How to Add Units to Your Portfolio, Without Buying More Properties—With “That ADU Guy,” Derek Sherrell

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How do you add more units to your existing portfolio, without buying more properties? You master the art of Accessory Dwelling Units (ADUs)! ADUs are additional units that many cities and towns allow you to add to your existing single family homes. In this episode, Jeff interviews Derek Sherrell, known as “That ADU Guy.” Derek is a passionate advocate for ADUs, and an extremely knowledgeable resource about all aspects of them. In this conversation, Jeff and Derek discuss a wide range of ADU topics, from how to find the right properties, to important construction considerations, to financing strategies and more!

Episode Transcript

But again, none of these have to do with with price like I’m never ever looking at the price. When I find out that it meets all of these criteria, that’s when I work backwards to the price and, and what what I like to talk and share about the strategy is we can pay more. Like we don’t have to get a deal like everybody’s looking for a deal, I pay more, I pay more than then people want for their property A lot of times because I know the potential that it has. So we get so focused in in real estate on price and getting good deals and I need an off market seller and how to lowball I’m like that’s not the case in this strategy if if all the kind of pegs fit, and there’s a pretty easy roadmap to a second or third unit, I like to offer and pay more

Jeff Stephens 

welcome to racking up rentals, a show about how regular people, those of us without huge war chests of capital or insider connections can build lasting wealth acquiring a portfolio of buy and hold real estate. But we don’t just go mainstream looking at what’s on the market and asking banks for loans. Nor are we posting WE BUY HOUSES signs we’re just looking for quote, motivated sellers to make lowball offers to. You see we are people oriented deal makers. We sit down directly with sellers to work out Win Win deals without agents or any other obstacles and buy properties nobody else even knows are for sale. I’m Jeff from the thoughtful real estate entrepreneur. If you’re the kind of real estate investor who wants long term wealth, not get rich quick gimmicks or pictures of yourself holding fat checks on social media. This show is for you. Join me and quietly become the wealthiest person on your block. Now let’s go rack up a rental portfolio. Hey, thank you for joining me for another episode of racking up rentals. Show Notes for this episode can be found at thoughtful our e.com/e 151 Please do us a big favor by hitting that follow button or subscribe button or whatever it says in your app. These days. It really really helps fellow thoughtful real estate entrepreneurs to find this show. Onward with today’s episode and in today’s episode, I’m really pleased to bring to you an interview I just did with my new friend Derek Sherelle. Derek and I were both presenting at a conference recently called the Northwest action Summit. And Derek is known as that adu guy. Now what’s an adu? Well, Derek is going to explain it to you. But it’s an accessory dwelling unit, it’s an additional unit that you can often have at a single family home. And building ad use. It can be an excellent, excellent strategy that I’ve personally used myself multiple times to really expand your portfolio without buying more properties. And so Derek has just a wealth of knowledge about this topic, but also a real passionate advocate for ad use and how they sort of fit into the housing ecosystem, and the overall landscape. So without further ado, I’m going to tee up this interview right now between me and Derek Sherelle. That adu guy. All right, Derek, thanks so much for joining me today.

Glad to be here. Glad to help. Yeah, I was

Jeff Stephens 

excited to see that you were on the docket of the Northwest action Summit, where you and I both presented last weekend, because I just think this topic of, of ad use is something that is still maybe a little bit more underground than it needs to be. And I think a lot of real estate investors can really benefit from figuring out how they can incorporate this into their investing strategy. So I’m excited to chat with you.

Outstanding, yeah, let’s let’s dig into it. I couldn’t agree with you more.

Jeff Stephens 

Yeah. So I guess just for context. What is an adu for somebody who’s not maybe 100% sure what this means first off.

Yeah. Great question, Jeff. So I’ll just give you a quick flyover view an accessory dwelling unit is a second. This is most the most important point legal dwelling on a lot that’s primarily been reserved for single family housing. So it’s not a multifamily setup. It’s not multiple houses on a multifamily lot. It’s a second legal dwelling on a lot that’s been reserved primarily for single family housing. And I call it the backdoor to an affordable duplex.

