The Dollars and "Sense" Behind Adding Accessory Buildings to Your Property - How to Turn Equity Into Cash-flow, Without Having to Sell

Jake Trim

Real estate is a no-brainer investment

I’ll go out on a limb here for a moment and say that if you are reading this, you subscribe to the premise that real estate is a sound investment and mechanism for building wealth.  Sure, we’ve probably all lived through the Great Recession where we saw values drop significantly for the first time in our lives, but since that time we’ve seen unbelievable returns on our investments here in the Pacific Northwest.

One property or 20, you need to think like an investor

You may not think of yourself as a “real estate investor”, but if you look at the long-term view of homeownership, that’s exactly what you are.  

You purchase real estate, upgrade, personalize, modernize, and eventually, you’ll likely sell for a profit since historically real estate is the best form of investment.  That may take 2 years or 20 years, but you’ll then roll those profits into a new purchase of a home and start the process all over.

Some of us will pay off our homes and others will downsize by selling and purchasing that maintenance-free condo or home in a lower-cost area, all to decrease operating expenses so we can increase our flexibility to travel, fish, read, paint or whatever retirement looks like for you.  

It’s the real estate circle of life and we live in a great area to capitalize on these opportunities.

Now that we’ve all accepted that we are “real estate investors”, it feels good right?  Well, don’t update your LinkedIn profile just yet.  Being a savvy investor comes with a responsibility.  Our kids, nieces, nephews, and coworkers may start asking for advice as they start their journey, so let’s make sure we’ve got some good guidance for them.  

What home improvements have the highest ROI?

There are countless articles out there discussing the ROI (Return on Investment) for different home improvement projects that build equity.  The ones that I see most often are kitchen and bathroom remodels, deck additions, and energy-efficient component upgrades like windows, furnaces, water heaters, etc.  

When you have new buyers tour your home, the last thing they want to see is a costly to-do list.  They want to focus on aesthetics to make it their own.  If you’ve done the heavy lifting, you can realize the equity gained and create more competition among buyers, resulting in a higher sale price for you.  

It’s been my experience that how you upgrade can make or break the return.  For example, a modern, clean, and updated kitchen with modern appliances that cost $20,000 vs. super high-end finishes that may cost $100,000 may not net the same ROI.  It’s the point of diminishing returns, and it’s something to keep in mind as you invest in your home.  

The opposite is also true.  Don’t go too cheap and leave equity on the table.  You want buyers to come into your home and think you have a $50,000 kitchen that you only spent $20,000 to create.  

But appraisers set the standards

Appraisers take a similar approach when establishing a value for your home, so shouldn’t we all work to meet those standards?  At the end of the day, you can get an offer for $300,000 over the asking price, but the bank will rely on the appraiser to say whether that is a reasonable price.  Their relationship is focused on risk management for the new buyer and lender.  

Use your equity to supercharge your valuation

As your home appreciates over time with market changes and improvements, you can use this equity to reinvest in your home.  Consider this supercharging your valuation.  

Using that equity for a kitchen remodel, for example, leaves savings intact but does add to your household payments, unless you are simultaneously refinancing into a lower interest rate to offset the increased loan amount with a cashback refinance or a home equity line of credit (HELOC).  

You only cash out on these investments when you sell.  

However, what if you could use that equity to create positive cash flow without having to sell?  Let’s put a pin in this for now.

Rental income unlocks investment growth through cash-flow

Real estate investing also comes in another form, which is purchasing an investment property as a rental.  The goal in this scenario is to rent it out for more than your mortgage payment for positive cash flow.  

Often these loans come with a much higher down payment requirement, so you may be rolling equity from your existing home or cash savings into the purchase of the new one.  

In some places like Seattle, it is no longer cost-effective to purchase a rental

In the Pacific Northwest, these investment properties are increasingly more difficult to attain.  This is due in part to the total cost of the property, or the down payment and closing costs required to purchase it.  

It’s an increasingly heavy lift, so many homeowners are making a realization.  “I already have property.  It just happens to have my home on it.”  Enter the accessory dwelling unit (ADU) into your investment portfolio.    

ADU’s fix the equation

An accessory dwelling unit is an actual house that is considered subordinate to your existing home.  It will undoubtedly increase equity in your property over the long run, but what are they and can you turn a profit in the short term by building one?

Usually built behind the primary residence and typically smaller in size, accessory dwellings are becoming popular due to the decrease in permitting requirements and the increase in support from many building departments.  

Yeah, you heard that right….less regulation in construction.  

For example, Snohomish County has recently removed the conditional use permit requirement on secondary homes up to 1200 square feet on certain properties.  There are some caveats with location, acreage, access to water, sewer, and the overall size compared to your existing home.  

However, at a fraction of the cost of a secondary property purchase, you can use the equity in your home to create positive monthly cash flow.  

I’m not a mortgage professional, so let’s use some easy round figures.  It’s not unreasonable to have a $500-$700 monthly equity line of credit payment of $150,000 which you could use to build an accessory dwelling on your current property.  

You can then rent that second home easily for $1,000 or more per month in this area for a one-bedroom one-bath rental.  That could be a positive cash flow of $300 to $500 per month.  

This is much more than the monthly income you get out of a kitchen or bathroom remodel, which is only realized when you sell.  

These homes also help to provide additional housing options in an area that is desperately in need of them.  

There is a strong rental market here in the Pacific Northwest and an opportunity for you to capitalize on it.  Don’t leave it all to massive multi-family housing investors when you may have the ultimate investment property already in your possession.  It’s that grassy spot in your backyard!

Our lifestyle and needs for housing change over time, as does our budget.  Make sure to ponder these questions:

• Can the intended tenant finance the construction?  An example is a parent or parents who are selling their existing home and downsizing.

• Do I have the equity in my home to get a cash-back refinance or home equity line of credit?  If so, what are the payments, and what are the rental rates in my area?  Does it provide positive cash flow?

• Whether the tenant is purchasing outright, or you are financing this venture, what ongoing expenses will you need to include or account for such as utilities, maintenance, internet, or landscaping.

• What is your exit strategy if you intend to sell your home?  How might you reimburse the tenant who may have financed the build should you intend to sell?

Shedding light on your backyard makeover

I hope it was helpful, but I’d like to mention one other popular trend in home improvement that is rapidly aiding in equity growth.  

That’s accessory buildings that are not necessarily intended for a rental but used instead for recreational or professional space.  This isn’t your typical portable building for tool and yard maintenance equipment.  Stay tuned for an upcoming post comparing appreciable structures to the alternative.

You may love your home, but it’s a little small and not meeting your needs any longer, especially with kids that may be involved in remote learning or those of us working remotely from home. I think we can all agree that your square footage may seem to shrink the more time you spend indoors.  

The backyard getaway is a perfect “addition” to your home.  A 200 square foot guest suite, office, recreational shed, or hobby shop can enhance your quality of life at your existing home and will likely promote you staying in that home much longer.  

Regardless of how you structure your real estate portfolio, we wish you all the best.  Should you find yourself in a position to build an accessory dwelling, recreational shed, or detached office, we are thankful you have made your way to Watershed Structures.  Thank you!

We hope you find this information thought-provoking and helpful, but please consult actual professionals for your investments.  We are not financial advisors, mortgage bankers, or appraisers, so any advice, statistics, or dollar figures are anecdotal and come from our own experience as homeowners and observers.

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