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Posted about 3 years ago

The Cashflow of ADUs in California

Normal 1611895376 Pexels Josh Hild 2801312

You may be asking yourself if you do not live in California, what is an ADU, well, it’s short for Accessory Dwelling Unit. They have been gaining more popularity since California Legislature enacted some laws in 2017 to allow homeowners to build a second unit on their own property due to the housing crisis we have in California. The California government wanted to provide more housing to people by giving homeowners the option to build on their own parcel. ADUs provide cashflow for California homeowners and investors that eclipse the income a person would get one just SFR rental.

History of California ADUs

Here is some information to get everyone caught up to where we are today with the ADU evolution. Back in 2017 the state officials create laws to allow current primary homeowners to build a second unit on their property by converting an existing garage, existing structure, or building from ground up. The reason for this was to create more housing for people due to the impact that California has felt by the low housing availability for the demand of people, and the lack of space that California has for houses. This new law allowed primary homeowners to build a place for their aging family who could live for free or for a smaller cost then buying something existing. It also created a break for the investors that have properties and wanted to rent out a whole other house in their backyard for cash to cover some of their mortgage.

Fast forward to 2020, the State of California changed the laws to providing the ability for any homeowner, owner occupied to non-owner occupied to build a ground up ADU build on their property. It created the ability for real estate investors that have a rental, or a multifamily investment to be able to build an ADU, convert an existing garage to an ADU, and build a Junior ADU on the property which forms three units on one lot. This is a massive change for those people looking to perform a value-add investment in a state that people say does not have any ability to cashflow.

The ADU and conversions have some restrictions to size and setbacks (distance between the property line and the structure). The lot size of the property is not a factor anymore as of 2020, and you can even convert a garage with no restrictions on cities making the owner add parking to the property. The parking standard was taken away and before 2020 the property needed to provide the additional parking for any parking spots that were taken away due to the ADU building.

Normal 1611895450 Pexels Tina Nord 816377

Why is this a California SFR Investment a Game Changer

As investors look for value add to a property including myself, there are many different ways to provide this with the ADU addition to the legislature. Everyone talks about not being able to cashflow properties in California, well now the flood gates have opened for the ability to do this as an average joe investor that wants to stay within the state to get their cashflow.

ADUs and Junior ADUs (JADUs) can create the income you need to get that cashflow coming in that no one has been able to do with a random SFR investments. The reason is that the house will go up in value even if you bought the home at market value, and that is because you can add just one ADU which turns the property into a duplex instantly. Before 2017 there were fewer ways to value add a property, which could be buying a SFR and then taking it down to build a new house or looking a long time to buy that property that is zoned different that a normal SFR is built on.

Imagine buying a rental property before ADUs, and the rental value was $2200.00 and your mortgage with 25% down was $1950 with property taxes and insurance, that does not include cap ex, maintenance, or property management. Well, you would be in what we call a negative cashflow situation which is what a lot of properties were back before 2017 without the ADU law change. Now you can buy that same property add just one unit that is a 2bed/1bath and add $1,500 plus to your income and be cash flowing $500-$750 a month after all expenses. These numbers need to include building costs too, so make sure you add those into the formula.

In the past many people would always just say one of two things, there is nothing that cash flows in California, or we have to wait for the market to drop to get something in California to cashflow. It’s not true anymore even to the people that do not have a source for off market properties that come every now and then.

What’s the catch on the ADU Craze

More people have started to pick up on the advantage of ADUs, this is especially true the cities in the extremely congested areas for instances Los Angeles or San Francisco. This was the main focus for the lawmakers and where the biggest impact would be seen. Now that they have loosened regulation on the laws for properties and building ADUs there have been an immense increase in people using this to their advantage with some drawbacks that can be expected.

The laws have loosened and forced cities to amend their once corrected ADU laws to conform to the State of California standards. As these cities try to catch up with the only 1 year old change, there have been delays for two story ADUs to be approved even with cities that have no laws that state they do not allow the two story ADU. These cities drag their feet to get the permits approved until it’s unbearable for the owner to keep paying the high fees of the debt to make that value-add improvement.

The other downfall is the price of the ground up build and the converted garage, or the JADU. In the areas of lower price points, the price per square foot is $200-$250, and the higher end markets are $225-$275 price per square foot. That can be very expensive anywhere from $160,000 to $220,000 if you are building ground up, or if you are converting the prices are a little less. This does not factor in the costs for architectural costs, structural engineering costs, and plan submission with plan checks.

Another drawback would be the delays from the city and the contractors that you pick for the build. The reason this is a challenge is because cities are notoriously slow at approving plans, and now with this year on the heels of COVID it has slowed the approval process down even more. The contractors that have been working on ADUs also have many other projects going on, which has created delays for the completion of the build as well.

Why Should You Still Buy a Home and Use the ADU Model

All the above is telling you as an investor, is that you need to run the numbers as you are supposed to on every single project, and investment. Make sure that the numbers work after you buy the property and do all the work to it. Do the due diligence on the property and the city as well prior to buying or starting a project. The property needs to cashflow, and you need to make sure the investment is a good one going into the deal.

You can BRRRR the deal if the numbers work, and that will get your money out of the property from what you put in on the property. That means at the purchase price, you’ll need to factor the cost of down payment, construction costs, time delays that are worked into the deal, and what the ARV price will be on the property. Even at a lot of market values for the properties these accessory dwelling units are creating a higher appraisal value due to the second unit added.

The best reason why, is that it cashflows in California, while buying at market value, and you can BRRRR it all in one! You do not have to leave the state to find these deals! I want to stay within California and continue to invest, and there is nothing that intrigues me to leave the state right now with real estate investing, and this really gives the opportunity to all investors that feel the same way.

Conclusion

I am here letting you know that this can actually happen for you, which is not a far distant dream, it’s a true north star to invest correctly within California and not leave if you do not want to. There are a lot more moving parts from just buying a rental and that is it; however, if it was easy everyone would be out doing this strategy and then we would have to go find another option that would be a great investment. It’s the classic find an opportunity and go all in until it’s full by the masses then move to another sector.



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