How to Unlock Your Home’s Hidden Passive Income Stream (ADUs 101)

Summary

BiggerPockets Real Estate Podcast: Episode Summary Episode Title: How to Unlock Your Home’s Hidden Passive Income Stream (ADUs 101)
Release Date: March 19, 2025
Host: Dave Meyer
Guest: Derek Sherrill

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1. Introduction to ADUs

The episode kicks off with host Dave Meyer introducing the concept of Accessory Dwelling Units (ADUs) as a lucrative avenue for generating passive income from residential properties. Dave poses the idea that homeowners might already have untapped income streams in their basements, garages, or backyards through ADUs.

Notable Quote:
Dave Meyer [00:00]: "There may be a hidden passive income stream in your basement right now or in your garage or your backyard."

2. Understanding ADUs

Brandon Turner elaborates on what ADUs entail, describing them as second living spaces on a property. These can range from converted basements and attics to tiny homes in backyards or detached units built from garages.

Notable Quote:
Brandon Turner [00:07]: "ADUs can mean putting a tiny home in your backyard or converting your garage into a separate unit."

3. Introducing Derek Sherrill

The podcast welcomes Derek Sherrill, known as "the ADU guy," who has been involved in ADU development since his high school days in 1996. Derek shares his mission of promoting affordable and profitable real estate through open-source ADU plans available on his website and YouTube channel.

Notable Quote:
Derek Sherrill [02:24]: "We give away free plans all over the country. We teach people how to build the plans that we give away via our YouTube channel. And we don't sell anything. We're truly just here to help people build more attainable infill housing."

4. The Appeal and Growth of ADUs

Derek discusses the unique advantages of ADUs, emphasizing their role as a bridge to multifamily development in low-density neighborhoods. He highlights the financial benefits, such as the ability to secure long-term fixed-rate mortgages and inherent cost savings from pre-existing utilities and land ownership.

Notable Quote:
Derek Sherrill [03:14]: "ADUs are the training wheels to development. Most of the utilities are already there, providing significant cost savings."

Brandon adds that ADUs are particularly attractive in today’s market where cash flow is harder to achieve, making ADUs a compelling addition to existing rental properties.

5. Current Market Trends and Zoning Reforms

The discussion shifts to the recent sweeping zoning reforms across multiple states aimed at addressing the housing affordability crisis. Derek underscores that outdated zoning laws have historically restricted housing supply, and state legislatures are now mandating more ADU-friendly regulations to increase affordable housing availability.

Notable Quote:
Derek Sherrill [09:56]: "State legislators are stepping in, saying cities have failed to manage housing effectively, and they're enforcing model codes to facilitate ADU development."

Brandon emphasizes that ADUs are filling a critical void by increasing housing supply, thereby moderating price growth and providing more attainable housing options without relying on traditional subsidized models.

6. Financing ADUs

A significant portion of the episode delves into the financing mechanisms for ADU projects. Derek shares various strategies, including leveraging home equity lines of credit (HELOCs), construction loans, and private financing options. He explains the importance of maintaining good relationships with lenders and ensuring a solid repayment plan to manage short-term interest-only debt effectively.

Notable Quote:
Derek Sherrill [29:10]: "Use a combination of construction loans, bridge loans, or home equity lines of credit. The hardest part is getting the project done, but once you have the asset, it's easy to recoup your investment."

Brandon and Derek discuss practical steps for financing, such as starting with a minimal down payment on the primary property and utilizing personal or private funds to finance the ADU construction.

7. Building Strategies and Cost Management

Derek offers valuable insights into cost-effective ADU construction, advocating for simple, rectangular designs to minimize expenses. He warns that each additional architectural complexity can significantly inflate costs, recommending standardized designs to achieve economies of scale and streamline the building process.

Notable Quote:
Derek Sherrill [33:18]: "Start with a simple design. Every corner added to a rectangular ADU can cost at least $10,000 more."

He further advises self-managing projects where possible and maintaining consistency in fixtures and materials to reduce maintenance complexities and costs.

8. Implementation Tips for Investors

Derek provides actionable advice for investors looking to implement ADU strategies, emphasizing the importance of understanding local zoning regulations and building relationships with city planners. He encourages investors to utilize resources like pre-approved ADU plans to expedite the permitting process and reduce costs.

Notable Quote:
Derek Sherrill [16:48]: "Look for cities that already have pre-approved accessory dwelling unit plans. It streamlines the process, saving time and money."

