:
      Quote from @Dan H.:
      Quote from @Bradley Buxton:

      @Adam Watanabe

      Converting a garage is not the best idea for the exit of a property. Many people still want garages for primary residences. By having a garage converted, you limit the value of the home and the buyer pool to investors. At 120k/2k that is 60 months or 5 years on the return. @Dan H. has some good insights on ADU conversions.
      Generally, it would be better to put the $120k towards the down payment of another property so you can gain the equity even if the cashflow is breakeven. 


      thanks for the tag.   To the OP, I regularly check ADU addition underwriting.  I encourage accurate and conservative underwriting.  On an ADU addition, the most important aspect of the underwriting is to KNOW the value that will be added by the ADU.  In the absence of sufficiently comps, expect a very poor valuation.  

      I suspect the cost to convert an 450' garage to an ADU will approach $150k. The issue is it will likely add ~$75k of value resulting in an initial negative $75k (a value subtract). This initial negative position needs to be recovered before any cash flow is obtained.

      I am also a bit skeptical that a 450’ unit can achieve $2k rent in Sacramento.

      Using 50% rule (expenses other than mortgage is 50%) on a financed ADU, 8% 30 your loan at 80% LTV.

      $2000 - $1000 (50% rule) - $881 (P&i) = $119/month
      $75k/$119 = 630 months to recover the initial negative equity. This is 52.5 years.

      Let’s use OP’s $120k with $45k initial negative position.
      $2000 - $1000 - $704 (P&i) = $296/ month
      $45k/$296 = 152 months or 12,7 years to recover the initial equity.

      Building a single smal, unit is very expensive development.

      Here is a list of why adding a single ADU in single family zoned areas in my CA market is typically a poor RE investment:
      1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
      2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
      3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
      4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
      5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
      6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
      7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
      8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
      9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
      10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
      11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
      12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.

      Good luck

       @Dan H.

      Thanks for the thoughtful break-down, Dan! It's really helpful seeing all the numbers and you also raised some really good points that I'll need to further investigate. We're closer to Davis, CA and we have various acquaintances who are renting their attached ADUs for at least $2K a month. One of our friends is even getting close to $2,250 (Airbnb fees deducted) for his 350ft attached ADU (which doesn't even have a stove!).

      Other than purchasing a property with an ADU, it seems like an attached garage conversion is one of the more cost-friendly ways to go. Are there ever situations when you would support building an ADU for rental income? If so, what would that look like? We'll most likely stay in the home anywhere from 7-10 years. If we converted the garage to an ADU, that would allow for eventually 3 rentals on the property (Main house, 1 detached ADU, 1 attached ADU) which would incentivize holding onto the property even if we move out. I've already looked at the local codes and we don't need to live in one of the units to rent medium/long term.

      Curious to know what your thoughts are and if you would ever encourage ADU development for rental income. It gets harder and harder to find good deals out there which is why I've been lately hearing more about ADUs and the need to "build a good deal."

      Thanks in advance!

      "it seems like an attached garage conversion is one of the more cost-friendly ways to go"

      Yes, in my research, I have found that if you choose to convert an attached garage, you eliminate the requirement for solar, and can keep existing setbacks, etc, etc......

      0Reply
    • Adam Watanabe
      OP
      Member since 2023 · 7 posts · 4 votes
      1y
      Quote from @Dan H.:
      Quote from @Adam Watanabe:
      Quote from @Dan H.:
      Quote from @Bradley Buxton:

      @Adam Watanabe

      Converting a garage is not the best idea for the exit of a property. Many people still want garages for primary residences. By having a garage converted, you limit the value of the home and the buyer pool to investors. At 120k/2k that is 60 months or 5 years on the return. @Dan H. has some good insights on ADU conversions.
      Generally, it would be better to put the $120k towards the down payment of another property so you can gain the equity even if the cashflow is breakeven. 


      thanks for the tag.   To the OP, I regularly check ADU addition underwriting.  I encourage accurate and conservative underwriting.  On an ADU addition, the most important aspect of the underwriting is to KNOW the value that will be added by the ADU.  In the absence of sufficiently comps, expect a very poor valuation.  

      I suspect the cost to convert an 450' garage to an ADU will approach $150k. The issue is it will likely add ~$75k of value resulting in an initial negative $75k (a value subtract). This initial negative position needs to be recovered before any cash flow is obtained.

      I am also a bit skeptical that a 450’ unit can achieve $2k rent in Sacramento.

      Using 50% rule (expenses other than mortgage is 50%) on a financed ADU, 8% 30 your loan at 80% LTV.

      $2000 - $1000 (50% rule) - $881 (P&i) = $119/month
      $75k/$119 = 630 months to recover the initial negative equity. This is 52.5 years.

