ADU PART 2: ADU Financing- How to pay for an Accessory Dwelling Unit or Garage Conversion
You know ADUs are becoming increasingly popular in Los Angeles, but how much do they cost, how can you finance them, and how long do they take to build? All that and more coming up.
Hello everyone, my name is Cameron Stephens, the entertainment industry’s real estate agent and the owner of Stephens Real Estate, a real estate experience tailored to the creative client.
Today I want to talk about ADUs, which stands for Accessory Dwelling Unit, and talk more about the finance side of things. Really quick, this is part 2 in a video series on ADUs, so if you want to know more about how you can build one and the latest laws surrounding them, check out my other video in this series, linked below.
Ok, ADUs, you’re thinking you might want one for yourself, a ‘studio’, office space, a place for your band to practice, or a in-law suite. Maybe you want a standalone unit to be able to collect rental income. Fantastic, but how much do these ADUs cost?
Well as you may imagine, ADUs and garage conversions will vary greatly in cost based on the size and options you choose, but you can be certain it’s a decent expense. This is a major construction project where you are essentially building a complete home, albeit smaller in size, and with the increase in lumber prices and supply chains tight, they’re more expensive than they used to be a few years ago.
Even so, converting a garage into an ADU is the most cost-effective option because the major components already exist, but you still need to add many interior components such as walls, a kitchen, a bathroom, flooring, windows/doors, plumbing, HVAC, insulation, and all utilities, though you might already have water and electric running to your garage which makes it convenient. The biggest expense that most people aren’t thinking of though is constructing a sewer line that will need to connect to the main sewer line, usually by connecting to wherever the main house exits and connects to the city sewer.
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Ok let’s put some numbers on the table here. The cost for a garage conversion to ADU will range between $75,000-$125,000 depending on location and finishes. Costs to construct a brand new standalone ADU in Los Angeles unit can also vary based on size, location, access, etc, but will generally range from $100,000-$400,000. A good rule of thumb is to assume $250-$400 per square foot.
And of course that range makes sense, you can build something just the basics with the interior being lower end finishes, or you can build a two story ADU with multiple bedrooms and a rooftop deck. What you build depends upon you. Just remember that if you’re building a 2-story ADU, costs will go up because of the structural support required for the 2nd story.
These costs might seem high, but the return on investment can be staggering compared to traditional homes. For example, let’s say you’re trying to rent a single family home that cost $800k, a 3 bed 2 bathroom in a decent area of LA. You’re probably going to be able to rent that at somewhere between $3,200 and $3,500 depending on how updated it is. But that ADU that cost you $100k to build? That studio will likely rent for $1,200 to $1,500 in the same area, depending on finishes and square footage. Your rental income is 40% of the single family, but it costs 1/8th of the amount to do it. Or another way a monthly income of 3,500 as a ratio of 800,000 is .43 but a monthly income of $1,500 as a ratio of 100,000 is a whopping 1.5, over 3 times higher.
That’s why, from a financial perspective, if you already own a home, insteading hunting for a whole additional property to rent, people are highly considering building ADUs on their property for the rental income.
But look, the costs to build these secondary units are still quite significant, even if they are less than single family homes, so many people will need to consider financing and loan options for this project. There are a number of options worth considering based on your specific situation, and fortunately, more and more lenders are starting to offer ADU loan programs. So let’s go ahead and explore the most common ADU financing options in Los Angeles and even a few less traditional options.
First is a Home Equity Line of Credit, also known as a HELOC. Assuming you have an existing mortgage on your home, but you’ve also built up some equity in your home as prices have gone up, a HELOC loan may be a good option for you. Here, the bank essentially gives you a second mortgage on your home in the form of a credit line, likely to be 80-90% of the appraised value of your home minus what you owe on your existing mortgage.
The HELOC is a revolving credit line structured similar to a credit card: you can withdraw as much or little of the loan at any time and pay it back anytime, and you only pay interest based on the amount you have withdrawn. Usually, a HELOC loan is relatively quick and cheap to accomplish with minimal closing costs.
A Home Equity Loan is a good ADU financing option, as well as for any other large-scale renovation project, and is sometimes known as a second mortgage. It’s somewhat similar to a HELOC in that the homeowner is tapping the equity in their home above what is owed on their first mortgage, but the difference with a Home Equity Loan is that you receive the entire amount of the loan right away in a lump sum. The downside to this is having to pay interest on the full amount of the loan, unlike the HELOC. The upside is the interest rate can be fixed rather than variable like it often is with a HELOC.