9. Potential Returns and Case Studies

The guest highlights impressive return on investment (ROI) figures, showcasing projects where ADUs built for approximately $100,000 can generate rental incomes ranging from $1,600 to $1,800 per month. He contrasts high-cost markets, where ADU construction can reach $400 per square foot, with more economical builds offering substantial cash-on-cash returns for investors.

Notable Quote:
Derek Sherrill [23:18]: "We're building ADUs for $100,000 valued around $350,000 to $400,000, renting for $1,600 to $1,800 a month. That's insane."

Derek also shares his streamlined process, achieving construction and stabilization of ADUs within 90 days, underscoring the scalability and efficiency of his approach.

10. Conclusion and Key Takeaways

Wrapping up, Derek reiterates the dual benefits of ADUs for investors: enhancing property value and contributing to the affordable housing supply. He encourages listeners to educate themselves on local zoning laws, adopt simple and repeatable building designs, and maintain strong financial planning to optimize their ADU investments.

Notable Quote:
Derek Sherrill [38:07]: "The relationship with the lender is really important. When using a HELOC, have a solid repayment plan to avoid long-term interest debt."

Brandon and Dave thank Derek for his invaluable insights, highlighting the transformative potential of ADUs in the current real estate landscape.

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Key Insights and Strategies:

• ADU Definition and Types: ADUs can be separate units like tiny homes in the backyard, converted garages, or additional living spaces within existing structures.

• Market Opportunity: ADUs address the housing affordability crisis by increasing supply without the need for large-scale multifamily developments.

• Zoning Reforms: Recent legislative changes in several states are making ADU development more accessible by standardizing and simplifying zoning regulations.

• Cost Efficiency: Simple, standardized ADU designs significantly reduce construction costs and facilitate quicker builds.

• Financing Options: Utilizing HELOCs, construction loans, and private financing can effectively fund ADU projects, especially when combined with strategic property acquisitions.

• Scalability: Consistent building practices and design standardization enable investors to scale ADU projects efficiently, maximizing returns and reducing operational complexities.

• High ROI Potential: Properly executed ADU projects can yield impressive cash-on-cash returns, often surpassing traditional rental property investments.

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Conclusion:
This episode of the BiggerPockets Real Estate Podcast provides a comprehensive guide to leveraging ADUs as a powerful tool for generating passive income and expanding real estate portfolios. With expert advice from Derek Sherrill, listeners gain valuable knowledge on navigating zoning laws, financing construction, and implementing cost-effective building strategies to maximize returns and contribute to the growing need for affordable housing.

Transcript

[Dave Meyer]

There may be a hidden passive income.

[Brandon Turner]

Stream in your basement right now or in your garage or your backyard.

[Dave Meyer]

Today, we're breaking down one of the.

[Brandon Turner]

Most powerful ways to add cash flow to your investment properties or even your primary home.

[Dave Meyer]

What's up, everyone? I'm Dave Meyer, and this is the BiggerPockets podcast where we teach you how.

[Brandon Turner]

To achieve financial freedom through real estate investing.

[Dave Meyer]

Today, we're talking about accessory dwelling units, or ADUs.

[Brandon Turner]

And if you're not familiar with this.

[Dave Meyer]

Term, it just means a second living.

[Brandon Turner]

Space on one property that could be.

[Dave Meyer]

Closing off a basement or an attic.

[Brandon Turner]

To make it into an apartment.

[Dave Meyer]

It can mean putting a tiny home.

[Brandon Turner]

In your backyard or converting your garage into a separate unit. And this strategy has the potential to.

[Dave Meyer]

Massively improve the earning potential for any property. Just think about it. Creating an ADU can be as simple as putting up a couple of walls, and it can add an entire new rent check into your pocket every month.

[Brandon Turner]

Joining us on the show today is Derek Sherrill. You may know him as the ADU guy.

[Dave Meyer]

He's an investor who built his first.

[Brandon Turner]

ADU when he was still in high school nearly two decades ago, and has been leading the charge on this affordable.

[Dave Meyer]

And profitable real estate venture ever since.

[Brandon Turner]

Derek is going to explain to us.

[Dave Meyer]

How to find properties that are undervalued.

[Brandon Turner]

Because of their hidden ADU potential. Share which ADU options can generate the most revenue for the lowest cost and much more.

[Dave Meyer]

All right, let's bring on Derek.

[Brandon Turner]

Derek, welcome Back to the BiggerPockets podcast. It's great to have you here.

[Derek Sherrill]

Thanks for having me. Glad to be back.

[Brandon Turner]

Could you just give our audience, for anyone who hasn't listened to some of your previous episodes, just a brief intro to you and your investing career.