      Let’s use OP’s $120k with $45k initial negative position.
      $2000 - $1000 - $704 (P&i) = $296/ month
      $45k/$296 = 152 months or 12,7 years to recover the initial equity.

      Building a single smal, unit is very expensive development.

      Here is a list of why adding a single ADU in single family zoned areas in my CA market is typically a poor RE investment:
      1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
      2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
      3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
      4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
      5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
      6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
      7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
      8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
      9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
      10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
      11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
      12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.

      Good luck

       @Dan H.

      Thanks for the thoughtful break-down, Dan! It's really helpful seeing all the numbers and you also raised some really good points that I'll need to further investigate. We're closer to Davis, CA and we have various acquaintances who are renting their attached ADUs for at least $2K a month. One of our friends is even getting close to $2,250 (Airbnb fees deducted) for his 350ft attached ADU (which doesn't even have a stove!).

      Other than purchasing a property with an ADU, it seems like an attached garage conversion is one of the more cost-friendly ways to go. Are there ever situations when you would support building an ADU for rental income? If so, what would that look like? We'll most likely stay in the home anywhere from 7-10 years. If we converted the garage to an ADU, that would allow for eventually 3 rentals on the property (Main house, 1 detached ADU, 1 attached ADU) which would incentivize holding onto the property even if we move out. I've already looked at the local codes and we don't need to live in one of the units to rent medium/long term.

      Curious to know what your thoughts are and if you would ever encourage ADU development for rental income. It gets harder and harder to find good deals out there which is why I've been lately hearing more about ADUs and the need to "build a good deal."

      Thanks in advance!


      Is the $2k/month as an STR or LTR? STRs and MTRs are more work and have more expenses.

      if you are planning on adding a second ADU, is one a JADU? JADU in general lower the value of the property and require owner occupancy. If i is not a JADU, are you relying on a local ADU law?

      my wife has an acquaintance that adds ADUs in some of her OC coastal flips.  She only does this if she can find comps that show a valuation noticeably above her development cost (her ADU development costs are significantly lower than a non developer hands off ADU).  Note because she has her own development team, this is not a hands off ADU addition. Even with having her own development team, having the ADU add more than the cost of the addition  is an exception and not the normal.  Most flippers are not adding ADUs because even acting as GC the value added is typically less than the cost of the addition.

      In addition, if there are local laws that permit the addition of multiple ADUs, then it could be worth adding. The link i provided had the land provided by one of my protégés.  I suspect everyone will make money on that development but for sure my protege did well and has already exited (so even if it goes south, he has made his money). I am a partner on an effort that leverages San Diego rule that allows as many ADUs as desired to be converted from permitted space   The plan is to add 8 studio ADUs out of garage.  It seems like a good investment, but I fear I will lose money on this effort due to the hit in valuation of commercial MF.  Hopefully I am mistaken and I can get some profit.

      I agree RE investing is challenging at this time. However the large initial negative position and the other items I listed make adding an ADU typically a particularly poor investment. The ADU addition making the primary rent controlled (assuming more than 15 years old) can make LL more challenging (currently SFH are exempt from rent controlled state wide - Costa Hawkins).

      Make sure you know the value the ADU addition will add. Make sure you know the ramifications of adding an ADU. Make sure you understand the work involved and how the ADU addition will be financed.

      Good luck


      The $2k/month is for MTR usually targeted towards traveling medical professionals on contract for a few months. With enough foresight and planning, there isn't usually large gaps of vacancy. 

      We already have a 600ft DADU in our backyard, and the conversion would be an attached 450ft ADU (sharing kitchen wall to main unit) with a separate entrance and furnished with full kitchen, bathroom, living space, etc. As you foreshadowed, I would be acting as the general contractor to manage the project and even taking on some of the work myself. I already checked with the city and we would be approved to add the second ADU since it would be attached. CA is on the forefront of ADUs and appraising them seems to provide at least 70-80% of the original investment. Hoping more down the line as popularity grows. I don't think there would be any issues selling the home in the future. MF is hot and properties in our area aren't on the MLS for long!

      As far as funding goes, I could pay for probably half with cash then would either need to get a loan or potentially borrow from 401K.

      Really appreciate your perspective and providing more considerations! Will continue to research and look into options.

      Adam

      0Reply
    • Dan H.Pro Member
      Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
      1y
      Quote from @Adam Watanabe:
      Quote from @Dan H.:
      Quote from @Adam Watanabe:
      Quote from @Dan H.:
      Quote from @Bradley Buxton:

      @Adam Watanabe

      Converting a garage is not the best idea for the exit of a property. Many people still want garages for primary residences. By having a garage converted, you limit the value of the home and the buyer pool to investors. At 120k/2k that is 60 months or 5 years on the return. @Dan H. has some good insights on ADU conversions.
      Generally, it would be better to put the $120k towards the down payment of another property so you can gain the equity even if the cashflow is breakeven. 


      thanks for the tag.   To the OP, I regularly check ADU addition underwriting.  I encourage accurate and conservative underwriting.  On an ADU addition, the most important aspect of the underwriting is to KNOW the value that will be added by the ADU.  In the absence of sufficiently comps, expect a very poor valuation.  

