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How to Make My ADU a Profitable Investment in Santa Monica?
In Santa Monica, making an ADU (Accessory Dwelling Unit) a profitable investment can be challenging due to high costs and strict regulations. The solution involves understanding the local market, controlling construction expenses, and complying with zoning rules. This includes researching market trends, choosing cost-effective construction methods, and following local regulations. By focusing on these aspects, investors can enhance the value of their ADU and achieve better returns on their investment.
Introduction to ADU Investments in Santa Monica
Why are ADUs popular in California?
In California, where affordable housing is scarce and home prices are steep, ADUs are becoming a practical solution. Since there is limited land for new houses, building an ADU helps homeowners maximize their property. These units can accommodate family members, like elderly parents or adult children, or be rented out for additional income.
How can an ADU increase property value?
Building an ADU can increase a property’s value by adding more functional space. Whether used for family, rented, or converted into a home office, the extra space makes the property more appealing to buyers. In California, homes with ADUs are especially desirable because of their versatility, which can drive up the selling price.
Is it possible to sell an ADU in Santa Monica?
In California, AB 1033 gives cities the option to create rules that allow an ADU to be sold separately from the main house, much like how condos are sold, as long as certain requirements are met. For example, in places like Santa Monica, selling an ADU separately might be possible if certain conditions are met, such as when a nonprofit organization builds it, if there’s a shared ownership agreement, or if the city approves separate ownership for the ADU and the main house.
The ROI for building an ADU in Santa Monica
We analyzed multiple projects, and we determined that on average you should expect a 37% ROI for an ADU project in Santa Monica. The ROI does not account for the property's acquisition cost. This ROI value is low and it signals a risky investment. Consequently, unless you have personal goals you want to achieve, we consider that an ADU project in Santa Monica is a risky investment. 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 Santa Monica
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 $51,493, covering essential aspects of the project's development and approval process.
The total project cost, including hard and soft costs, is $394,393. 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 Santa Monica is estimated at $600. 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 $540,000 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 $145,607 or 37% ROI. At this level, building an ADU to sell it provides a relatively low return compared to both the costs and the market value. In addition to the low 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 Santa Monica comes with a total cost of $394,393. Financing with a 6.5% interest rate loan results in a monthly payment of $2,493 or $29,916/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 $57,600 per year. At this rental income, which gives you only $27,000 possible profit per year, you probably look at paying off the loan by simply renting the ADU.
The city rules state that rentals should last at least 30 days, so short-term rentals are prohibited. While services like Airbnb might bring in more money during busy seasons (for example, $600 for a five-night stay), long-term rentals offer steadier, more predictable income. With long-term rentals, you don't have to worry about finding new tenants all the time, cleaning between guests, or re-listing the property, which leads to more consistent earnings and less maintenance.
Check if the market value of your ADU covers the construction costs.
Is there financial assistance for building ADUs?
California offers financial assistance through the CalHFA ADU Grant Program, which gives homeowners up to $40,000 to cover the initial expenses of building an ADU. This money can be used for tasks like creating plans, getting permits, performing soil tests, and carrying out surveys and energy assessments before construction begins.
Building Your Team for the ADU Project
Once the funding is secured, make sure your property qualifies for an ADU and check if there are any size limits. If you plan to rent the ADU or use it as an investment, you’ll need to bring in experts like architects and contractors to manage the building process. Working with local contractors who are familiar with similar projects can also make the process more efficient.
What are some other financing options for building an ADU?
Home Equity Line of Credit (HELOC): This option lets you borrow money based on your home's value and withdraw funds as needed, offering flexibility for ongoing costs.
Home Equity Loan: This provides a lump sum loan based on your home’s equity, which you repay in fixed monthly installments.
Cash-Out Refinancing: By refinancing your existing mortgage for a larger amount, you can take the extra cash and use it for your ADU project.
Renovation Loans: These loans are specifically for home improvements and can help finance the construction of an ADU.
Private Lender Loans: Some private lenders offer loans specifically for ADUs, often with more flexible terms than traditional banks.
Potential Challenges and Solutions
Can an HOA prevent the construction of an ADU?
In California, laws like AB 670 and AB 3182 protect homeowners by preventing Homeowners Associations (HOAs) from blocking or putting unfair restrictions on ADUs in single-family zones. Any attempt by an HOA to block ADU construction is against the law and could result in legal consequences.
Maximizing Profitability in Santa Monica
Marketing Strategies to Increase ADU Investment Returns
To boost the potential return on your ADU investment, consider these strategies:
Team up with local real estate agents: Share tailored marketing materials to create connections that could lead to valuable partnerships.
Offer virtual tours: Let potential investors check out your ADU online, making it easier for them to assess the property without visiting in person.
Post helpful content on social media: Share useful information about ADUs on platforms like Instagram and Facebook to draw attention and build trust with potential buyers or renters.
Get the ADU Analysis to attract buyers and close quickly. It's 10x cheaper.
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