[Derek Sherrill]

Yeah, Real quickly, guys and gals out there. We plan, design, finance, build and hold accessory dwelling units, Also known as ADUs. Participated in my first ADU build in 1996 in this small southern Oregon town. And our goal now is to influence as much housing as we possibly can. And then when I die, I'm going to give it all away. And we do this through open source. So we give away free plans all over the country. We teach people how to build the plans that we give away via our YouTube channel. And. And we don't sell anything. You're not going to get an email from me. We truly are just here to help people build more attainable infill housing.

[Brandon Turner]

You were way ahead of the curve on ADUs because they've been getting popular at least from my perspective in the last few years. But you were several decades ahead. But can you tell everyone how you got started on your first one?

[Derek Sherrill]

I had a high school wood shop teacher, John Wesson was his name, and he handpicked a group of misfit kids that he knew probably weren't going to go straight to college. And he taught us a skill and he got this group of kids together, me being one of them, and we built an illegal ADU for another one of our high school teachers and I got the bug instantly. I started an apprenticeship in high school, became a licensed contractor shortly thereafter, and the rest was history.

[Brandon Turner]

For those people who don't know what an ADU is, it stands for accessory dwelling unit. But tell us a little bit about this asset class in particular, Derek. Like what about it is so interesting to you and why is it getting popular right now?

[Derek Sherrill]

What's unique about this asset class is it's really a hack to building small multifamily in A, a residential low density neighborhood that couldn't be construed as maybe more popular place to live. B, it can be financed residentially so you're not having to compete with, you know, resetting debt or variable rate debt. You can get long term, 30 year fixed rate mortgages on this product. And there's a lot of land. And the biggest benefit to this strategy is it's the training wheels to development. And most of the utilities in most cases are already there. So you get this huge cost savings and then on top of that you already own the land. So those are a few of the benefits. And I'd say one more kind of sneaker benefit is it's still an underutilized strategy. So there's, I think there's a lot of room for upside in the next five to 10 years.

[Brandon Turner]

And just for everyone listening, at least in my opinion, the most common way that people employ an ADU strategy is you buy a single family house or a duplex where there is zoning upside. We've talked a lot about this on the show recently is like trying to find opportunities and properties where the current usage of the property is not up to the maximum allowable buildable space.

[D]

Right?

[Brandon Turner]

So maybe you have a single family and you're allowed to build two units or they have a specific provision that allows for accessory dwelling units or detached dwelling units. And as Derek said, what's so cool about it is like if you could buy a property that's a rental property, that makes sense. Just as is the incremental benefit to adding an ADU Just seems so appealing because everything you just said, you already own the land, you already have the utilities running there. And so it just seems like the return you can generate on this incremental investment seems really compelling, especially in today's day and age where it's harder to find cash flow.

[Derek Sherrill]

Yeah, I couldn't agree more with everything you said, with the exception of one little piece where the primary house has to make sense.

[Brandon Turner]

Okay.

[Derek Sherrill]

And as I look back on most of our data, a lot of what we're buying, the primary house doesn't make sense as a rental. It doesn't cash flow, it doesn't even break even in most cases. And I have this argument all the time with people that say never ever buy a cash flow negative house. That is unless the upside is so great and your financial position can withstand a little bit of a loss on the front side because the value add on the back is so great. Everything that you said I agreed with, except for the primary having to make sense.

[Brandon Turner]

Well, I'm glad you're disagreeing. Let's dig into that a little bit. So when you're saying you buy this stuff where the primary doesn't make sense, given your business, you just know that you're going to do an adu. So does that mean within a year it makes sense or two years or like what sort of timeframe do you give yourself to turn it into a performing asset?

[Derek Sherrill]

So everything we're doing is turned and stabilized and has long term fixed rate debt in a year or less.

[Brandon Turner]

Okay.

[Derek Sherrill]

And so I know my upside is soon and the things that are really important for the upside and why I care less about how the primary house performs is, is the primary house in most cases is collateral damage to a few things. First and foremost always is location. Second is going to be access and then third is going to be infrastructure. So there may be a house that sat on the market for a while that's way overpriced, that would not work as a flip, it would not work as a short term rental. It definitely wouldn't work as a long term rental. But it has alley access, it's a few blocks from downtown and there's a brand new sewer main with stubs to the sidewalk and there's already a water meter in. So I come in there with what I call my ADU goggles. And if you guys aren't watching on YouTube right now, you can see these. If you're on a podcast, I'm putting on my $5 science class goggles. And, and what I want People to take away from this. This point is that you have to look at properties different. These are my ADU goggles. I show up and I look at a property through a different lens. And most of it is how do I save money in the long run? By good infrastructure, good access and good location. So that's why the primary house is less important. And then for kind of the icing on the cake of this strategy, if you're in an area that has a zoning upside as we go through this sweeping zoning reform across many states right now, a lot of states are now allowing you to sell these assets. So having the upside of potential a lot more value add when it's on its own tax lot is also a big piece of the puzzle of why the primary has less value in the initial underwri.

