Should I used equity to build a rental unit in my backyard?

Question

I have 60k in equity in my house. Im thinking of building a 2 bedroom 1000sq foot guest house and renting it out. Is this a good idea?

Albert Bui · Answer

It depends Andre, whats the estimated soft and hard costs to build this ADU/MIL unit in the backyard for 1000 sqft with 2bd/1ba ?

How I look at it quickly is if I can make 1.25-1.5% in gross rents per month (1.25-1.50% rule) based on the total anticipated cost of the construction (survey, permits, arch, const.,etc). This is a quick rule of thumb and there are other factors but generally if you can hit this you'll be able to refinance your original funds you spend back completely and still cashflow pretty well.

Dan K. · Answer

Hi @Andre Oakley, as @Lien Vuong mentioned, I am doing something similar. I have a multifamily and am converting 4 garages into an apartment.

Before paying professionals for help, look into zoning regulations in your area and find out what's allowed. You need to think about setbacks, how close you're allowed to build to your current structure, FAR for the property and how many dwelling units you can have on a lot that is your size. It's not fun homework, but that's my 2 cents.

Lien Vuong · Answer

That's fantastic that you have $60k of equity but have you figured out what you can actually pull out of it? It's not typically 100%. Additionally, a new structure is going to cost you more than that to build just for construction let alone permitting and plans.

I understand the value of that in terms of creating cash flow and adding to your property's future value but it definitely has to be a calculated risk. What is the timeframe it is going to take for construction? Do you have time in your schedule to manage a project like that? When would be your break even? When are you making back your money for buildings costs?

I think @Dan K. can speak more about this as he is adding a unit himself.

Wesley Davis · Answer

It depends on your goals.  I will tell you that in my house we turned the basement into a mother-in-law apartment and are renting it out.  We used equity in the house to do it as well.  The income is really nice, but we also have an amazing tenant so we have never had issues in 2 years he's been here.  I don't know what your state laws are, but whenever he moves out we are going to airbnb it.  I would try airbnb personally, they can make a lot of money (get you're 60k back faster), but has the potential for a little more headaches from what I've been told.