Jeff Stephens 

Yeah, yeah, absolutely. I’m actually excited and a little bit I want to chat about kind of the distinction between duplexes and ad use and how maybe they’re a little bit of a chameleon that like in some ways you can sort of argue they’re one in some ways you can argue there and other but what we can circle back to that so how did you kind of is your that adu guy, right? How did you? That doesn’t happen by accident, right? Like how did you first fall in love with the concept of ad use and become such an advocate for him?

Well, I started my adu journey in 1996. As a curious high school students, I had a woodshop teacher that kind of took me under his wing. He started a Construction Technology class and there was about 10 or 12 of us he put together a group of kind of troubled kids You will. And we built an illegal accessory dwelling unit for one of our other high school teachers. And so that was my first experience with the adu strategy. And for better or worse, I kind of tunnel visioned into the process, the art of building it, the art of planning it. And from there, I started a carpentry apprenticeship, I got my license as a builder right after high school. And I went kind of headfirst into the feast or famine world of contracting at a really young age. And, you know, late 90s, early 2000s. So it was, by necessity that I got into the business, it was how I was able to feed myself. And then over time, I just continued to hone it went from an interest to an obsession, and I really have been just laser focused, for better or for worse, again, on this one strategy that’s really an inch wide and several miles deep at this point. I’m still learning, not going to call myself an expert. But I will say adu experts usually will call me with their questions. So I’m always glad to help. And I’m always glad to talk to us. Yeah.

Jeff Stephens 

So to say you were an early adopter of ad use is like an extreme understatement. I mean, I feel like I was kind of an early adopter and I was at least a decade later than that it for deep and really come on my radar screen. So that’s, that’s amazing. And then I also I know that like your heart, I guess probably your heart and your mind have have said like, this is actually really a key to housing in the United States. And I know that it’s become a passion for you. So what is it that kind of like got into your soul? And said, like, no, I need to, I need to spread the word on this thing.

Yeah, great. Great. And I’ll be a little vulnerable here, Jeff, you know, it was it was really the lack of affordability that I saw growing up with a kind of a struggling artists single mom, the stuff was hard. And housing was always a challenge. And my family and I moved around a lot as a kid. And it’s something that’s near and dear to my heart, I you know, I do have what I would consider still a lot of privilege. But housing in my my childhood, and my early adult life was really hard. And so now I look at this as a way that I can potentially give back needed, infill housing is something that’s really again, near and dear to my heart. And it also just makes sense. You know, I always like to cover just a brush on demographics, that the American household is changing, we’re not we don’t need 2000 square feet for six people anymore, we really need, you know, most 62% of all US housing right now is filled with two or less people. So this is a strategy that is going to provide more needed infill housing, it’s not affordable, but it is more affordable. And really, the base of your question is because I grew up in apartments, and I never had the opportunity to live in potentially a house that didn’t have shared walls. And I’m looking for, you know, kind of the opportunity to share that with people. So that’s where it’s evolved from it started as a as a build, and a way to feed myself. And it’s kind of turned into what I kind of call advocacy work and outreach. Yeah,

Jeff Stephens 

yeah. Well, when we met the other day, and when I heard your presentation, I was just really clear that it’s it’s such a topic that it’s not just like, oh, this this is kind of what I do, and my brain knows about, but that your heart is really into it. And you believe a lot in it as well. So one of the questions that came to my mind, I wrote it down when I was listening to your presentation. The other day that I saved up to ask today is adu allowances and zoning codes and building rules and whatnot are are very regionalised. Maybe you’d say, right, it’s sort of unique from town to town or state to state. So you know, not that like a scientific answer. But when you kind of look at the whole country, like what percentage of the country as far as you know, our ad use, you know, legal and that there is a code specifically for them. To your knowledge, I’m just wondering, you know, we’ve got listeners kind of all over the place. And this isn’t something that just works in various parts of Oregon. It works in lots of different parts of the country, but like how I have AD use proliferated everywhere at this point.