[Brandon Turner]

Yeah, I think with that case we agree. I've been saying on the show for the last couple months now, talking about upside in different ways to find properties right now that if you could stabilize something within a year or so, like that's a good deal. It's not any different than doing a burr right when you buy a brrrr property, it's not going to perform right away. And so it's just about getting it to perform in a reasonable amount of time. And if you're doing that within a year, that's I think a pretty good timeline if the numbers make sense at the end of the day.

[Dave Meyer]

So can you just tell us a.

[Brandon Turner]

Little bit about the sweeping zoning changes you kind of alluded to just a minute ago? And one of the main reasons we wanted to have you back, because it's.

[Dave Meyer]

In the news everywhere right now. Can you just tell us a little.

[Brandon Turner]

Bit more about like what's driving this renewed or sort of increased interest in ADUs nationally right now?

[Derek Sherrill]

Yeah, for sure. There is, like I said, sweeping zoning reform coming across the western states. It's in the sun belt, it's on the east coast as well. Right now we have eight states with overarching outright awesome ADU law. And the main driver is, is pretty blunt. Cities in high priced areas have done a crappy job for the last 50 years when it comes to their zoning laws, when it comes to their comprehensive plans, when it comes to inclusionary areas. And it's basically made housing more and more and more unaffordable based on the premise of trying to keep riff raff, the poor, the black and the brown out of lower density, higher class neighborhoods. And it's been a massive fail. And we've seen that so now what's happening is state legislators are coming in and they're saying, hey, cities, you've done an absolute insert cuss word here, job of managing housing. And we're going to tie your hands and we're going to make some model code for the state and you're going to have to follow it.

[Brandon Turner]

Yep.

[Derek Sherrill]

So overarching state law is the biggest driver. And it's, it starts with the unaffordability of housing. And I am a proponent of more affordable. I've been a planning commissioner, I'm an amateur planner. I've been literally obsessed with housing for close to three decades. And I'm really careful about affordable housing. So we're creating more affordable. There's two kinds of housing in my mind. There's subsidized affordable and then there's more affordable, more attainable. And because an ADU is on a smaller piece of land and it's, it's a smaller footprint, it therefore is a more affordable, more attainable option.

[Brandon Turner]

That's a really important distinction. I like that you're calling it a difference between affordable housing, which is often used to describe, like you said, subsidized in some way by the public sector, by either local, state, federal government, that sort of affordable housing. But this ADU development strategy that you're talking about is more of a private sector style solution to affordable houses just by increasing housing supply, which in theory will at least moderate price growth or just sort of fill a void in the housing market these days because traditional developers just are building fewer and fewer smaller homes, fewer and fewer traditional starter home style properties. And so ADUs seem to be filling that void for a lot of people.

[Dave Meyer]

All right, Derek, I want to hear.

[Brandon Turner]

A little bit more about how people can implement an ADU strategy. But first we have to take a quick break. We'll be right back.

[Dave Meyer]

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[Dave Meyer]

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[Derek Sherrill]

Foreign.

[Brandon Turner]

Welcome back to the Bigger Pockets podcast here with Derek Sherrill. Talking about ADUs before the break, we were just talking about why ADUs are getting so much attention these days. Derek, tell us a little bit about now, how you see investors taking advantage of some of these trends. And if there are investors listening who want to turn a profit and help provide more affordable housing in their communities.

[Dave Meyer]

How do you recommend they get started?

[Derek Sherrill]

I would say the best way to get started is to familiarize yourself with the zoning regulations in the market you're trying to invest in. And this goes back to one of my friends, Henry Washington. He says this is a people business. People think it's a real estate business, but it's not. It's a people business. So you have to know the people. And when I say people, I'm talking about the planners. Okay, Call the city planning and zoning office and say, hey, I'm a local investor new to this market. I'm looking to do the ADU strategy. What areas would you shop in? Can you send me a zoning map that shows areas that would be a good spot for what we're trying to do? So I would always tell investors to build relationships. In every single market you go into, there's somebody in that market that's doing what you want to do. Find those people, whether they're in the public sector or the private sector. Add value to them if they're private. If they're public, just go ask questions and familiarize yourself with the zoning regulations. Again, I don't want to put anybody to sleep with the Z word, but that's where it starts. I mean, you could have the best location. You could have a suitcase full of money. But if the zoning regulations don't allow you to complete your strategy, you're barking up the wrong tree.