      I suspect the cost to convert an 450' garage to an ADU will approach $150k. The issue is it will likely add ~$75k of value resulting in an initial negative $75k (a value subtract). This initial negative position needs to be recovered before any cash flow is obtained.

      I am also a bit skeptical that a 450’ unit can achieve $2k rent in Sacramento.

      Using 50% rule (expenses other than mortgage is 50%) on a financed ADU, 8% 30 your loan at 80% LTV.

      $2000 - $1000 (50% rule) - $881 (P&i) = $119/month
      $75k/$119 = 630 months to recover the initial negative equity. This is 52.5 years.

      Let’s use OP’s $120k with $45k initial negative position.
      $2000 - $1000 - $704 (P&i) = $296/ month
      $45k/$296 = 152 months or 12,7 years to recover the initial equity.

      Building a single smal, unit is very expensive development.

      Here is a list of why adding a single ADU in single family zoned areas in my CA market is typically a poor RE investment:
      1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
      2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
      3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
      4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
      5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
      6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
      7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
      8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
      9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
      10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
      11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
      12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.

      Good luck

       @Dan H.

      Thanks for the thoughtful break-down, Dan! It's really helpful seeing all the numbers and you also raised some really good points that I'll need to further investigate. We're closer to Davis, CA and we have various acquaintances who are renting their attached ADUs for at least $2K a month. One of our friends is even getting close to $2,250 (Airbnb fees deducted) for his 350ft attached ADU (which doesn't even have a stove!).

      Other than purchasing a property with an ADU, it seems like an attached garage conversion is one of the more cost-friendly ways to go. Are there ever situations when you would support building an ADU for rental income? If so, what would that look like? We'll most likely stay in the home anywhere from 7-10 years. If we converted the garage to an ADU, that would allow for eventually 3 rentals on the property (Main house, 1 detached ADU, 1 attached ADU) which would incentivize holding onto the property even if we move out. I've already looked at the local codes and we don't need to live in one of the units to rent medium/long term.

      Curious to know what your thoughts are and if you would ever encourage ADU development for rental income. It gets harder and harder to find good deals out there which is why I've been lately hearing more about ADUs and the need to "build a good deal."

      Thanks in advance!


      Is the $2k/month as an STR or LTR? STRs and MTRs are more work and have more expenses.

      if you are planning on adding a second ADU, is one a JADU? JADU in general lower the value of the property and require owner occupancy. If i is not a JADU, are you relying on a local ADU law?

      my wife has an acquaintance that adds ADUs in some of her OC coastal flips.  She only does this if she can find comps that show a valuation noticeably above her development cost (her ADU development costs are significantly lower than a non developer hands off ADU).  Note because she has her own development team, this is not a hands off ADU addition. Even with having her own development team, having the ADU add more than the cost of the addition  is an exception and not the normal.  Most flippers are not adding ADUs because even acting as GC the value added is typically less than the cost of the addition.

      In addition, if there are local laws that permit the addition of multiple ADUs, then it could be worth adding. The link i provided had the land provided by one of my protégés.  I suspect everyone will make money on that development but for sure my protege did well and has already exited (so even if it goes south, he has made his money). I am a partner on an effort that leverages San Diego rule that allows as many ADUs as desired to be converted from permitted space   The plan is to add 8 studio ADUs out of garage.  It seems like a good investment, but I fear I will lose money on this effort due to the hit in valuation of commercial MF.  Hopefully I am mistaken and I can get some profit.

      I agree RE investing is challenging at this time. However the large initial negative position and the other items I listed make adding an ADU typically a particularly poor investment. The ADU addition making the primary rent controlled (assuming more than 15 years old) can make LL more challenging (currently SFH are exempt from rent controlled state wide - Costa Hawkins).

      Make sure you know the value the ADU addition will add. Make sure you know the ramifications of adding an ADU. Make sure you understand the work involved and how the ADU addition will be financed.

      Good luck


      The $2k/month is for MTR usually targeted towards traveling medical professionals on contract for a few months. With enough foresight and planning, there isn't usually large gaps of vacancy. 

      We already have a 600ft DADU in our backyard, and the conversion would be an attached 450ft ADU (sharing kitchen wall to main unit) with a separate entrance and furnished with full kitchen, bathroom, living space, etc. As you foreshadowed, I would be acting as the general contractor to manage the project and even taking on some of the work myself. I already checked with the city and we would be approved to add the second ADU since it would be attached. CA is on the forefront of ADUs and appraising them seems to provide at least 70-80% of the original investment. Hoping more down the line as popularity grows. I don't think there would be any issues selling the home in the future. MF is hot and properties in our area aren't on the MLS for long!