Yeah, that’s a that’s another great question. So ad use are kind of sweeping across the country. And I one thing that I like to tack on to your last question is, there was also a lot of luck involved in my story. And being in the industry in Oregon, where we were, before we even knew it. We were setting the industry standard on accessory dwelling units. We really are and have a lot of the model code across the country is based on best practices in Oregon and specifically up north in Portland, Oregon. So we have now I would say and this is Don’t quote me on exact numbers, but I would say probably 20% of states have kind of overarching state legislation that says cities and counties you’ve done Have a crappy job the last 5060 years managing long, mid and short term planning, and we’re going to tie your hands and make it easier for housing units to be produced. So with that being said, there’s some really strong accessory dwelling unit states, I mean, Oregon, California, New York, Connecticut, they’re coming into practice every single day. And I’d like to say that COVID Whether it was directly related to the pandemic, or maybe people just had more time, or there was more organized legislation, that really the last two years there’s been some huge growth in this adu opportunity across the country. And to touch on your original question of why is it so different in every area? Because most state laws and most states that implement this are saying, Hey, these are allowable uses in any single family zoning that outright allows a single family house that is dependent on realistic siting and design standards. And that language allows municipalities in ah, jays to kind of put their little twist on there. There’s still a lot of states that haven’t got on board with this. Some of the states that have got on board are making it really easy to permit really easy to build, but they’re putting certain restrictions like parking or residency requirements, or no short term rentals, things like that. So the overall answer is it very, it depends a lot based on area. And I always, always, always, always tell people, and you can’t stress this enough to become an expert in your local zoning code. Because what you can do even one city and an Oregon where at us are very well established, you’re not going to be able to do maybe one city over so state to state county to county, all the way across the country. You know, for investors, a good kind of rule of thumb that I tell people to follow is look for, if you can look for blue areas in red states. And that is probably kind of the home run of a new emerging adu market where you have planning, you have legislators, you have city council members, you have planning commissioners that are pro infill housing, and then you also have overarching state legislation that is a little bit more landlord friendly. And when I say landlord friendly, it’s not like stick to the tenant because that’s that’s not how I feel. I mean, I come from the lens of a tenant and how do we create good housing for our customer without our customer, we have nothing. So when when I say it’s landlord friendly, it just means that it’s easier for landlords to provide really good quality and more affordable, more attainable housing for tenants.

Jeff Stephens 

Yeah, yeah. I remember you saying that the other day, become an expert in your local zoning code. And I feel like that’s something that we don’t talk about enough, probably in the real estate investing community at large, but specifically, even in my community here of thoughtful real estate entrepreneurs, you know, sometimes people ask me like, Well, why do you? Why do you say real estate entrepreneurs instead of real estate investors? And a big part of my answer to that question is I like us to be flexible in maybe different ways that we can identify and capitalize on the opportunity that a particular situation presents and I have always felt I mean, I learned this from my coaches. The person who has the best grasp on the details of the local zoning code is the person who’s going to be able to see opportunity best ran you know the dimensions that are required for this and that and and you will see opportunity where others don’t and to me that’s a big part of like why this is a thoughtful real estate type of a topic is that we can see opportunity where others don’t every other buyer might be just looking at an existing single family house seeing an existing single family house, but your lens or you can call them at what adu goggles the other day, right. Your au goggles. Yeah, I knew they’d be handing the adu goggles, right, give you a totally different perspective on what’s possible. So I’m glad that you mentioned that because I almost forgot to bring up that idea of becoming a local or the expert in the local zoning code.

