All Forum Posts by: Dan H.

Have you talked with a lender?   Long ago when I moved from an owner occupied and converted it to a rental, by showing a rental lease agreement the lender included a percentage of the rent toward my income.   This may allow you to qualify for a new loan and keep your current loans.  A good lender may have other suggestions.

I looked at underwriting from a Rock Star STR hostess last night. One option she was looking at was 11% HML. Seems terrible, but she is so good at STR income versus property cost (and already has a STR in same area that is much smaller that she is getting great income) that she still projected a good return. Note I do not have the illusion that I can match her income in that market, she appears to be exceptional in her niche.

My point with the above rockstar, the interest rate has to be compared with the expected income.   Paying higher rate to produce high income can be the smarter choice over a low interest rate that is producing minimum return on investment.  

If you find a good enough deal, you can find a financial partner.. Financial partner will expect a high equity position.  Most investors underestimate how much equity the financial partner will desire, but 1) they have virtually all the risk 2) there are a lot of investment options for those with capital.  3) you experience is on the light side.   The most favorable financial partners will be family and friends.

good luck

I have not yet purchased my tickets but plan on being there maybe with my 22 year old son who is getting into RE.

I really enjoyed the last one in Cancun.  I fear Vegas will be larger than I like (Orlando was larger than I liked.  San Diego was very good size).

I hope you enjoy BPCon and find it rewarding.  

Quote from @Bol Oke:

The the door is in the second floor and opens to the deck. The deck serves the upper unit of the duplex as a secondary exit. attached is a picture. Open to suggestions on the best way to handle this!

 Here that is more referred to as a balcony but not a very attractive one.  Normally I would recommend keeping balconies, but this one is not great.

 I would check your local jurisdiction rules as egress rules are jurisdiction specific.   I like to error on the side of caution when it comes to egress.  I had a studio that exited into its own atrium.  The atrium had 2 exit doors.  It bothered me that there was no way to evacuate from the studio directly outside so I added a door to the outside.   There was only one place the door could go and it was in the bathroom. Not conventional, but an additional egress option for the tenant.   

Good luck

Quote from @Bruce Woodruff:

Quote from @Dan H.:

Quote from @Bruce Woodruff:

Quote from @Carolyn Fuller:

Quote from @Lauren Kormylo:

I don't have international guests.  But this absolutely will affect international travel.  I have family and friends in Canada who regularly visit the US, and they've cancelled all trips for the foreseeable future, they are hopping mad.  I don't know how much this will affect guests from other countries, but it is bound to.  I hope since your guests come mainly for the school there, you'll be spared a lot of it.

Unfortunately, this administration is at war with universities and scientific research and I rely heavily on Harvard & MIT which are taking major hits. They have already frozen hiring and I suspect that means there will be fewer visiting scholars. That certainly feels like what is happening, given the fact that our MTR inquires are way down and we haven't leased the full calendar year.

There are 4 legs of our retirement income and 3 of them are under threat (Stock Market, Rental Income, Social Security). 

I agree that we really don't know what will happen with Social Security but Musk has certainly been rattling his chainsaw. 

We know what is happening to the stock market but some people think it is short term pain and others fear a recession. I'm a lot less sanguine than @Bruce Woodruff but I also am in wait and see mode. 

And I know for a fact that my rental income is taking a major hit. It now just depends upon how large a hit. So far, I know we will be down by at least by $6000 this year.

Sigh... 

Actually, to be accurate, it is the Universities that have chosen their path and are finally getting called on their S**t.
And the Stock Market and Social Security are not under any threat. Once the economy settles down from the tariffs and all of these fraud and waste exposures, we (the US) will be rolling again. Just be patient. you will be fine, and I wish you the best!

I hope you’re right but I question the basis of your belief.  Trump is associated with more bankruptcies than any other individual that I am aware of (at least 6).  His initial “released” tax return shows he lost more money that year than any other US tax payer. 

the S&P 500 has lost ~$5.25 trillion in 3 weeks which is the worst since the Covid decline. 

what is occurring with DOGE is people with no domain knowledge are looking for fraud and determining who loses their job.  They are doing this without regard to the legality or costs.   My analogy is if your banker came to your job site to inspect the quality of work.  The banker may be intelligent, but he has no domain knowledge. 

as the saying goes, I am expecting a bumpy ride. I am fortunate to be financially diversified.

time will tell, but I do not share your confidence and my basis is based on trump’s financial track record.  