      As far as funding goes, I could pay for probably half with cash then would either need to get a loan or potentially borrow from 401K.

      Really appreciate your perspective and providing more considerations! Will continue to research and look into options.

      Adam


       >CA is on the forefront of ADUs and appraising them seems to provide at least 70-80% of the original investment.

      I do not know the source of your number but suspect it came from an ADU vendor. ADUs in southern Ca rarely get an appraised value as high as 70% of the hands off costs of a single ADU addition. I look at Southern CA ADU underwriting fairly regularly. I also go to RE meet ups where ADU appraisals are discussed. Do you have a mortgage broker? Ask where they are seeing appraisals of ADU valuations. Yours not being hands off will have a lower addition cost depending on how much work you do and how good you are at managing the effort. This makes it difficult to have an expectation on valuation to addition costs.

      >Hoping more down the line as popularity grows. 

      I have been hearing this from ADU vendors since they became legal statewide. here is things to consider 1) it has been 10 years since ADUs were allowed statewide (SB1069) and longer in many jurisdictions 2) building a single, small unit is the most expensive residential development and even more so when built by the consumer. There is no reason, despite what ADU vendors might say, to believe the ADU valuations will change significantly with more time. I do not know how long ADU vendors expect it to take but apparently more than 10 years.

      in addition, are you sure the ADU being added is not classified as a JADU? Statewide a lot can have one ADU and one JADU but jurisdictions can allow more (they cannot allow less). JADU are virtually worthless at appraisal due to OO requirement. make sure it is not a JADU being added.

      Good luck

      0Reply
    • Scott ScovilleBusiness Member
      Real Estate Agent · Sacramento, CA · Member since 2019 · 497 posts · 272 votes
      1y
      Quote from @Dan H.:
      Quote from @Adam Watanabe:
      Quote from @Dan H.:
      Quote from @Adam Watanabe:
      Quote from @Dan H.:
      Quote from @Bradley Buxton:

      @Adam Watanabe

      Converting a garage is not the best idea for the exit of a property. Many people still want garages for primary residences. By having a garage converted, you limit the value of the home and the buyer pool to investors. At 120k/2k that is 60 months or 5 years on the return. @Dan H. has some good insights on ADU conversions.
      Generally, it would be better to put the $120k towards the down payment of another property so you can gain the equity even if the cashflow is breakeven. 


      thanks for the tag.   To the OP, I regularly check ADU addition underwriting.  I encourage accurate and conservative underwriting.  On an ADU addition, the most important aspect of the underwriting is to KNOW the value that will be added by the ADU.  In the absence of sufficiently comps, expect a very poor valuation.  

      I suspect the cost to convert an 450' garage to an ADU will approach $150k. The issue is it will likely add ~$75k of value resulting in an initial negative $75k (a value subtract). This initial negative position needs to be recovered before any cash flow is obtained.

      I am also a bit skeptical that a 450’ unit can achieve $2k rent in Sacramento.

      Using 50% rule (expenses other than mortgage is 50%) on a financed ADU, 8% 30 your loan at 80% LTV.

      $2000 - $1000 (50% rule) - $881 (P&i) = $119/month
      $75k/$119 = 630 months to recover the initial negative equity. This is 52.5 years.

      Let’s use OP’s $120k with $45k initial negative position.
      $2000 - $1000 - $704 (P&i) = $296/ month
      $45k/$296 = 152 months or 12,7 years to recover the initial equity.

      Building a single smal, unit is very expensive development.