The cash-out refinance is another good ADU loan option. A cash-out refinance replaces the first mortgage with a new mortgage and extracts some of your equity in the home as cash that can be used to pay for construction. The process is very similar to a traditional mortgage refinance, but instead of refinancing for the exact amount of your current mortgage, you would refinance for a higher amount. This will be used to both pay off your existing loan and provide you additional cash for your renovation, ADU, or garage conversion project.
Just like other types of ADU financing options I’ve discussed, a cash-out refinance requires that you’ve built up some equity in the value of your home, so the maximum amount of your refinance will usually be about 80% of the value of your home.
A cash-out refinance is one of the best options for ADU financing in Los Angeles for several reasons. Because it’s very similar to a traditional refinance, you are likely to get the best possible interest rate. If your current mortgage interest rate is higher than today’s current rates, this loan is an opportunity to reduce your rate. Also, a refinance comes with a traditional loan term of 30 years (with other available options like 15 or 20 years), so it’s likely your monthly payment can stay within your current budget.
Another way of financing an ADU or garage conversion is by using an ADU renovation loan. These loans are personal loans that are not secured by your property. They are quicker and easier to secure than more traditional loans and are based on your income qualifications and not property value and equity buildup.
Usually, the amount of these loans has been limited to about $100,000. Also, because the loan is not secured by the property, it will come with a higher interest rate and a shorter payback period. This form of ADU loan is good for those looking for speed and simplicity. Not every lender offers these types of lending, so if you want to consider something like this, reach out and I’d be happy to connect you to a lender that can do the loan.
Another option for ADU financing is a construction loan. This loan is a bit more complicated than the traditional products above and will require more work on your part. A lender will provide you a construction loan in an amount that is a percentage (80-95%) of the “completed value” of your ADU. Your lender will have their own underwriter to determine the value of your completed project and lend based on that. This loan is usually a short-term loan, usually one year, and may come with a somewhat higher interest rate than a conventional loan.
In order to qualify for this type of ADU loan, you will need to provide the lender with items like your completed plans, schedule, and budget created by a licensed, insured general contractor. Usually, the lender will not fund the loan until you also have a building permit in hand. Once the loan is approved and funded, the lender will only release payments to the contractor in chunks , called “draws”, based on their progress, which will be verified in person by an inspector working for the bank.
During the term of this loan, you will likely just pay interest on the amount outstanding each month. At the end of the one-year construction loan period, this loan should automatically convert to a long-term, permanent loan of 30 years, which may be at a fixed or variable interest rate.
Ok that’s a lot of financing thrown your way at once, so if you need any of these points clarified, please don’t hesitate to reach out. Let’s end with how long these ADUs take to build.
As you can imagine, the timing is different for an ADU garage conversion versus a brand new construction project. For an ADU garage conversion, you can expect the entire process to take 3-6 months, which includes the time to design the architectural plans, wait for the city to conduct plan check, and finally, the construction process, which will take about 2-3 months.
A new standalone unit will take longer for city plan check and require a longer construction process, so you can expect the entire process to take 6-9 months, with the construction phase lasting 3-6 months.
The good news is that you don’t have to be displaced during construction. Sure, there will be noise and dust back there, but you can still live in your home while the ADU is being constructed, unlike if you were renovating your own home where most people choose to move out during significant renovation.
Ok there you have it! Thank you for watching, I hope you learned something about ADU costs and how to finance them, as well as the time it takes to construct one! In the next video of this series I’ll do a rapid fire Q&A to quickly answer a ton of the common ADU questions.
At Stephens Real Estate we specialize in working with creative professionals, entrepreneurs, and especially people in the entertainment industry because I spent 7 years of my life working in animation and visual effects. That is why I designed Stephens Real Estate to be tailored to the creative client.
I also designed a few value adding programs for both buyers and sellers that no one else is offering. For buyers, we put together a full marketing plan that paints you as the right buyer for your dream home. We can help recommend local lenders that will fit your financing situation, even if you’re freelance. And don’t worry about the inspections, we’ve got you covered. They’re free, all of them, no questions asked.
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So, if you like my energy and personality, and think my expertise and the programs I offer would benefit you, please don’t hesitate to reach out. Additionally if you know someone that would benefit from connecting with me, I’d absolutely love an introduction.
A thank you to GreatBuildz for some of the wonderful information that helped me put this video and article together. You can learn more about them here: