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How to Make My ADU a Profitable Investment in San Diego City?
In San Diego City, making an ADU investment profitable can be tough with a competitive market and rising costs. To address this, focus on upgrading your property’s features, targeting key tenant groups, and utilizing available financial options. By doing so, you can enhance your ADU’s appeal, attract the right tenants, and increase rental income.
Introduction to ADU Investments in San Diego City
Why are ADUs popular in California?
ADUs, also known as granny flats or backyard cottages, are gaining popularity in California because they help address the state’s housing shortage. With high home prices and limited new housing being built, ADUs let homeowners add living space without buying more land. These units offer flexible uses, like generating rental income, providing affordable housing, or creating living spaces for young professionals, families, or seniors. They also allow people to stay close to family and remain in their community.
How can an ADU increase property value?
Adding an ADU can boost a property’s value by providing extra space that can be rented or used for various purposes. Buyers often find homes with ADUs more attractive because they offer opportunities for rental income, multi-generational living, or private workspaces. In California’s competitive housing market, the added square footage and versatility make properties with ADUs stand out.
Is it possible to sell an ADU in San Diego 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 San Diego 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 San Diego City
We analyzed multiple projects, and we determined that on average you should expect a 115% ROI for an ADU project in San Diego City. This ROI does not account for the property's acquisition cost. Compared to other areas, this ROI is quite high, making San Diego 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%+.
Interested to find out the market value of an ADU for your property?
Case study: 900 sq. ft. ADU built in San Diego 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 $325, resulting in total hard costs of $292,500. 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 $38,260 covering essential aspects of the project's development and approval process.
The total project cost, including hard and soft costs, is $330,760. 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 San Diego City is estimated at $789. 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 $710,100 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 $379,340 or 115% 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 San Diego City comes with a total cost of $330,760. Financing with a 6.5% interest rate loan results in a monthly payment of $2,091 or $25,092/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 $42,000 per year. At this rental income, which gives you a $17,000 possible profit per year, you probably look at paying off the loan by simply renting the ADU.
City rules state that rentals should be for at least 30 days, so short-term stays are not allowed. While renting through sites like Airbnb can bring in extra money during busy times, long-term rentals offer more stable and dependable income. With long-term rentals, you won’t need to keep searching for new tenants, cleaning between stays, or re-advertising the property, leading to steady earnings and less maintenance.
Check if the market value of your ADU covers the construction costs.
Is there financial assistance for building ADUs?
Yes, California provides financial help through the CalHFA ADU Grant Program, which started on September 20, 2021. This program offers up to $40,000 to qualified homeowners to help with initial costs like permits, design, surveys, soil testing, and impact fees. The aim is to make building ADUs more affordable and help increase housing options.
Building Your Team for the ADU Project
Once you have funding, make sure your property meets the necessary ADU requirements, including size limits. Determine the purpose of your ADU, whether for rental or other uses and hire professionals such as architects and contractors to manage the project. It's helpful to work with contractors familiar with local regulations, and you can find them by checking out other nearby construction projects.
What are some other financing options for building an ADU?
1. Home Equity Line of Credit (HELOC)
A HELOC lets you borrow money using the value of your home, much like a credit card. You can take out money when you need it, offering flexibility for covering ADU costs.
2. Home Equity Loan
With this loan, you get a lump sum of money upfront based on your home’s value. It has fixed monthly payments, making it a straightforward and reliable option.
3. Cash-Out Refinance
This involves refinancing your mortgage for a higher amount and taking the difference in cash. It eliminates the need for a second loan and provides funds for your ADU.
4. Renovation Loans
These loans are specifically for home improvement projects, including ADUs, and can cover the costs of construction.
5. Private Loans
Some private lenders offer loans tailored for ADU construction, which can be customized to suit your specific needs.
Potential Challenges and Solutions
Can an HOA prevent the construction of an ADU?
No, California laws (AB 670 and AB 3182) prevent homeowners’ associations (HOAs) from blocking or putting unreasonable limits on ADUs for single-family homes. If an HOA tries to stop an ADU, their rules won’t hold up and could lead to fines.
Maximizing Profitability in San Diego City
Marketing Strategies to Increase ADU Investment Returns
To increase the profitability of an ADU, try these marketing strategies:
1. Know Local Rental Prices
Research the rental prices of ADUs in your area to set a competitive and reasonable rate. You can use online tools to help you understand demand and pricing.
2. Work with Real Estate Agents
Collaborate with local real estate agents and provide them with marketing materials to help attract tenants or investors.
3. Use Social Media
Promote the benefits of ADUs on platforms like Facebook and Instagram to connect with potential renters or buyers and build trust.
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