LATimes: Debunking the Myths + Understanding the Numbers

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

Similarly, current homeowners want to know if they should be applying for construction financing to break ground on an ADU addition. 

Honestly, it’s hard to chide them for their interest. 

Adding an ADU combats the housing shortage (which means less paperwork + fees from planning departments), provides a passive source of income, and increases the overall value of a piece of property.

Yet there are considerations that most people overlook.

No guarantees

The first and most obvious consideration is that nothing is guaranteed in real estate. Yes, adding an ADU to your parcel (or buying a lot with an ADU already added) should lead to a higher future value, but that’s not a locked-in certainty. 

Moreover, being able to recognize that uptick in value might take years and years of appreciation. 

So, if you’re planning on owning a given home for less than ten years, you need to do some serious thinking (and risk assessing) before you say “I want to own a property with an ADU.” 

Location, location, location

Just because an ADU isn’t a primary dwelling doesn’t mean it’s except from the fundamental rule of real estate: 

Location, location, location.

As one appraiser mentioned in Mr. Healey’s LA Times article, “Even if it’s the same quality, same materials, same size…you cannot give the same value to the ADU located in Beverly Hills and located in Compton.”

ADU’s in popular locations are going to be both appraised and rented at a higher value than those in a less popular location. What does that mean for you as the buyer of a property with an ADU?—It means you can’t have inflated expectations of your rental earnings.

Your ADU isn’t special. For all intents and purposes, it’s going to generate the same amount of cash as any comparable rental property in your neighborhood. 

Nothing is free

I mentioned this a few months ago, but ADUs are generally small, stand-alone construction projects. In other words, you’re probably not a professional property developer capable of sourcing materials, labor, and other building-related resources at scale.

That means four things:

1) You’re going to be paying higher prices per-unit for everything you buy, from lumber to concrete to copper.

2) You’re going to be paying higher wages per-hour for every professional you hire, from framers to electricians. 

3) You’re going to be paying higher financing costs (from loan origination fees to annual interest) than a large developer might pay.

4) You’re going to be the last-in and last-out on your contractor’s priority list. In other words, because your ADU project is a small one, contractors and their crews will deprioritize your ADU in the face of bigger, more valuable projects. That means your build will take longer to start and to finish than it otherwise should. 

The tax man cometh…

One of my favorite call-outs from Jon’s article (and something I failed to mention in my previous write-up about ADUs) is that they come with an increased tax burden.

Yes, the state of California and the city of LA want to encourage more construction, but they also want to get paid (as all governments do).

Therefore, when you build your ADU, the value of that ADU will be factored into your overall property value. Similarly, if you buy a property with an ADU on it, the value of that ADU will be factored into the property’s assessed value. 

Using the example from Jon’s article, “if you have a house valued at $1 million and spend $200,000 to add an ADU, your annual tax bill will increase by about $2,500, from roughly $12,500 to roughly $15,000.”

(Between county taxes and municipal taxes, the property tax rate in LA county is about 1.25%.) 

In other words, before you build an ADU, make sure you’re prepared to pay a few thousand dollars a year extra in taxes (assuming you’re renting your ADU and didn’t over-borrow to finance the construction, you should be able to cover the additional taxes quickly.)

Prepare to pay a premium if you’re buying…

For those in the market to buy a home, you should know your options are going to be slim if you’re dead set on owning an ADU as well. What I mean is, at any given moment only between 10% and 20% of listings include an ADU.

Put a different way, if you’re looking for a specific home, of a specific size, in a specific area, layering in a “it needs to also have an ADU”, is going to make your housing search akin to finding a needle in a haystack.

I mean…maybe that’s a little extreme, but it will definitely make your housing search more complicated and drawn out.

And when you do find that needle, the listing price will include that markup—about 24% on average, but that premium could be 35% depending on the ADU’s size.

“That’s OK, Shannon. I’ll just build an ADU on the lot after I buy.”

Not so fast, friend.

The reality is, not every lot is big enough to accommodate an ADU. California law requires all new ADUs to be at least 150 square feet whether they’re attached or detached to the primary dwelling. Lots come in different shapes, sizes, and layouts–depending upon what’s on the market in the area you want to live, it might be difficult to find a property with enough extra space to accommodate ADU construction. 

Even if you do have a lot that’s big enough to handle an ADU build, are you prepared to deal with all the little idiosyncrasies of performing construction in Los Angeles? 

For example, if your ADU is detached, the county requires that you include solar panels. 

Similarly, if your ADU is more than a half-mile from public transit access, the city requires that you provide the unit with a dedicated parking space, be it a garage, carport, or something else. 

While well-intentioned, when you’re in the throes of construction these and other under-the-radar regulations can make it feel like the city is nickel and diming you—it’s a feeling that can ruin the ownership experience. 

What’s the alternative?

I said it before and I’ll say it again—if you want to occupy a property with a rental, don’t limit yourself to ADUs. 

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. 

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