      Here is a list of why adding a single ADU in single family zoned areas in my CA market is typically a poor RE investment:
      1) The value added by the ADU addition is often significantly less than the cost of adding the ADU. Search the BP for ADU appraisals to encounter numerous examples. This creates a negative initial position. This negative position can consume years of cash flow to recover. Make sure you know the value the ADU will add to the property before building the ADU.
      2) the financing on an ADU is typically far worse than for initial investment property acquisition or is often not leveraged by the ADU (HELOC, cash out refi, etc). Leverage magnifies return.
      3) The effort involved in adding an ADU is comparable or larger than a rehab associated with a BRRRR. However if I do a BRRRR I can achieve infinite return by extracting all of my investment. Due to item 1, adding an ADU can require years to start achieving any return (once the accumulated cash flow recovers the initial negative position).
      4) Adding an ADU is a slow process. It can take a year or more to complete an ADU. During this time you are not generating any return from the money invested in the ADU. This amounts to lost opportunity because if you had purchased RE, at the closing it can start producing return.
      5) ADUs detract from the existing structure whether this is privacy, a garage, or just yard space.
      6) this is related to number 1, but there are many more buyers looking to purchase homes for their family than there are RE investors looking to purchase small unit count properties. This may affect value or time required to sell.
      7) Adding an ADU does not make the property a duplex. For example in many jurisdictions I can STR units in a duplex but cannot STR an ADU (some jurisdictions will let you STR if you owner occupy). Duplex have different zoning that may permit additional units. Duplex can always add additional units via the ADU laws.
      8) Related to number 1, purchasing a property with an existing ADU is cheaper than buying a property and adding an ADU. Why add an ADU if it can be purchased cheaper?
      9) adding multiple ADUs or adding an ADU to a quad looses F/F conventional financing. This reduces exit options and affects the value.
      10) Small number of small units is the most expensive residential development there is. This implies residential units can be built at lower costs and provide better return than building a single ADU.
      11) adding an ADU to SFH can make the SFH fall under rent control. In CA currently only MF properties are rent controlled. If the house is older than 15 years old and an ADU is added, it can become rent controlled. Rent control laws are market specific. Make sure you know the impact that adding an ADU will have on any rent control.
      12) investors seldom include the land value in the overall ADU costs. The reality is the land has value.

      Good luck

       @Dan H.

      Thanks for the thoughtful break-down, Dan! It's really helpful seeing all the numbers and you also raised some really good points that I'll need to further investigate. We're closer to Davis, CA and we have various acquaintances who are renting their attached ADUs for at least $2K a month. One of our friends is even getting close to $2,250 (Airbnb fees deducted) for his 350ft attached ADU (which doesn't even have a stove!).

      Other than purchasing a property with an ADU, it seems like an attached garage conversion is one of the more cost-friendly ways to go. Are there ever situations when you would support building an ADU for rental income? If so, what would that look like? We'll most likely stay in the home anywhere from 7-10 years. If we converted the garage to an ADU, that would allow for eventually 3 rentals on the property (Main house, 1 detached ADU, 1 attached ADU) which would incentivize holding onto the property even if we move out. I've already looked at the local codes and we don't need to live in one of the units to rent medium/long term.

      Curious to know what your thoughts are and if you would ever encourage ADU development for rental income. It gets harder and harder to find good deals out there which is why I've been lately hearing more about ADUs and the need to "build a good deal."

      Thanks in advance!


      Is the $2k/month as an STR or LTR? STRs and MTRs are more work and have more expenses.

      if you are planning on adding a second ADU, is one a JADU? JADU in general lower the value of the property and require owner occupancy. If i is not a JADU, are you relying on a local ADU law?

      my wife has an acquaintance that adds ADUs in some of her OC coastal flips.  She only does this if she can find comps that show a valuation noticeably above her development cost (her ADU development costs are significantly lower than a non developer hands off ADU).  Note because she has her own development team, this is not a hands off ADU addition. Even with having her own development team, having the ADU add more than the cost of the addition  is an exception and not the normal.  Most flippers are not adding ADUs because even acting as GC the value added is typically less than the cost of the addition.

      In addition, if there are local laws that permit the addition of multiple ADUs, then it could be worth adding. The link i provided had the land provided by one of my protégés.  I suspect everyone will make money on that development but for sure my protege did well and has already exited (so even if it goes south, he has made his money). I am a partner on an effort that leverages San Diego rule that allows as many ADUs as desired to be converted from permitted space   The plan is to add 8 studio ADUs out of garage.  It seems like a good investment, but I fear I will lose money on this effort due to the hit in valuation of commercial MF.  Hopefully I am mistaken and I can get some profit.

      I agree RE investing is challenging at this time. However the large initial negative position and the other items I listed make adding an ADU typically a particularly poor investment. The ADU addition making the primary rent controlled (assuming more than 15 years old) can make LL more challenging (currently SFH are exempt from rent controlled state wide - Costa Hawkins).

      Make sure you know the value the ADU addition will add. Make sure you know the ramifications of adding an ADU. Make sure you understand the work involved and how the ADU addition will be financed.

      Good luck


      The $2k/month is for MTR usually targeted towards traveling medical professionals on contract for a few months. With enough foresight and planning, there isn't usually large gaps of vacancy. 

      We already have a 600ft DADU in our backyard, and the conversion would be an attached 450ft ADU (sharing kitchen wall to main unit) with a separate entrance and furnished with full kitchen, bathroom, living space, etc. As you foreshadowed, I would be acting as the general contractor to manage the project and even taking on some of the work myself. I already checked with the city and we would be approved to add the second ADU since it would be attached. CA is on the forefront of ADUs and appraising them seems to provide at least 70-80% of the original investment. Hoping more down the line as popularity grows. I don't think there would be any issues selling the home in the future. MF is hot and properties in our area aren't on the MLS for long!