[Brandon Turner]

And is there anything in particular people should be looking for in the zoning regulation? Obviously you're looking for permission, right, that ADUs in general are permitted. But are there certain states or Regulations or provisions that you think make ADUS easier than other types of implementations right now?

[Derek Sherrill]

Yeah, yeah. I'll go over some things to look for. So we're looking for codes that don't have off street parking requirements, we're looking for codes that don't have residency requirements. Those are a couple of poison pills in the ADU community. And then the best way to figure out if the city is really ADU friendly is just to ask them how many accessory dwelling unit permits they've granted in the last year or the last biennium or whatnot. If it's two, that's going to be a tough market. If it's Seattle and they're like, we gave out 25,000 sets of plans last year and 19,000 of them were for ADU related builds, you're in the right spot. Another thing that I always tell investors to look for is look for cities that already have pre approved accessory dwelling unit plans. And what that allows you to do is completely streamline the process, save time and save money. And it may not be your exact design and you still have to go through the zoning process of plotting that footprint on the land that you want to build it. But when cities have free pre approved ADU plans, you know, they're ADU friendly.

[Brandon Turner]

That's really good. And can you just find that on a, on a local website?

[Derek Sherrill]

Yeah, you can find it on a local website. If I'm looking at, let's just say Austin, I'll just, I'll just type in Austin ADU program and it'll usually take you to a city site. And within 30 seconds an average intelligence person such as myself can find out if they have a program or not.

[Brandon Turner]

For sure.

[Derek Sherrill]

But never be afraid to call the planning and zoning office and ask them for advice or ask them for resources.

[Brandon Turner]

Awesome. That's great advice. And I would imagine when you, when you do find these places, they're supportive. But are there contractors or builders who specialize in these plans? Because I would imagine as a contractor you can make a pretty good business like really getting good at these pre approved plans.

[Derek Sherrill]

There should be, I will say, unfortunately the public private partnership is pretty sparse. And that's because a lot of cities, probably rightfully so, don't want to endorse any individuals.

[Dave Meyer]

Sure.

[Derek Sherrill]

But always ask the planners. You know what architects do you like what builders get their plans submitted with just one try. So they're not supposed to tell you. But again, it's a people business. And if you're personable and you ask good questions, they'll help you.

[Brandon Turner]

So that's great, that's awesome to know. On the zoning side, what about on the property side? Because it seems to me, you know, I live in Seattle now that there is all sorts of different things. Like when I was investing mostly endeavor, you saw a lot of basement conversions or simple stuff like that. Whereas here you see full on detached 1200 square foot houses being built as ADUs. So what do you find Derek, is the most economical way for people to get into the ADU game?

[Derek Sherrill]

The most economical way to get into the ADU game is by far to buy a primary single family house with some sort of functional obsolescence or split level layout where you can convert a section of that primary house into a legal separate unit. My favorite is look for a house that has a master bedroom and bathroom on one side with an exterior entrance. You simply do some fire and life safety wall work. You, you do a fire separation wall, you pull the permits and you can easily turn a standard house into a shared wall. Side by side duplex, that is by far the easiest. If the basement already has exterior access egress windows in a bathroom, that's not a bad option. So that's by far the most affordable. That's where I teach all the first time home buyers to look. You're literally shopping for a duplex that nobody else can see. Again, ADU goggles, come on. So that's the most economical and I would say the most economical and then like the most upside are complete different sides of the scale. So the, the best investment in my opinion is going to be to buy a property that has room to build or convert a standalone detached accessory dwelling unit. Okay folks, Tenants want the same things that homeowners want in this order. They want location, they want privacy and they want amenities. And I'm telling you, we're seeing this already in lots of markets. There's more multifamily than ever being built. There's all this absorption that's taking place. There's major concessions. If you have a shared wall or an over under adu, you're competing with most of the multifamily. If you have a standalone product with privacy, they have their own little sitting area, maybe they have a fenced yard. You, you are going to have what we like to call a really high demand, low supply product. So although it's a lot more money to build a new standalone unit, it's going to be way more valuable. You're going to have way more tenants and you're also going to potentially, if you don't already have the option to split it off and sell it or to split it off, refinance it on its own note because it's its own piece of land and really scoop massive leverage.

