In previous posts we covered many subjects; from what is an ADU, why you should build one, what is the real ROI for doing an ADU, to how to manage your units like a boss.
Hopefully, by now you have acted and built those units, have excellent tenants, and
you’re paying off not only the cost of the project but also some of your primary mortgage and other basic expenses with the extra income.
But what now? What is the next step in the process? How can you start this process and multiply it?
Well, that's easy - buy another house and do it all over again!
Although this post is not a post for helping people understand better how to buy real estate properties, I will offer some tips on the most qualified properties to buy and how to go through the process.
(For in-depth guides on how to buy properties, I recommend The Book on Investing in Real Estate with No (and Low) Money Down by Brandon Turner and The Book on Rental Property Investing by Brandon Turner.)
Step 1 - Build Equity
The first step in the process is to determine how much equity you currently have in your primary residence. Most likely, you will not be able to refinance and cash out of your house if you own less than 20% equity. If you don’t have the 20% equity in your primary residence yet, you will probably need to wait until you have made more payments and the property value goes up., Some lenders will allow you to cash out up to 95% of your house equity with an FHA loan, but I would not recommend that.
Step 2 - Refinance and Cash Out
Now let’s assume that after the construction of the ADU and the JADU, you brought the bank assessor to the property and he approved a cash-out refinance of $200,000, still leaving you with 30% equity
Step 3 - House Hunting
Now you can start looking for a new house, knowing that you have a $200,000 down
payment for your new property. Lenders will most likely require you to have a 20%-25% down payment for an investment property, which means that you will potentially be able to buy a house for $800,000-$1,000,000.
In general, for a rental property, you may want to buy a 3 or 4 bedroom house with a 2-car attached garage of approximately 400 sq ft for the JADU (noting JADU restrictions as discussed earlier) and a large enough backyard to build an 800 sq ft ADU. In addition, you would want this house to have a long driveway, great street parking, and no slope.
A viable alternative is a 5-bedroom house with a detached garage, where you can convert two of the bedrooms into a separate 400 sq ft JADU unit and extend the garage from its current size to about 800 sq ft for an ADU unit.
Other layouts may work as well, but take into consideration that any other layouts will typically make the construction costs significantly higher. For example, building a second-story ADU or building on a hillside can almost double the cost of construction.
Step 4 - Secure Financing
To buy a new house, most mortgage companies ask you for:
1. A 20-25 percent down payment
2. Your employment history
3. Documents showing you have a Debt-to-Income Ratio of less than 35-40 percent.
To calculate your Debt-to-Income (DTI) Ratio, they will add all your monthly payments such as mortgage payments for your primary residence, other monthly loan payments, car payments, and other monthly fixed payments that you have, and they will divide that number by the sum of the monthly income that you generate. The income will include your job and other income. You will be able to add income from the ADU and JADU only after 2 years of renting those units.
For example, if you have a total monthly loan payment of $2,000, and you have $10,000 post-tax income, your debt-to-income ratio is 20% and the banks might lend you approximately $450,000 with a 3.5% interest rate for 30 years to buy another property.
However, if your debts are $4,000 and your income is $10,000, your debt to income will be 40% and the banks will not lend you the funds you need to buy another property because your DTI Ratio is too high. In this case, you might want to try to consolidate some of your short-term debts or high-interest rate debts into long-term, low-interest debts. That will reduce your DTI Ratio and potentially allow you to borrow more money.
Step 5 – Purchase Property, Build ADU and JADU, Rent to Great Tenants, and Repeat
Pro tip:
Buying a real estate investment property is a big decision that should be consulted with a real estate agent, CPA, financial advisor, and lawyer. There is a lot of work to be done. For more information visit www.aduguru.us\help.
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