Introduction to ADU Investments in Los Angeles City

Why are ADUs popular in California?

ADUs (Accessory Dwelling Units), also known as granny flats or in-law units, are becoming increasingly popular in California due to the state's housing shortage. As home prices rise and fewer new homes are built, ADUs provide an affordable solution for homeowners to create extra living space on their property without the need for additional land. These units can offer affordable rental housing, extra income for homeowners, and versatile living options for various groups, including young professionals, families, and seniors. They help people stay close to family and maintain community ties.

How can an ADU increase property value?

Adding an ADU can boost a home's value by offering extra, rentable space, which appeals to buyers seeking income opportunities or flexible living options. In California, properties with ADUs are generally worth more because they provide versatility—whether for renting, accommodating extended family, or even setting up a home office. An ADU also adds usable space to the property, making it more attractive and valuable in a competitive real estate market.

Is it possible to sell an ADU in Los Angeles City?

In California, AB 1033 allows local authorities to set rules for selling an ADU and the main house separately as condominiums, as long as ADU regulations are followed. In Los Angeles City, selling an ADU is possible under certain conditions. The ADU should be built by a qualified nonprofit organization, there should be a recorded agreement between co-owners, or the city should approve selling the ADU and the main house as separate condominiums.

The ROI for building an ADU in Los Angeles City

We analyzed multiple projects, and we determined that on average you should expect a 131% ROI for an ADU project in Los Angeles City. This ROI does not account for the property's acquisition cost. Compared to other areas, this ROI is quite high, making Los Angeles City an appealing and promising location for real estate development. As a benchmark, a good investment for us is when the ROI is min. 50%+.

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Case study: 900 sq. ft. ADU built in Los Angeles City

Scenario 1: Build to sell

ADU Building Area

The project involves constructing an ADU with a total area of 900 square feet. This ADU is large enough for a 2 bedroom, 1 bath unit. This scenario assumes that you already own this property and there is an existing primary residential unit on site.

Total Project Cost

Based on the industry reports, the construction cost per square foot is $381, resulting in total hard costs of $342,900. Soft costs encompass various expenses incurred during the planning, design, and permitting stages of the project. These include fees for professional services such as land surveying, structural engineering, architectural design, soil engineering, and permit fees. In this case, the soft costs amount to $42,777, covering essential aspects of the project's development and approval process.

The total project cost, including hard and soft costs, is $385,677. This estimate reflects the overall investment required to complete the construction project and obtain the necessary approvals.

Total Added Market Value

The sale price per square foot for a residential house in Los Angeles City is estimated at $990. This represents the anticipated value of the completed building per unit area in the current real estate market.

Multiplying the market value per square foot by the building area yields the total added market value. In this case, the completed project is expected to add $891,000 to the property.

ROI (Return on Investment)

The ROI provides insight into the project's profitability by comparing the total added market value to the total project cost. In this analysis, the potential gross Profit without considering acquisition or financing costs amounts to $505,323 or 131% ROI. At this level of return, the investment in an ADU to sell it offers a substantial return on investment relative to the total project cost and the market value making the city a highly attractive and promising location for housing projects. In addition to the high return, you’ll have to consider the short capital gain tax, in case you want to sell it before 2 year's end.

Scenario 2: Build to rent

Potential Rental Income of an ADU

Constructing a 900-square-foot ADU in Los Angeles City comes with a total cost of $385,677. Financing with a 6.5% interest rate loan results in a monthly payment of $2,437 or $29,244/year. Ideally, renting out the main house could cover this payment, while the ADU serves as a source of additional income. Renting out a 2 bedroom, 1 bath ADU long-term could generate approximately $37,200 per year. At this rental income, which gives you a $8,000 possible profit per year, you probably look at paying off the loan by simply renting the ADU.

City regulations require rentals to be at least 30 days long, meaning short-term rentals are not allowed. While platforms like Airbnb can bring in extra income during peak times (for example, $600 for a five-night stay), long-term rentals provide more reliable and steady income. With long-term rentals, you won’t have to constantly find new tenants, clean between guests, or re-list the property, resulting in more consistent earnings and less upkeep.

Check if the market value of your ADU covers the construction costs.

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Is there financial assistance for building ADUs?

Yes, California has the CalHFA ADU Grant Program, which, as of September 20, 2021, provides up to $40,000 to eligible homeowners. This grant covers initial costs like permits, design plans, surveys, soil tests, and impact fees needed to start construction. The program aims to make it easier for homeowners to build ADUs and increase housing options.

Building Your Team for the ADU Project

After securing funding, confirm your property meets the requirements for building an ADU and check for size limits. Decide if the ADU will be for rental or other purposes, then hire professionals such as architects and contractors to handle the construction. Local contractors familiar with area regulations are often a good choice, and you can identify potential contractors by observing other nearby projects.

What are some other financing options for building an ADU?

HELOC (Home Equity Line of Credit)

Borrow money based on your home’s value, similar to using a credit card. You can draw funds as needed, making it a convenient option for ADU projects.

Home Equity Loan

Receive a fixed amount upfront based on your home’s equity. With steady monthly payments, it’s a straightforward and predictable choice.

Cash-Out Refinance

Refinance your mortgage for a higher amount and take the extra money as cash. This option provides funds for the ADU without needing a separate loan.

Renovation Loans

Specifically designed for home improvements, these loans can cover the cost of building an ADU.

Private Lender Loans

Some private lenders offer flexible loans tailored for ADU construction, allowing terms that suit your project needs.

Potential Challenges and Solutions

Can an HOA prevent the construction of an ADU?

No, recent California laws (AB 670 and AB 3182) prevent HOAs from denying or adding unreasonable restrictions to ADU construction on single-family properties. HOA rules that attempt to stop ADUs are unenforceable and can result in penalties.

Maximizing Profitability in Los Angeles City

Marketing Strategies to Increase ADU Investment Returns

To maximize returns on an ADU investment, consider these marketing strategies:

Understand Local Rental Prices

Check what other ADUs in your area are renting for to set a fair and competitive price. Use online platforms to compare rates and get an idea of rental demand.

Build Connections

Reach out to local real estate agents with customized materials to create partnerships that could help you find tenants or investors.

Share Helpful Content

Post about ADU benefits on social media like Instagram or Facebook to connect with potential renters or investors and establish trust.

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