Yeah, yeah, great point. It’s probably the most valuable underutilized piece of any real estate deal, in my opinion. It’s it’s literally the rulebook of how we make money and nobody wants to look at it or read it or take the time. And the worst part of that is it’s not that much time and it’s usually not that much reading. And I tell people, if they’re going into an emerging market or they’re going into an established market, it doesn’t matter what you’re looking to do. If you want to build an RV park, you want to Manufactured Home Park, you want to do mixed use, you want to do self storage, it doesn’t matter. Read the zoning code, look at allowable uses study the zoning map, you can really become an expert in this and in a weekend and have such a leg up on other investors. You’re going to be educating your realtor, you’re going to be potentially educating your You’re owner and your case where you have a lot of followers, they’re looking for kind of off market owner seller finance. So you can really bring a lot to the table with just education by teaching people the rules that really are the umbrella of the product that they’re trying to sell and you’re trying to buy. So you couldn’t have said that better, and nobody looks at it, I still don’t understand why it’s so overlooked, when it’s the playbook for our strategy. And it’s just one more tool as well, you know, if you can be really good at zoning, and you can be really good at writing offers, and you can be really good at at talking about different creative financing options, and you can be really good at painting the house, it’s just one more tool that’s going to make you better, it’s gonna it’s gonna bring you to the top of the list and a competitive market, especially today, where we live and appreciation markets on the West Coast, is you need every single advantage you can to get a decent deal or to make a decent deal. And if you have any hopes at a great deal, you’re just going to need more and more tools than your competitors. So that’s that’s why I always kind of harp on zoning, even though it’s no fun, it’s not sexy. You can’t really talk about it. Nobody’s interested in hearing about it. But it’s it’s probably the most important part of any real estate strategy.

Jeff Stephens 

Yeah, yeah. Yeah, it’s not it’s not like curling up with the latest Dan Brown book or something like that. But I think it’s very, very valuable reading. Very valuable reading. So, okay, so yeah, let’s talk about the adu goggles a little bit. Because I think that this is something that if if somebody could walk away from listening to this podcast, I would love nothing more than for them to come out with their own sort of adu goggles so that every seller they’re talking to from here on out every property they’re looking at, they’re seeing a different like lens on what they might have seen before. I call this sort of, in my, my language, opportunity vision when when when we look at something and we whatever opportunity we see is hopefully different than and more than what other people see. Right? And even the sellers of the properties we’re talking about buying. I like to say that we can we can negotiate to buy an Apple, but what we’re really buying is an orange. So in this case, you know, we’re negotiating to buy a house based on what it is, which is a house and the sellers thing. I’m selling you a house and you’re like yes, I’m buying the house. However in your head, you’re you’re thinking I’m buying a house and a future adu. And to me that like that’s what I mean when I talk about opportunity vision. So if you could give give everybody like kind of a quick briefing on like, just like the basic level of putting those adu goggles on right so you find yourself you get a call back from a seller or you’re gonna go have a little chat with them at the property perhaps what are the top couple things that your eyes are scanning the property for? To get kind of a quick assessment of how much potential you see there? I mean, to some degree, every lot has adu potential, right? If you’re in an adu like a municipality that allows you to use you could pretty much technically kind of do it anywhere. However, there are certainly certain places properties are going to kind of lend themselves a little bit better to it. So can you give us a briefing on like, what should people be looking for? In order to strap on those adu goggles?