Best of luck to everyone

Well, you're certainly entitled to your opinion, I'm sure that you realize that your views are a product of your filters. Most/many successful business people have had bankruptcies (Ray Kroc comes to mind). As someone who grew up outside of DC with parents/neighbors.friends who worked in that mess, it was obvious to anyone even back then that, let's say 'half' the people working there were incompetent, lazy or crooked.

It will take a while and will have some unpleasant periods, but nonetheless it must be done. I fail to see how anyonne cannot agree that we need to cut at least some waste and fraud.

One of the FB groups that I frequent is a hiking group. It amazes me how many of these folks are screaming because there are some NAtional PArk Rangers that got fired. Now they can't have a guided hike, they have to go by themselves (for a while). They just scream about the cuts and seem to have zero clue as to what is going on with our country and the deficit. (Note, someone with some sense finally postedthe actual numbers - 1000 Park Rangers have been fired from over 400 Parks....do the math..that's 2.5 rangers per park. You;re telling me that we cano't get by with that reduction? This is just one example out of many.

Everybody suck it up and stay happy and positive!

 >you're certainly entitled to your opinion,

Nothing I posted is opinion.  Trump is associated with at least 6 bankruptcies, the first tax return to go public showed he had the most negative income in the US, THE S&P is down ~$5.25 trillion in last 3 weeks, and DOGE is comprised of employees with no domain experience.   Which of these do you believe to be opinion?

>Most/many successful business people have had bankruptcies (Ray Kroc comes to mind).

I would like to see your source that many/most business people are associated with a bankruptcy.   Bonus if you can find anyone other than Trump associated with 6 bankruptcies.   I agree people are associated with bankruptcies but believe it is a small percent.  I believe it is a much smaller percentage that is associated with multiple.   I believe you are in rare company to be associated with at least 6 bankruptcies.

>It should be clear to anyone that we need to do some serious trimming of the Gov't fat.

I believe the debt was too high and it had to be addressed.   I also believe in separation of powers.  Congress has the power of the purse.   The proper way for this to occur is congress decides on the budgets to trim or the taxes to be increased.   The departments with domain expertise decides how to best meet their budget still providing the service the public needs. 

Congress is abdicating its responsibility and letting the executive branch do this craziness.   The cuts are not about saving money.   If it was the oversite that generates money would not have been among the first let go.   In addition they would have calculated in the costs of the layoffs and legal battles.   Layoffs of people with employment contracts that state they can be let go for performance reasons and stating virtually all of them are being let go for performance regardless of their employee reviews is clearly not in line with the employees contracts. These will be costly reductions.

It is about dismantling the government.  

>- 1000 Park Rangers have been fired from over 400 Parks....do the math..that's 2.5 rangers per park. You;re telling me that we cano't get by with that reduction?

I am not sure the source of your numbers. Can you post the source!   Have you been to a national park in the last couple weeks?  I go out a lot (most years I camp more than 30 days and some years I camp more than 60 days).   Grand Canyon wait time recently to enter the park was 1.5 hours.  I heard the number of employees for manning the gates at south entrance but forget the exact numbers.   This weekend I was at Red Rock Canyon.  It has been on a quota for a while so the wait was not bad but slightly poor (2 gates were open).  I feel rangers in NPs work.  I felt the wait line to talk to rangers in NP/NM visitor centers was already too long.  I will say that at a remote forest ranger station I encountered 2 employees that I thought were dead weight (story is too long to post), but that has been the exception rather than the rule.   It is my belief the back country rangers were already too few.  

To bring this back to RE, there are government leased buildings (I did not actually count the number but ~10 leases) in the San Diego area that the government wants to break the lease and not pay their obligation (similar to what X did) .  The issue is X fighting to break their contracts in a legal system just has the ramification to not trust X to abide by their contracts.  If the government cannot be counted on to honor their contracts the ramifications is large as it creates distrust.  What confidence is there that fed bonds will be paid?  What about other fed debt?  What about other fed contracts being honored?  I am not associated in any way with any of the building the government is trying to break their lease   But as an RE investor prior to now, I would have paid a premium for a building with a lease to fed government high quality tenant.  Similarly, previously, a fed government tenant would get my best terms due to what previously had been a highly reliable tenant.  They basically have squandered that benefit.

We seem to disagree on how things are getting done.   We both hope everything works out, but I think it will not.   I think we are in for a rough ride.  Time will tell.  

Quote from @James Huff:

@Andy Pham hey Andy,

I will be looking at about $400-500 in cash flow a month and will managing this myself. I really wanted to get hands on and learn how the process works before I get property manager involved.should be a great learning process but didn't know what people thought of low cash flow until I refi.