      As far as funding goes, I could pay for probably half with cash then would either need to get a loan or potentially borrow from 401K.

      Really appreciate your perspective and providing more considerations! Will continue to research and look into options.

      Adam


       >CA is on the forefront of ADUs and appraising them seems to provide at least 70-80% of the original investment.

      I do not know the source of your number but suspect it came from an ADU vendor. ADUs in southern Ca rarely get an appraised value as high as 70% of the hands off costs of a single ADU addition. I look at Southern CA ADU underwriting fairly regularly. I also go to RE meet ups where ADU appraisals are discussed. Do you have a mortgage broker? Ask where they are seeing appraisals of ADU valuations. Yours not being hands off will have a lower addition cost depending on how much work you do and how good you are at managing the effort. This makes it difficult to have an expectation on valuation to addition costs.

      >Hoping more down the line as popularity grows. 

      I have been hearing this from ADU vendors since they became legal statewide. here is things to consider 1) it has been 10 years since ADUs were allowed statewide (SB1069) and longer in many jurisdictions 2) building a single, small unit is the most expensive residential development and even more so when built by the consumer. There is no reason, despite what ADU vendors might say, to believe the ADU valuations will change significantly with more time. I do not know how long ADU vendors expect it to take but apparently more than 10 years.

      in addition, are you sure the ADU being added is not classified as a JADU? Statewide a lot can have one ADU and one JADU but jurisdictions can allow more (they cannot allow less). JADU are virtually worthless at appraisal due to OO requirement. make sure it is not a JADU being added.

      Good luck

      @Dan H. yeah, agree. Even with the increase in ADU's, theirs a lack of comparables in most areas and the appraisals are coming in lower than what most homeowners are expecting. If you're looking for forced appreciation, I don't think an ADU is the best dollar for dollar approach. I have multiple ADU's and they are strictly cash flow plays.

      [email protected]415-933-2202
      Scoville Realty & Investments LLC
      WebsiteView Page
      0Reply
  • Michael SmytheBusiness Member
    Real Estate Agent · Metro Detroit · Member since 2023 · 4k+ posts · 3k+ votes
    1y

    @Adam Watanabe

    Recommend you first figure out the property Class you want to invest in, THEN figure out the corresponding location to invest in.

    Why is Property Class so important for investors to understand and apply in their investing strategies?

    Because the Property Class dictates the Class of the tenant pool that the property will attract.

    The Tenant Class greatly impacts rental income stability and property maintenance/damage by tenants.

    Both Property Class and Tenant Class affect what type of contractors, handymen and property management companies will work on a property.

    If you buy & renovate a property in Class D area to Class A standards, what Tenant Class will rent it?

    Or, if you put several Class D tenants in a Class A four-plex, what do you think will happen to the property?

    So, if you fail to apply the correct assumptions to a property, your expectations won’t be met and it may even be a financial disaster.

    We use the following to rank Property Classes, in order of importance:

    • Property Tenant Pool: closely linked to location, but not always.
    • Property Location: closely linked to tenant pool, but not always.
    • Property Condition & Amenities: it’s important to, “Maintain to the Neighborhood.”

    Key metrics for each Property Class:

    Class A Properties:
    Tenant Pool: Majority of FICO scores 680+, no convictions/evictions in last 7 years.
    Tenant Default: 0-5% probability of eviction or early lease termination.
    Section 8: Class A rents are too high and won’t be approved.
    Vacancies: 5-10%, depending on market conditions.
    Cashflow vs Appreciation: Typically, 3-5 years for positive cashflow, but you get highest relative rent & value appreciation.

    Class B Properties:
    Tenant Pool: Majority of FICO scores 620-680, some blemishes, no convictions/evictions in last 5 years.
    Tenant Default    : 5-10% probability of eviction or early lease termination.
    Vacancies    : 10-15%, depending on market conditions.
    Cashflow vs Appreciation: Typically, 1-3 years for positive cashflow, balanced amounts of relative rent & value appreciation.
    Section 8: Class B rents are usually too high for the Section 8 program.

    Class C Properties:
    Tenant Pool: Majority of FICO scores 560-620, many blemishes, but should have no convictions/evictions in last 3 years. Verifying recent 2-years of rental history very important! Same for 2-years of job/income stability.
    Tenant Default: 10-20% probability of eviction or early lease termination.
    Section 8: Class C rents usually meet program requirements, proper screening still recommended.
    Vacancies: 10-20%, depending on market conditions and tenant screening.
    Cashflow vs Appreciation: Should cashflow immediately, at the lower end of relative rent & value appreciation.