Yeah, yeah. Awesome. So first and foremost is you have to do your homework, you have to start again, we can’t get tunnel vision on the house, the location, the price, the paint, the curb appeal. It’s Is this an area that has accessory dwelling units in their code is allowable uses period? Because if it’s not this strategy does not apply. So you have to already know when you go on that appointment that this is an area that the adu strategy is deployable. And the next thing I’m looking for right when I pull up is parking. Is there off street parking? Can I meet off street parking requirements? Am I going to be able to turn this into an accessory dwelling unit strategy property and park the tenants in both places or three places if you’re in an area that allows to a to use. So parking is huge. The next thing that I’m going to look for is kind of utilities I really am looking for where’s the utility panel? Where is the sewer line? I mean, I always I’m known for this whenever I go look at a house I go straight to the crawlspace and I stick my head underneath and I look at where the water lines coming in. I look at where the sewer lines coming in, because that’s the roadmap of the infrastructure that I’m going to need to split this into two or three units. So those are some quick things that I look for. I also look for really obvious signs that this is going to be an easy adu property and my first lens on my adu goggles and for those watching this you can see it I’m just putting on a goofy pair of you know science class goggles but it’s what is going to be easy and affordable and attainable. So I’m looking for split level houses I’m looking for maybe a bonus room above a garage I always look for the low line First is the master bedroom on a different side of the house. So I first looked for where would an attached accessory dwelling unit go. And that’s easier than building a detached accessory dwelling unit, which we’ll kind of touch on in a minute. But the first thing is I’m looking for us parking. I’m looking for utilities. And I’m looking for Where’s an easy spot to deploy this strategy? And then I think the the final gauge that I always use is how does it feel? You know, I don’t understand how people can buy volume where they where they don’t even go, maybe they send an acquisitions person out. You know, I’m not at that level. But I also don’t feel that that’s the best opportunity. If you have maybe less than 100 units, you need to show up there. How does it feel? How does it smell? How does it look? Is the neighbor’s dog barking at you for 30 minutes straight while you’re walking around? How is the traffic? Is there a stop sign near as the speed limits 35 or 45 in front of the house? So there’s a lot of variables that I kind of throw into the stew in my head that I’m kind of analyzing as I walk around, but those are the those are the first few. Yeah, and if it’s a if it’s a detached accessory dwelling unit play, I’m looking for first and foremost a flat lot. Yeah, flat, if the if it’s got a gigantic backyard, but it’s downhill and it’s covered with trees. That’s not going to be easy to run sewer, it’s not going to be easy to build a foundation it’ll probably have to be you know, engineered by a soil engineer. There’s all these things that drive costs so if it’s detached I want access maybe driving access, maybe foot access, but I want a flat lot that’s the most important thing and probably second to that would be is there alley access?

Jeff Stephens 

Yeah, yeah, yeah. Oh alleys or Yeah, art alleys. Fantastic for ad use because and not you know, gosh, it’s it’s a it’s a small percentage of neighborhoods that are designed in a way that have alleys but I absolutely love alley neighborhoods for adu is because you can build that thing back there, whether it’s detached or attached, and the residence even though technically I’m sure in most codes like there has to be some path to the actual street frontage. You know, for the for the the adu. In reality, they’ll probably be approaching their adu from the alley. So it feels very private almost feels like two properties on one on one property, anyway, yeah.

Very, very well said. Yeah, Alley access is great. Most codes read that you have to have parking within 200 feet of the unit. So you don’t have to be able to drive beside the house to the backyard. If you’re on an alley usually can drive to it. So that’s that’s a benefit. But you know, I’ve learned over the years doing this strategy lots and lots of times and helping hundreds of people do it that you don’t have to be able to pull right up to an accessory dwelling people don’t mind walking 3050 100 feet even to that unit. But yeah, those are those are the things that I’m looking for. When I throw my adu goggles on when I get to a property, the sewer line, you know, I this is kind of a little more technical, but within five feet of the exterior of the house per code, you have to have a sewer clean out. So a lot of times if you do a lap around the house, you’ll see what looks like the back end of a spud gun, it’s really just a three or four inch plastic cap. And that is where a plumber would come and you know, maybe pour out your sewer if you had a clog but that’s going to indicate where the sewer comes out of the house. And if you pop that cap off, and you look down into it with a flashlight, you can see how deep it is. And if it’s really deep what that’s going to tell me is that I’ll have a long range kind of circle outside of that primary house where I can put an accessory dwelling unit and make fall for sewer so power and you know, water, cable gas, all that stuff can be run flat underground, but sewer unless we want to pump it which we try not to has to follow with grade so great is another really big one if it’s a detached, but again, none of these have to do with with price like I’m never ever looking at the price. When I find out that it meets all of these criteria. That’s when I work backwards to the price and and what what I like to talk and share about the strategy is we can pay more like we don’t have to get a deal like everybody’s looking for a deal I pay more I pay more than then people want for their property A lot of times because I know the potential that it has. So we get so focused in in real estate on price and getting good deals and I need an off market seller I got a lowball and like that’s not the case in this strategy if if all the kind of pegs fit and there’s a pretty easy roadmap to a second or third unit. I like to offer and pay more. Yeah,