[Brandon Turner]

Awesome. Yeah, I see these popping up all over in Seattle. They're very popular here, but you see them in other markets too. And I'm always just curious like how much they cost to build. And I'm sure it's very regional but do you have any ballpark numbers for it?

[Derek Sherrill]

Yeah, I'll give you some really good examples. So I'll give you the Spectrum. So I'd say in high value markets, let's just say Southern California, San Diego, Austin, Texas, Seattle, Washington, we're seeing three to four hundred dollars a square foot as kind of a semi custom builder grade. For example, a lot of places allow you to build up to 1,000 square feet and we're seeing those cost anywhere from 3 to $400,000. And that's hands off as an investor hiring a contractor through relationships to get decent volume pricing.

[Brandon Turner]

Okay.

[Derek Sherrill]

And then on the other end of the spectrum, we owning construction and planning, designing, financing, building and holding affordable, simple designed ADUs. We're building ADUs for $100,000.

[Brandon Turner]

Wow.

[Derek Sherrill]

And bigger isn't always better. You know our number one unit and this is a unit that we give away. You can go to that ADU guy dot com. The free plans are on the top of our website, big red tab. And we're building these 600 square foot ADUs for $100,000. They're valued around 350 to 4 and they rent for anywhere from 16 to $1800 a month. So what?

[Brandon Turner]

That's insane.

[Derek Sherrill]

The spectrum is 100,000 to 400,000. Bigger isn't always better.

[Dave Meyer]

Derek, I do want to ask you.

[Brandon Turner]

More about those numbers because let's dig into those and just like actually figure out what kind of returns you can get here because they seem crazy. But we do have to take a quick break. But before we do go on break, I wanted to ask you. We just put bpcon tickets for sale up early. Birds are out right now and I understand you're coming this year to Vegas and you're going to be speaking. Can you tell us a little bit about what your session is going to be on?

[Derek Sherrill]

I'm going to be talking about 80 years, everything about them, how to look for them, how to build them, how to find properties and how to drive profit while adding needed infill housing. So I'm really humbled to be asked back for the third straight year and I can't wait to meet you in person.

[Brandon Turner]

Awesome. Yeah, well very on brand for you. Still talking about if you want to.

[Dave Meyer]

Check out those early bird tickets, make.

[Brandon Turner]

Sure to go to biggerpockets.com conference and get your early bird ticket today. We'll be right back.

[Dave Meyer]

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[Dave Meyer]

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[Brandon Turner]

Welcome Back to the BiggerPockets podcast here with Derek Sherrill. Talking about Adus. Before the break he shared some some insights into numbers. And just as a reminder, you're saying that sort of high price markets you could expect to pay 3 to 400 bucks a square foot. But you're able to build some properties at $100,000 that we're renting for 16 to 1800 bucks a month, which is crazy, right? I mean that those are just remarkable numbers. Even if you bought that for cash, that's a 20% cash on cash return. So can you just tell us maybe first and foremost, like how do you finance these deals? Are you building them and buying them for cash or are you able to get a loan to build an ADU multiple ways?

[Derek Sherrill]

And I want to say this for our new investors out here. I want to give some clarity. So I'm still to this day house hacking. I could live anywhere I want, in any neighborhood, in any house, and I still house hack. So the best way is to just buy a primary house and then find a way to get the money. There's a ton of products that are popping up every day similar to a construction loan or to a bridge loan. There's some really good ones where they'll give you maybe 100% loan to value on the unbuilt ADU based on your plan set and an appraisal when it's finished. The hardest part is getting the project done. Once you have the asset, it's really easy to get your money back. I mean it's the simplest brrrr ever. Yeah, it's the simplest refi ever. I mean we're able to build so much equity into these and as long as you don't over design, over build and overspend, I mean we're getting 100% of our money back every single time on assets that still cash flow. So when you mentioned the 20% cash on cash, if we were going to use just a cap rate model where you're paying cash, well, we're making infinite return because we have no money in the deal. And it's also a brand new asset that has very little to no capex or maintenance for a long time. I'm not trying to be biased here, but I'm super biased. This is an amazing product.

[Brandon Turner]

So you are trying to be biased.

[Derek Sherrill]

Oh yes. And more people need to hear about this. And again folks, I've got nothing to sell. Like I literally train my competition for free. I just couldn't be more bullish right now on this asset class.

[Brandon Turner]

In my head, I'm trying to think about the order of operations here. So does that mean if you're trying to get a single family, do you buy the single family and finance it and then try and get a secondary loan? Are you Saying that maybe you bring your plans to your purchase mortgage and try and get all the financing done at once up front.