    Class D Properties:
    Tenant Pool: Majority of FICO scores under 560, little to no good tradelines, lots of collections & chargeoffs, but should have no convictions/evictions in last 12 months. Verifying last 2-years of rental history and income/employment extremely important to find the “best of the worst”.
    Tenant Default: 20-30% probability of eviction or early lease termination.

    Section 8: Class D rents meet program requirements, often challenges to pass Section 8 inspection.
    Vacancies: 20%+, depending on market conditions and tenant screening.
    Cashflow vs Appreciation: Typically, all cashflow with little, maybe even negative, relative rent & value appreciation.

    Where did we get our FICO credit score information from?

    Check out this chart:

    FICO Score

    Pct of Population

    Default Probability

    800 or more

    13.00%

    1.00%

    750-799

    27.00%

    1.00%

    700-749

    18.00%

    4.40%

    650-699

    15.00%

    8.90%

    600-649

    12.00%

    15.80%

    550-599

    8.00%

    22.50%

    500-549

    5.00%

    28.40%

    Less than 499

    2.00%

    41.00%

    Source: Fair Isaac Company

    Make sure you understand the Class of properties you are looking at and the corresponding results to expect.

    Metro Detroit has 132 cities, the City of Detroit 183 Neighborhoods, which we’re analyzing and classifying. Check out the map on our website where we’ve made this all easy to follow.

    We can also share numerous examples of properties & portfolios we’ve assisted investors with!

    DM us if you’d like to discuss this logical approach in greater detail!

    Logical Property Management4.9446 Reviews
    WebsiteView Page
    1Reply
  • Andrew SyriosPro Member
    Moderator
    Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes
    1y

    I think with detached garages that are relatively far away from the main house, this definitely makes sense. (Especially if the house also has an attached garage as people like having garages of course). If it's right next door or really small, probably not. 

    Also it needs to be a good structure and not some jury-rigged thing that's more like a glorified shed as many detached garages are. In that case, you might as well just build a new structure which is usually probably not worth it. 

    Podcast Guest on Show #121
    0Reply
  • Bruce WoodruffPro Member
    Contractor/Investor/Consultant · San Diego / Phoenix · Member since 2021 · 12k+ posts · 15k+ votes
    1y

    Before you evven think more about converting the garage...... go and talk to the City Planning Dept about it. Be totally honest about your intent. There may be some regulations that will make it too difficult to even consider.

    Although I believe California is making it much easier to do now. They have an ill-conceived notion that it will solve the perceived 'housing crisis', Lol....

    1Reply
  • Brian Larson
    Investor · San Jose, CA · Member since 2018 · 313 posts · 230 votes
    1y

    @Adam Watanabe

    The idea of an ADU might make sense in Sacramento but it would depend on where this property is located. Is it in a trendy downtown place with lots of renters (i.e. Midtown, Land Park, Curtis Park, Tahoe Park, etc.)? If so, then I might consider it.

    Also, are you certain about the conversion costs?  How many contractors have you spoken with?  Do you know what plans and permits will cost?  You should probably do more research and maybe find some local people in Sacramento that have ADUs to get advice.

    Many of the people above are from out-of-state (OOS) so they don't understand all the rules in California or Sacramento. Sacramento is an ADU-friendly city so I would not be concerned about the city approving your conversion.

    1Reply
    • Adam Watanabe
      OP
      Member since 2023 · 7 posts · 4 votes
      1y
      Quote from @Brian Larson:

      @Adam Watanabe

      The idea of an ADU might make sense in Sacramento but it would depend on where this property is located. Is it in a trendy downtown place with lots of renters (i.e. Midtown, Land Park, Curtis Park, Tahoe Park, etc.)? If so, then I might consider it.

      Also, are you certain about the conversion costs?  How many contractors have you spoken with?  Do you know what plans and permits will cost?  You should probably do more research and maybe find some local people in Sacramento that have ADUs to get advice.

      Many of the people above are from out-of-state (OOS) so they don't understand all the rules in California or Sacramento. Sacramento is an ADU-friendly city so I would not be concerned about the city approving your conversion.

       @Brian Larson

      Hi Brian, 

      We're close to the Woodland/Davis area so there are a lot of traveling medical professionals with contracts that rent in our area. I've done some research and have connected with a handful of designers and contractors. I would also take on some of the work myself (demolition, flooring, painting, cabinets, etc.) and am factoring that in as well. I've checked with the city and they said I would be approved to convert my garage to ADU. Some other positive info:
      - Already have plumbing and electricity in the garage
      - According to the designer, the garage is already in a good state to convert
      - I can rent the units while not living on the property
      - Street parking for tenants is acceptable
      - After researching other ADUs renting, I'm pretty sure I could get around 2K a month

      Thanks for your thoughtful message and I'll continue doing my research. Please let me know if you have any other thoughts around this!

