Sacramento garage conversion worth it?

Question

Hey BP community,

I own a property in the Tallac Village neighborhood of Sacramento. I'm considering converting my detached 400 sq ft garage into a legal ADU so I can live in it and rent out the main house. I am overwhelmed dealing with contractors as I am going about this alone with a full time corporate job. I've contacted a couple adu companies and their pricing is up there.

I want to make sure this isn’t a case of overspending for limited upside. Any advice or lessons learned would be hugely appreciated!

Thanks in advance 🙏

Rick Albert · Answer

It is all about opportunity costs.

The advantage is easier to manage with a second unit on the lot. But an argument could be made that you could take that $150K (or however much it costs) and reinvest in a different house hack. Are there properties with ADUs already built? If so, I would consider that route. Live in the new ADU, rent out the main house and rent out your previous residence. You used the same case and now have triple the doors with two properties appreciating, loan buy down, tax benefits, and cash flow. You scale faster.

Scott Scoville · Answer

Hey Chelsea, we've converted garages and also built new ADU's. Tallac Village is a great spot, I have a rental over on 62nd St. Happy to jump on a call and answer any questions.

Scott Scoville · Answer

Just DM'd you.

Chelsea Jeffers · Answer

I appreciate that response. All of that makes total sense. The garage conversion was mainly started to create a space for me to live so I can rent out the main house so I am not carrying the mortgage alone and don’t have to resort to renting and paying someone else’s mortgage.

I do however hope that property values in this area will increase over time as I see a lot of growth in my area and diverse quality of housing on my street and surrounding streets. I have an appointment with an appraiser to provide a before and after in order for me to have a clearer picture of the position I am putting myself in. I just wanting to be sure I am heading in the right direction.

Dan H. · Answer

>I do however hope that property values in this area will increase over time as I see a lot of growth in my area and diverse quality of housing on my street and surrounding streets. Sacramento appreciation has been quite good.  If it continues and you use leverage to multiply the return from appreciation, it should result in a good return for a long hold.  According to neighborhoodscout, Sacramento residential values has increased 264% for this century (9 out of 10 nationally).  Your market has historically done very well.   I suspect it will continue to do well on a long term basis.https://www.neighborhoodscout.com/ca/sacramento/real-estate. Good luck

Dan H. · Answer

In most CA markets the valuation of the ADU creates a negative equity position.   Per NAR data (Nov 2021) the average property with an ADU sold for $75k more than the average price of properties without an ADU.   In my San Diego market hands off garage conversions are ~$150k depending on various things.   With lower grade finishes and other budget conscious decisions you can get a little lower.  On the opposite, it can be quite a bit more expensive.  If I add 15% to the ADU valuation for it being almost 4 years old it is $85.5k.   Basically a $65k negative initial position.  https://www.nar.realtor/magazine/real-estate-news/study-adus...As you noted, adding an ADU is a lot of effort, but there are additional reasons that an ADU addition is not an optimal RE investment.  Note you existing home becomes rent controlled if it is over 15 years old (which I am confident was not the intent of senator Weinstein and the 15 year exempt limit).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