James

 Did you have an experienced investor look at your underwriting?  Did you compare your underwriting to the 50% rule?   Did you justify ant discrepancy?

I will make the prediction that the answer to each of the above is “no”.  

what dollar amount did you use for maintenance/cap ex?  How did you derive it?  What value did you use for vacancy?  How did you derive it?  

The reality is the 1% rule is negative at that rent point and your ratio is far worse than 1%.  This alone tells me it is cash negative.

let’s evaluate via the. 59% rule (which is aggressive at that rent point):
2600 (rent) - 1300 (50% rule) - 1598 (30yr, 80% LTV) = negative $298/month

As stated at that rent point you will do worse than this.

If you are purchasing a duplex for $290k, the historical long term appreciation likely has not exceeded CPI (or barely surpassed it).

negative cash flow and not good appreciation.  It should provide a learning opportunity, but I question if this education is at too high a price. 

What city is the duplex located?

good luck

Quote from @Bruce Woodruff:

Quote from @Carolyn Fuller:

Quote from @Lauren Kormylo:

I don't have international guests.  But this absolutely will affect international travel.  I have family and friends in Canada who regularly visit the US, and they've cancelled all trips for the foreseeable future, they are hopping mad.  I don't know how much this will affect guests from other countries, but it is bound to.  I hope since your guests come mainly for the school there, you'll be spared a lot of it.

Unfortunately, this administration is at war with universities and scientific research and I rely heavily on Harvard & MIT which are taking major hits. They have already frozen hiring and I suspect that means there will be fewer visiting scholars. That certainly feels like what is happening, given the fact that our MTR inquires are way down and we haven't leased the full calendar year.

There are 4 legs of our retirement income and 3 of them are under threat (Stock Market, Rental Income, Social Security). 

I agree that we really don't know what will happen with Social Security but Musk has certainly been rattling his chainsaw. 

We know what is happening to the stock market but some people think it is short term pain and others fear a recession. I'm a lot less sanguine than @Bruce Woodruff but I also am in wait and see mode. 

And I know for a fact that my rental income is taking a major hit. It now just depends upon how large a hit. So far, I know we will be down by at least by $6000 this year.

Sigh... 

Actually, to be accurate, it is the Universities that have chosen their path and are finally getting called on their S**t.
And the Stock Market and Social Security are not under any threat. Once the economy settles down from the tariffs and all of these fraud and waste exposures, we (the US) will be rolling again. Just be patient. you will be fine, and I wish you the best!

I hope you’re right but I question the basis of your belief.  Trump is associated with more bankruptcies than any other individual that I am aware of (at least 6).  His initial “released” tax return shows he lost more money that year than any other US tax payer. 

the S&P 500 has lost ~$5.25 trillion in 3 weeks which is the worst since the Covid decline. 

what is occurring with DOGE is people with no domain knowledge are looking for fraud and determining who loses their job.  They are doing this without regard to the legality or costs.   My analogy is if your banker came to your job site to inspect the quality of work.  The banker may be intelligent, but he has no domain knowledge. 

as the saying goes, I am expecting a bumpy ride. I am fortunate to be financially diversified.

time will tell, but I do not share your confidence and my basis is based on trump’s financial track record.  

Best of luck to everyone

@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

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

Quote from @Alan Asriants:

Likely a home equity loan might be better since you dont have to worry about paying off the equity quickly and arent subject to higher rates and random rate changes which can destroy your cash flow.

Long term loans are best for long term projects

HELOC and lines of credit are good for get in and get out situations.

Its possible you can use a heloc to build the property as that can be cheaper for you and then you can do a cash out refi to pay off the heloc since your home is fully paid off. That might be cheaper and better bet than home equity loan. YOu need to reach out to local bank and see difference in rate and terms.

Also you need to know that investing 100k in an adu will not always increase your value by 100k. (Example)

if you need a solid contractor in the area for a bid, reach out anytime. my partner is a solid builder

 >you need to know that investing 100k in an adu will not always increase your value by 100k. (Example)

I would word this much stronger. It is rare for a single ADU addition in southern CA to add as much value as the hands cost of adding the ADU. This creates a negative position that needs to be recovered before sny cash flow is achieved. Search Bigger Pockets for posts on ADU valuation. Make sure before you add an ADU you know the value that will be added.

Here are reasons adding a single ADU to a single family home in Southern CA is typically a poor 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.

Do accurate and conservative underwriting to include the likely initial negative position.  I have literally seen underwriting that depicts over a decade to recover the initial negative position.  

Good luck

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