      0Reply
  • Jaron WallingPro Member
    Rental Property Investor · Indianapolis, IN · Member since 2018 · 4k+ posts · 4k+ votes
    1y

    @Dan H. Really enjoyed your post about ADUs. 

    I recently went down the rabbit researching the costs to build an ADU because I found one around the corner from our rental. I believe it was built without permits. Nothing on the county property record shows the ADU in the backyard. I think they even built it them self's.

    I found a contractor that builds 650 sqft. ADUs for about $170k which is inline with your cost estimate. That's more than SFH sell for in our target neighborhoods. Your post hammered home the fact that it's a terrible investment in my market. In a perfect world we could rebuild a garage and construct and ADU, adding rental income, and providing additional housing. In real life I can't see that happening. We don't even have progressive zoning and building codes in our market. You never see them built on older lots. It's always new builds with big lots ($400k+). It's marketed as an in-law suite or house-hack opportunity for the buyer.

    0Reply
  • Scott ScovilleBusiness Member
    Real Estate Agent · Sacramento, CA · Member since 2019 · 497 posts · 272 votes
    1y

    Hey Adam, looks like you have some great options. It really depends on your goals. ADU builds are great, but you may not get the dollar for dollar value on an ADU conversion. But if it's cash flow you're looking for, it's a good option. If you're looking for appreciation and some cash flow, look small multi family or spread out your cash and buy a few value add SFH's. I'm an investor and agent in Sacramento. Be happy to chat about this anytime.

    [email protected]415-933-2202
    Scoville Realty & Investments LLC
    WebsiteView Page
    0Reply
  • Dan H.Pro Member
    Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
    1y

    @Adam Watanabe

    Are you aware that 2 ADUs excludes the use of conventional (Fannie/freddie (f/f)) financing?   The loss of conventional financing will negatively affect the valuation.   

    Not eligible for conventional residential financing

    - multiple ADUs

    - ADU added to a quad

    Make sure you are aware of the impacts of adding a second ADU.

    Good luck

    0Reply
    • Adam Watanabe
      OP
      Member since 2023 · 7 posts · 4 votes
      1y
      Quote from @Dan H.:

      @Adam Watanabe

      Are you aware that 2 ADUs excludes the use of conventional (Fannie/freddie (f/f)) financing?   The loss of conventional financing will negatively affect the valuation.   

      Not eligible for conventional residential financing

      - multiple ADUs

      - ADU added to a quad

      Make sure you are aware of the impacts of adding a second ADU.

      Good luck


      I just found this out, and it's definitely something to consider. Appreciate all of your insights, Dan!

      1Reply
  • Kristi KandelPro Member
    Developer · Fort Myers Beach, FL · Member since 2018 · 383 posts · 195 votes
    1y
    Quote from @Adam Watanabe:

    Hi there! My wife and I recently purchased a single family home with a detached ADU outside the Sacramento, CA area. We just started medium-term renting the ADU through Furnished Finder and it's been an incredible experience. We barely notice our tenant and his rent covers about half of our mortgage. You might say I'm a little hooked and am considering other real estate investments. One idea would be to convert our attached 450 sq ft garage into an ADU to rent. It would cost around $100-120K and could rent for around $2K a month. This would be nearing the 2% rule which seems pretty good especially in today's market. Not to mention, we would be building equity into our house and it would cover the other half of the mortgage.

    The other option would be to look for a property to purchase out of state to BRRRR. I would most likely try to find a multi-family to update, then hire a property manager to takeover. I wouldn't get near the rate of return as I would on the ADU, but I would be diversifying my housing investments.

    Thoughts and comments would be much appreciated. Thank you!

     @Adam Watanabe I finished converting a garage that the seller got halfway. It's a cash cow and I intend on keeping the property for a long time. That being said, the way I set it up was that a future buyer could fairly easily turn it back into a SFH (no garage but easily just a larger home). One downside is that no matter house much insulation, carpets with pads, furring walls out more, etc. we do you're going to hear your neighbors to some extent. I love house hacking so I wouldn't take it back but something to consider.

    0Reply
    • Adam Watanabe
      OP
      Member since 2023 · 7 posts · 4 votes
      1y

      @Kristi Kandel 

      Glad to hear the conversation has been working out for you! That rental cash flow is so nice. Appreciate you sharing your experience. Sounds like you thought about the long term impact of the conversion as well. Smart!

      0Reply
  • Brian Larson
    Investor · San Jose, CA · Member since 2018 · 313 posts · 230 votes
    1y

    @Adam Watanabe

    It sounds like you are doing all the right things.  I'd talk to to some more contractors though.

    Also, it sounds like you have some local designers/architects but if you are still looking talk to @Adam Mayberry - I have personally used him for ADU design in the past and he is great.

    Best of luck with your project.

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