Jeff Stephens 

absolutely. i i and everybody listening definitely totally agrees with that, that we’re not in the business of finding distress and and trying to find ways to just squeeze it we’re trying to you know, negotiate in a very relational manner. But as I like to teach my coaching students, we’re looking for upside more than just trying to get a discount of what’s already there we’re trying to look for, for upside. And I think that that so that’s, that’s a big topic I wanted to make sure that we cover here is, you know, in my, in my opinion, my experience my perspective, the an ad you can take a deal that doesn’t make sense as a house and make it makes sense, or, or when this sort of marginal and it kind of goes from like, well cash rate $50 a month in the black positive cash flow. That’s not really meeting my standards. But now with an adu it absolutely, you know, exceeds my or meets or exceeds my expectations, or it can take something that doesn’t quite work actually doesn’t quite pencil and actually make it. Make it pencil. And, you know, the first time this this, this hit me was when my own coach Greg said, you know, we’ll think about it this way if you buy this property, and you can underwrite it, so it kind of like just breaks even. But there’s this potential for an adu, it’s kind of like, you’ve got a free building lots, right? You’ve, you bought something that by itself isn’t, you know, giving you a huge financial wind each month, but you have a free lot to build on, right? So if somebody is listening to this with, you know, like a 1% rule kind of mentality, which is not really, you know, what I do, but a lot of people bring that like, okay, 1% Rule kind of thing. They can look at a single family home deal and say, well, this doesn’t meet the 1% rule, so I won’t buy it. But the truth is, if you can get it close enough, you might be able to just build on your sort of, quote, free building lot to build an adu. That’s it meets or exceeds that 1% rule. And then the property as a whole is meeting your standard for whatever cash flow might be. So I don’t it’s like a suddenly I became the guest here Sorry for going off on a tangent. Oh, no,

you’re right. You’re right on you’re right on. That’s why you’re the host. And you’re you have the success you do is because you understand it. And that’s a great, great point. So every house that we’re looking to buy with this strategy is going to have option for an attached adu and a land bank lot for detached adu. And that’s really exciting that we that you even brought that up, because there’s some legislation that’s brand new in our state, where there’s going to be potential to build a detached accessory dwelling unit, and then do a fee simple lot split and be able to sell that off separately and not with condo law with actual fee simple law. So there’s another huge advantage if if somebody buys a house, they’ve got this free lot. For all intents and purposes, it’s not a free lot because it’s on the on the same primary tax, a lot of record, but it’s a free buildable space, that now with some new state legislation in our state, this is an Oregon in 2022 is potentially going to be able to be split off with a minor land partition and sold. So that’s you know, you take an average property of say four or $500,000. And you build what last year would have been appraised at $100,000 500 square foot adu in the back. But if you do it this year, and you split the lot, it might cost you another 20% to bring private services to that. But you have a small lot and a small house that may be valued at 400,000. So the upside is just it’s huge. So when you when you went down the strategy of kind of the free lat method, that’s more true than most people know, because of new legislation. And I see that, in my opinion is gonna also sweep across the country as we set the standard for that. And you know, other areas like California, which is probably the largest adu market in the country right now, with a lot of people and a lot of money and a lot of media. And as soon as they get that, that train moving, it’s going to be really hard to slow it down. I see that becoming a huge play. We’re not going to have super affordable housing anywhere, but because it’ll be on smaller lots. And there’ll be smaller units. They’re going to be more affordable because of that. Yeah. And I see that gaining traction too. Yeah.