[Derek Sherrill]

My theory is put as little as you possibly can down with the primary purchase. 3.5% FHA or 5% conventional or 0% if you're a service member. Thank you. And then use the cash reserves. You have to build the ADU because you're really going to want to refinance out when you're done with the adu, especially if it's on the same lot. Yes, there are products you can show up to a closing table. Talk to your lender. If your lender doesn't know anything about a 2 or 3k loan or a construction improvement loan or what we call like a bridge build to fixed rate loan, which is where you close a loan with one closing fee, one signing and you have renovation money and like maybe a year long time to do that and then you have the long term fixed rate product that it rolls into. You're going to have to use a combination of one of those. But I just want to tell people that the good old fashioned hard work way is how I started and is how I still do it. So buy a house low down, save up to build the adu. You might have to get creative. Call a family member that has money. A lot of employer sponsored plans will let you borrow 50% up to 50k from your 457 or your 401k. You can also use a private loan. You can use a credit card if you have good credit and you can get, you know, no interest for 18 months. Do whatever you can. It's usually a financial stack of multiple different sections of money to build that unit. And then when you're done, you have this new value just like a brrrr. I call it, call it a builder.

[Dave Meyer]

It is.

[Brandon Turner]

I mean the idea behind it though is. Exactly.

[Derek Sherrill]

Yeah. And it's, it's a slam dunk. It's so much easier than a remodel. Some of my big investor friends, you know that flip 200 houses a year, they're getting into development and they're, they're sending me texts just like, oh my gosh, now I get it. Like it's just so much easier. There's so many less variables because it's repeatable, right? Oh, it's a lot more scalable, it's a lot more repeatable and there's just so many less variables. You don't have surprises when you're building new standalone construction.

[Brandon Turner]

Yeah. And I imagine it's awesome. That you give away these plans for free. I'm looking at them right now. They literally, you can just go get them on Derek's website. Well, if you're just doing this in a neighborhood, you building the same thing over and over again. So like, you obviously learn how to do it well. The people who are building it learn to do it it well and you just get much more efficient, I imagine over time.

[Derek Sherrill]

That's exactly right. I'll give everybody my three tips to saving money on your ADU build. And it's, it's, it's easier than you think. It's one is start with a simple design. Okay. A rectangular structure, A single, you know, gable roof or a flat shed roof. Every corner we deviate from a rectangle is a minimum of $10,000. So start with a simple design.

[Brandon Turner]

Wait, say that again.

[Derek Sherrill]

Every, every corner we add to a rectangle is a minimum $10,000 costs. So if you have a rectangular ADU and you're like, well, I want mine to have a bump out or I want it to be an L shape, or I want it to look like a snout house or I want to do a pop out, you know, you've got more siding, more corners, more trenching, more gutters, more roof line, more labor, more everything. And just because it's a simple design doesn't mean they don't look custom or cool or tenants don't love.

[Brandon Turner]

Sure.

[Derek Sherrill]

So anyways, start with simple design. Self manage the project if possible and do as much of the physical work as you can yourself. And again, for the non builder people, that doesn't mean you can't do dump runs on the weekends. It doesn't mean you can't do the landscaping or paint or do a bunch of things to save costs. But yes to your original question, by building the same thing over and over and over, we get this kind of economy of scale. We don't have any decision fatigue. And then we're building property management into our units. So we keep all these. And if somebody calls in with a leaky faucet, we don't have to guess what cartridge it is. We use the same faucet all the time. We give away all of our resources there too. There's a shopping list on our website where you can see all the fixtures and knobs and appliances we use, but we just keep it simple. The crews know how to build them, we know how to manage them, and then the only thing we change is the location orientation and the color.

[Brandon Turner]

Yeah, I would imagine that you and your team can Build these things in your sleep now because you've done it so many times.

[Derek Sherrill]

Yeah, our goal always is 90 days. We build two at a time in 90 days. We just did four and just over 120 days. But if, if we're breaking ground and we're not handing keys to a tenant 90 days later, I'm not happy.

[Brandon Turner]

Wow, that's super impressive. That's, that's faster than any flip that most people can do when you annualize your return there. I'm sure it's very, very good. One thing we haven't talked about, Derek, but I assume it's sort of the same principle here is adding an ADU to properties that you already own. Because this is sort of what at least personally has attracted me to it because I own some properties that do well right now but have the ability to add ADUs. And I'm thinking to myself, I could probably build this for $150,000. I can probably use a line of credit to finance it and I can lease it out for probably 1200 bucks a month in this market. And so, you know, even if I finance it to keep 20% down, that's 30 grand I'd have to keep into this deal and I'm going to be making 15 grand off of it a year. It's like a 50% cash on cash return for that portion of my investment. It's crazy. So is this taking off as well that investors with existing portfolios are doing this too?

