It’s no secret that owning rental real estate can be an excellent way to build wealth. This hybrid of business and investment can provide steady income and growth over the long term.
But if you happen to be in a “HCOL” (high cost of living area), how can you find deals that make sense? Even if you can find a “good” deal, the typical 20% down payment required can easily stretch into six figure territory. How can a new investor with limited funds ever get started?
Here in California, the housing crisis is real. Experts estimate a housing shortage of 20 to 30 percent. This equates to millions of homes needed to meet current demand. Housing production would need to quadruple to meet demand and keep prices from rising.
What Can Be Done?
A McKinsey Global Institute study finds that California could add as many as 793000 units to existing single family homes.
On January 1st of 2020 California rolled out new regulations to further ease restrictions on the building of ADU’s and JADU’s. These Accessory dwelling units and “Junior” Accessory dwelling units can be added on to an existing home or built in a backyard.
This combination of lack of housing and eased building codes is a golden opportunity for ambitious homeowners. Today I’ll be sharing an interview with a couple who took this opportunity and started building a real estate empire in the comfort of their own backyard.
J. Alfred is a 33 year old Project manager and draftsman who just completed converting his detached garage into a 650 square foot ADU.
Why did you choose to get started in real estate?
It just kind of happened. I bought my first house at 22 years old. Not because is was a good investment but because that is what people told me to do. “Own your own house”, “never pay rent”, “your home is your best asset”, so I did. Unfortunately the commute to my job was unbearable and so I ended up renting the house to a tenant. Again, this is what other people told me I should do. Being a landlord at that young age with no experience was hard. The bills got paid but the tenants were always causing problems with the neighbors and ended up trashing the house. After 4 years I cleaned it up and sold it for a profit. I didn’t really know what i was doing, but it worked out okay.
Why did you choose to build an ADU?
I’ve always wanted to get into the rental market, but prices are just so high in Southern California. But I didn’t wake up one morning and say ” I’m building an ADU”. I have a coworker that is always brainstorming ideas for Financial Independence. We started talking about ADU’s being a possible entry point into real estate. The cost of an ADU is a fraction of the cost of most single family homes, and the market rate for rent is very high. The next day he had printed out the building codes for my city. I thought about it for awhile, then told myself “I can do this”.
Can you describe your ADU project?
The project started with an existing garage that was only used for storage. the previous owner had added on a bathroom to be used in conjunction with the swimming pool. We spoke to our city building department and found that we could add on to the garage to increase square footage. We added 240 square feet to the existing garage for a total square footage of 650 square feet.
The existing garage became an open concept living room / dining room and kitchen. The new portion contains one bedroom, one bathroom and a laundry area. There is even a small private backyard. Overall it looks like a full one bedroom house.
What is your experience with building?
Growing up with a father that worked in construction helped a lot. I didn’t learn how to build a house, but I did learn the basics. My father never wanted me to be in the construction industry and so I went to school and got an Associates degree in Architecture. I currently work for a commercial construction company doing project management and drafting.
How long did the project take?
I did the project as an owner / builder. It took a long time since I was doing everything by myself. I applied for the permits in October of 2017. ADU’s are not that common and so it took a long time for the city to approve it. It was already May of 2018 by the time they were approved. I also had to relocate my pool equipment to make way for the addition. All in all it took a full year of working nights and weekends to complete the project in May of 2019. Signing up a tenant before it was completed pushed me pretty hard the last month or so. They moved in in June.
How did you finance the project?
I started the project not really knowing how I would pay for it. A friend of mine helped with the drawings and so I knew the initial costs of submitting them would be low. I payed $9,545 for the permits out of my savings. When I got the approval for the project I went to my bank and got a HELOC for $25,000. That ran out quickly and I asked for another $25,000. When I ran out of that they gave me a credit card with a limit of $13,000. In total I spent just under $73,000. I’m able to rent the unit for $1550 a month right now.
What was the hardest part?
Time. Everything took longer than we planned. When I thought the foundation was ready, the inspector required additional underpinning to the existing structure. We moved some things around during framing because they just didn’t work. I couldn’t find shingles to match the existing roof, etc, etc.
What was the biggest lesson you learned?
Learning how a building goes together from start to finish was a great experience. It was very satisfying to see it come to life. I still smile every time I see it.
How did your spouse feel about the project?
She absolutely did not want to do it. She had valid concerns about the time and money required. But I spoke to all her concerns and reassured her that I would get it done. It was a tough sell, but in the end I think she values the financial security that the extra income provides.
What advice would you give to someone interested in building an ADU?
Before you start the project, make sure you understand the numbers. Know how much it will cost up front. Realize that you will be making payments during the construction and can you afford them? Know how long it will take and plan accordingly.
Also the work doesn’t stop when the building is done. You’ll need to find tenants, maintain the property and keep track of income and expenses. Trust me, there is more paperwork than you think.
What is it like to have renters living so close to you?
That was always a concern of ours. We wondered if they would play loud music or have parties. We worried that they wouldn’t pay the rent and we would have to evict them. You just have to screen them and check their background. I recommend reading “The Book on Rental Property Investing” by Brandon Turner from Bigger Pockets. There is a good chapter on tenants.
What are your plans for the future?
I’d like to purchase a distressed property and rehab it into a rental property. I plan to convert the garage into an ADU just like I did at my own house. The new ADU guidelines for 2020 should make that much easier.
Any final thoughts?
The process is long and it will test you in many ways you haven’t been tested. But trust me, it’s worth it. Nothing ventured, nothing gained.
If you live in a high cost area, don’t give up on your dream to invest in rental property. You may not be able to follow the “typical” path, but there are other paths available.
Building an ADU is long but doable project. If you decide to take it on, educate yourself on the process. Have a good grip on the details of financing.
Getting the costs down to rock bottom level will require you to put in a large amount of physical effort. Be honest with yourself about your abilities. You may decide to just do the project management and leave the actual building to others.
Building something with your own hands is one of the most confidence building exercises you can take on. A strong back can make up for a lack of capital.
The world belongs to the energeticRalph Waldo Emerson