Jeff Stephens 

Yeah, it makes sense that it would so one of my big aha is when you were speaking the other day was about I guess I put it into the headline of like the difference between creating new space as an adu versus repurposing some space that’s already in the property basically, finished space as as an adu, right. So my whole frame of reference really before was like, oh, yeah, there’s a garage. It’s just a garage. It could be converted to an adu. It’s kind of the creation of new space. Right. Or I mentioned the other day, a lot of basement. I have a lot of like basement mentality in my market. There’s a lot of homes from the 20s a lot of basements and I’m always walking into basements and quickly with my adu goggles, trying to assess whether there’s good potential in there or not. But when you talk the other day, you talked about the idea of looking at like maybe a three bedroom, two bath house and basically lopping off the master suite. And starting with that, and that was a totally I don’t know why I’ve never thought about that before but I That was an aha moment for me. Can you explain to us kind of what you mean by that strategy as a as an efficient and effective way to kind of, you know, a catapult launching pad for an adu?

Yeah, great. So I’m looking for the most affordable and efficient, achievable way to create a second unit. And I want to keep the price as low as I can. So I can pass the savings on to my tenant, I also want to keep the price as low as I can to create a higher yield. And the easiest way to do that is to take the path of least resistance, and most of the time, it’s going to be converting already legal living space. Not only is it easier, it’s faster, we’re not having to change, usually, hardly any of the utilities. It doesn’t always work. But I’m looking for if you if you’re a current homeowner, and you wanted to play this strategy, it may not work in your house. But if you’re looking to buy your first adu property, there’s no excuse, you can’t find one because they’re all over the place. And things I look for are just odd kind of archaic, bad designs, you know, a lot of houses that were built in the 80s had these big second, formal dining rooms, those are perfect if you have a master bedroom that’s on a different side of the house. What’s so cool about the master bedroom conversion strategy is it’s going to be an easy effective way because it’s already has it already has a living space. Say it’s a larger bedroom, maybe three or 400 square feet, and it already has a bathroom. All we’re going to need to add to make that a legal second dwelling that’s going to be applicable for its own living space and its own certificate of occupancy is a heat source. And it’s going to need some sort of kitchen. And it’s really easy to run hot and cold water. And to run a two inch drain. If you already have a bathroom, you have a four inch drain, or a three inch drain, but it’ll be really easy to hook up a sink. And it’s really easy to run power. So you were basically looking for a master bedroom that has a 10 to 12 foot single wall that we can put a one wall galley kitchen on, because those utilities are really easy to run. It’s the bathroom that’s always the hardest. And so people say hey, this has a adu potential, there’s a nice big garage, I want to put a an adu in the garage. And there’s there’s two huge red flags there. One is it’s going to be really hard to meet the parking standard at the at the city planning level, when you take away your parking and you turn into living space. And two, it’s a lot of times it’s really hard to get fall because a house most of the time is going to be built on a crawlspace foundation elevated 24 to 36 inches above grade. And just based on basic, simple principles of having to drive in and out of a garage is usually 24 to 36 inches lower than the finished living space in the house. That’s why a lot of times you have steps from your garage, which is going to be a plumbing issue. And that’s if you’re able to cut down into the concrete and make fall for plumbing. Some municipalities will put what are called sleepers down and insulate that floor which puts you closer to the ceiling. And so if you don’t have a vault, vaulted ceiling, in your in your garage, you’re gonna have some head height issues. And by the time you kind of revamp your grades for plumbing and pull the roof off of your garage to get some volume, you may as well have just built a standalone. So I always just tell people look for the easiest spot and my experience for doing this for two and a half decades. It’s always going to be the master bedroom or a different part of the house. That’s not the garage. I shouldn’t say always I’ve seen a couple examples where a garage would be decent. And I get this question all the time that people say Derrick that’s not true. I just did one above my garage above a garage is different. If you have bonus room above your garage or you have vaulted trusses or you have attic trusses and you have this big space above your garage, which a lot of people do that’s completely different than a garage conversion. When I hear garage conversion. That means they’re going to turn the space where they park into an adu. So I like to look for the easy, simple way. And the other thing that sometimes comes up with a Master is already has the bedroom that could be a studio it could be walled off into a one one you put in the kitchen and then many times we have to punch an exterior door in but when it comes to cutting in a door and put it in a kitchenette, that’s literally a couple week project that you can do for 30 or $40,000. Whereas if you’re going to revamp and change the use of a space, like a garage or a detached shed or something that people automatically go to with their adu goggles, you’re just going to spend more time and money.

