[Real Estate Risk] – Adding an ADU in LA?

Given the housing shortage in Los Angeles (and California, in general) prospective buyers are very curious about single-family residences with ADU potential.

From a high-level view, that curiosity makes a ton of sense. If you add an ADU to your newly purchased property you…

• Help combat the housing shortage.
• Add a passive income stream to your life.
• Increase the overall value of your new property.
• Avoid plunging into a competitive multifamily market. 
• Are unlikely to encounter any meaningful red tape from the local planning commission because politicians know they need to increase housing density.

All in all, adding an ADU sounds pretty positive, right?

The devil is in the detail

Unfortunately, the reality of adding an ADU is a bit more complicated than that the high-level view makes it seem. 

What you need to understand about ADUs is, they’re meant to put the cost of construction and property development in the hands of homeowners rather than developers. 

(FUN FACT: If 5% of all single-family homeowners in Los Angeles added an ADU to their property, the local housing shortage would cease to exist.)

However, developers are in the business of…well…developing. They not only know how to go about facilitating every aspect of a construction project (financing, permitting, hiring labor, sourcing materials, etc.) but they can do everything faster and for less money per square foot than a private home owner ever could. 

Granted Los Angeles county is trying to do things that mitigate the cost of ADU construction for homeowners—making pre-approved, fast-track architectural plans available for purchase, for example—but there’s no way to truly level the playing field.

The average developer will have deeper pockets and better contacts than the average homeowner could ever dream of. 

A hypothetical scenario 

Pretend for a moment you’re the owner of a single-family residence with a standalone two-car garage. 

You never drive, but even if you did, your neighborhood is never short on street parking.

After much deliberation, you decide to transform that two-car garage into a source of income—you’re going to convert it into an 1-bedroom ADU you can rent for $2,000 per month. 

You talk to some general contractors. 

You get quotes for lumber, lighting, drywall, labor—everything you need to craft a functional living space.

It’s going to cost you $100,000 all-in. 

That means you’re looking at more than four years of occupancy (50 months) before you even break even on your investment.

Not ideal.

Especially when you consider ADU construction isn’t the easiest thing in the world of finance, which means if you don’t have the cash on-hand, you might not be doing any building. 

The picture is even bleaker if you don’t already own the property yet.

To buy a single-family home in LA in this market, you’ve got to assume a sales price of at least $1,000,000.

If you finance 85% of that price, you need $150,000 for the down payment PLUS some additional capital to cover closing costs. (Yes, you could qualify for a lower down payment, but in this market you’re not winning any bids putting 5% or 10% down, so let’s assume a minimum of 15% down.)

That’s $175,000 cash for the house ($150,000 down payment + $25,000 closing costs) and another $100,000 for the ADU addition—$275,000 total.

That is a LOT of money. 

The question you need to ask yourself… 

Do I want a single-family home with an ADU bad enough to come up with almost $300,000 in cash?

If the answer isn’t a resounding YES, you’re probably better off looking at other options. 

My recommendation?—Think about a duplex. 

For $1,250,000 (about $190,000 down in cash) you can land a nice, two-unit property in Los Angeles County that you can use as both your primary residence and a passive income stream. 

To be clear, getting a duplex isn’t a walk in the park—the multifamily market isn’t some sleepy part of real estate. Things are as competitive as ever right now. 

But when you compare the economics of purchasing a duplex versus a single-family home and adding an ADU, the math suggests you’ll spend less and get more if you go the multifamily route. 

Making the right decision

Having gone through the ADU process myself here in LA (I’ll talk about it in more detail in my next email), I can tell you that constructing an accessory dwelling on your property is far from a headache-free adventure. 

That isn’t to say I regret the decision (I don’t at all) but it’s not necessarily something I’m excited to do again any time soon. 

If you’re debating whether to go the duplex route or the single-family home + ADU route, shoot me an email at ShannonShue@KW.com or give me a call at 310-853-0335. Tell me a little bit about your situation and what you’re really looking for in an investment. From there, I can make a recommendation that best suits your needs. 

-Shannon