Apartment Therapy
How to Make My ADU a Profitable Investment in San Francisco?
Investment in an ADU in San Francisco can be a profitable project, but it comes with challenges. Homeowners often find it difficult to maximize rental income, manage costs, and navigate local regulations. However, with the right strategies, it's possible to improve the financial returns of your ADU. This includes setting the right rental prices, efficiently managing both soft and hard costs, and ensuring compliance with zoning and building requirements. In this article, you'll learn practical approaches to increase the profitability of your ADU investment.
Introduction to ADU Investments in San Francisco
Why are ADUs popular in California?
ADUs, or granny flats and backyard cottages, are becoming more common in California as a solution to the state's housing shortage. With high home prices and a lack of new housing, ADUs allow homeowners to add extra living space without needing more land. These units can be used in many ways, such as generating rental income, providing affordable housing, or offering living space for family members, young professionals, or seniors. They also help people stay close to loved ones and remain in their communities.
How can an ADU increase property value?
Adding an ADU can increase the value of a property by offering extra space that can be rented out or used for different purposes. Homes with ADUs are often more appealing to buyers because they provide opportunities for rental income, multi-generational living, or private workspaces. In California's competitive housing market, the extra space and flexibility make properties with ADUs more desirable.
Is it possible to sell an ADU in San Francisco?
In California, AB 1033 allows local authorities to create rules for selling an ADU and the main house separately as condos, as long as ADU regulations are followed. In San Francisco, it's possible to sell an ADU separately under certain conditions. The ADU should be built by a qualified nonprofit organization, there must be an agreement between co-owners, or the city must approve selling the ADU and main house as separate condos.
The ROI for building an ADU in San Francisco
We analyzed multiple projects, and we determined that on average you should expect a 247% ROI for an ADU project in San Francisco. This ROI does not account for the property's acquisition cost. Compared to other areas, this ROI is quite high, making San Francisco 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 Francisco
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 $46,007 covering essential aspects of the project's development and approval process.
The total project cost, including hard and soft costs, is $388,907. 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 Francisco is estimated at $1,500. 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 $1,350,000 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 $961,092 or 247% 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 Francisco comes with a total cost of $388,907. Financing with a 6.5% interest rate loan results in a monthly payment of $2,458 or $29,496/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 $12,000 possible profit per year, you probably look at paying off the loan by simply renting the ADU.
City rules require rentals to be at least 30 days, meaning short-term stays aren’t allowed. While renting through platforms like Airbnb can bring in extra income during peak times, long-term rentals provide more reliable and consistent earnings. With long-term tenants, you won’t have to keep finding new renters, cleaning between stays, or advertising the property, resulting in steady income and less supervision.
Check if the market value of your ADU covers the construction costs.
Is there financial assistance for building ADUs?
Yes, California offers financial support through the CalHFA ADU Grant Program, which began on September 20, 2021. The program provides up to $40,000 to eligible homeowners to cover initial expenses like permits, design, surveys, soil testing, and impact fees. The goal is to make building ADUs more affordable and increase housing options.
Building Your Team for the ADU Project
After securing funding, make sure your property meets the ADU requirements, including size limits. Decide on the purpose of your ADU, whether for renting or other uses and hire professionals like architects and contractors to manage the project. It’s useful to work with contractors who are familiar with local rules, which you can find by looking at other nearby construction projects.
What are some other financing options for building an ADU?
Home Equity Line of Credit (HELOC)
A HELOC allows you to borrow money against the value of your home, similar to a credit card. You can withdraw money as needed, making it a flexible option for covering ADU expenses.
Home Equity Loan
This type of loan gives you a lump sum of money upfront based on your home’s value. It comes with fixed monthly payments, providing a reliable and straightforward way to finance your ADU.
Cash-Out Refinance
With a cash-out refinance, you refinance your mortgage for a higher amount and take the difference in cash. This provides the funds for your ADU without needing a second loan.
Renovation Loans
These loans are specifically designed for home improvement projects, including ADUs, and can help cover construction costs.
Private Loans
Private lenders may offer loans tailored for ADU construction. These loans can be customized to fit 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 stopping or placing unreasonable restrictions on ADUs in single-family homes. If an HOA tries to block an ADU, their rules won’t be enforceable, and they could face fines.
Maximizing Profitability in San Francisco
Marketing Strategies to Increase ADU Investment Returns
To increase the profitability of an ADU, try these marketing strategies:
Work with Real Estate Agents
Partner with local real estate agents and provide marketing materials to attract potential tenants or buyers.
Know Local Rental Prices
Research rental prices for ADUs in your area to set a competitive rate. Online tools can help you assess local demand and pricing trends.
Use Social Media
Promote the advantages of ADUs on social media platforms like Facebook and Instagram to reach potential renters or buyers and build trust in your property.
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