[Derek Sherrill]

Yeah, yeah, it is. A lot of the calls I get and emails and DMs daily are for, for that same exact question is, hey, I've got a couple of properties in a good spot that are flat with good access and as opposed to going out and trying to buy something else, I'm just going to improve what I have. Yeah, that's a great investment. And you know, a few years ago I would say just do a cash out refinance, lock it in and get your build money there. But the home equity line of credit is amazing. It's my secret weapon. When I say I'm building with cash, a lot of my cash is just interest only home equity secured to properties that I own. So, you know, we've got a big HELOC that's at like seven and a half percent. It's, it's prime, it's at prime rate and it's interest only. So we'll go, we'll pull the HELOC on a build and because it's a month late, will build the unit. We'll occupy the unit, we'll refinance the unit. And a lot of times we only pay debt for two and a half months. So on a hundred thousand dollar ADU at seven and a half percent, it roughly costs us three thousand dollars to build a hundred thousand dollar asset that appraises at $400,000.

[Brandon Turner]

It's insane. Wow.

[Derek Sherrill]

You know, I get a lot of flack for giving a lot of stuff away. And like in my mind and in my heart, like I just sometimes feel like I'm cheating. It's like how could I not give all this stuff away? I can't believe we're able to do this. So the home equity is very, very, very, very powerful. But you have to have a plan on the back end to refinance it. And more importantly than the plan, everybody can have a plan. You have to be able to execute. You've got to be lendable, you have to have a good debt to income ratio. Don't go build your first adu, get this big rent check and go buy a brand new Toyota Tacoma and crush your dti.

[Brandon Turner]

Yeah.

[Derek Sherrill]

So the relationship with the lender is really, really important. So when you're using the heloc, how do you pay the HELOC back? Because we don't like interest only debt long term. That's a short term play.

[Brandon Turner]

Great. Very practical advice, Derek. Thank you. I think that financing piece is going to be super important for a lot of people who are thinking about how to do this. HELOC is a great way to do it. Highly recommend thinking about that. This is kind of a perfect situation for when you want to use a line of credit for these like short term types of investments. Derek, this has been super helpful. Thank you so much for sharing all of your knowledge before we get out of here. You know you mentioned that a bunch of states have done this and they might be coming to more near you. Can you tell us, do you know like off the top of your head the states where this is more achievable than others?

[Derek Sherrill]

Oh yeah, home run states right now. Oregon, California, Washington, Arizona, Montana, Connecticut. Oh wow. Most of Texas, not state of Texas, but most of Texas. So there's, there's about eight right now that have overarching state law with about 10 or 15 in the works. And my prediction is that in the next maybe five to eight years it'll be half of the country.

[Brandon Turner]

Yeah, the trend just seems to be going in this direction. Like you hear more and more even if they're not at states like you said, local levels. A lot of municipalities are encouraging this because honestly, people don't have that many other ideas to create more affordable housing, and this is one that has been proven to work. And so I would expect that people will scale it. And as Derek has shown us today, it makes sense on both sides, right? It makes sense from a investor standpoint and it hopefully is going to also create some more affordable housing, as Derek had said. Well, thank you so much for being here, Derek. We really appreciate your time and I look forward forward to seeing you at bpcon later this year.

[Derek Sherrill]

Awesome. Thanks for having me, folks.

[Brandon Turner]

Thanks again for watching. We'll see you next time.

[Dave Meyer]

Thank you all for listening to the Biggerpockets Real Estate Podcast. Make sure you get all our new episodes by subscribing on YouTube, Apple, Spotify.

[Brandon Turner]

Or any other podcast platform.

[Dave Meyer]

Our new episodes come out Monday, Wednesday and Friday. I'm the host and executive producer of the show, Dave Meyer. The show is produced by Ian K, Copywriting is by Calico, content and editing is by Exodus Media. If you'd like to learn more about real estate investing or to sign up for our free newsletter, please visit www.biggerpockets.com.

[E]

The content of this podcast is for informational purposes only. All host and participant opinions are their own. Investment in any asset, real estate included, involves risk, so use your best judgment and consult with qualified advisors before investing. You should only risk capital you can afford to lose, and remember, past performance is not indicative of future results. Biggerpockets LLC disclaims all liability for direct, indirect, consequential or other damages arising from a reliance on information presented in this podcast.