Jeff Stephens 

Yeah, so in the case of like, lopping off the master suite and converting it into an adu, so there’s going to be fire separation requirements there too. Is that right?

Yeah, yeah. So there, they’ll have to be a fire break, depending on your HG building code. If you look at the International residential building code, it’s pretty simple to meet. You just do I like to do two layers of five eighths type X drywall and do that for two reasons. I would only need one layer to meet fire code but I like to do two layers and in between those two layers of five eighths I do a proprietary sound proofing calm lb, called greenblue. If you’re going to do any shared wall over under side by side, any shared wall Adu, I recommend you go to sound cow.com. And look at their soundproofing strategies. Because it’s really, really important. We don’t want to put all this time and money and effort into this project, and then have two tenants that are always complaining about noise from the other. That’s one reason why I steer away from over unders personally because of noise. But the the life safety is going to be walling off that shared space and making sure that there’s a continuous fire break from floor to ceiling. Sometimes, if there’s an attic, the building department will make you go up in the attic and actually do a fire break there as well. A lot of jurisdictions will also make sure that you have an independently separate wired smoke detector Oh to detector in each unit, so they’re not on the same system. In other words, and they’re they’re pretty simple to get permitted. I like to the strategy I use, I looked for the plans at the county or the city of when the house was built. So the planning department is going to want to see the current design of the house. So if I get the current blueprints from when it was built, I have that and then I simply copy those blueprints, and I just use a red pen over the same blueprints to show the changes that I’m gonna make where I’m going to be running power where I’m going to have GFI protected outlets above the kitchenette, stuff like that. So it’s also easier to plan. Yeah, yeah. When you’re doing when you’re doing an adu conversion, I call them convertibles. And I’m not talking about the sports car where the top comes down. I’m talking about a cash producing asset that will buy one of those for you. Yeah,

Jeff Stephens 

absolutely. So there are going to be some times when somebody is looking at a property that actually is zoned for for two units is the zoning and by itself is already allowing two units. And so I just remember this in a couple of deals myself was I was looking at this thing. I want to add a second unit and I think I could kind of go the duplex route. Or I could go the adu route, either way, but actually turned out there. They were very different paths, right. So for people who come across that situation that what are some of the considerations that somebody might have and sort of deciding which route to go down? Does that make sense?

Yeah, it makes perfect sense. It depends on your goals. The only reason I got into the attached accessory dwelling unit strategy and threw that into my repertoire of ad use is because one of my favorite markets that I invest in allows two accessory dwelling units. But if you have to one has to be attached and one has to be detached. The differences in the planning world between an accessory dwelling unit and a duplex are actually very clear and they’re very different animals. A duplex is usually in a multifamily zone and you’re held to a multifamily standard. So think fire sprinklers, sidewalks, curb and gutter street trees, think a lot more money to to create a duplex. In most cases, duplex isn’t going to have a size cap requirement like accessories do the accessory dwelling unit, the easiest way to explain it is accessory to the primary structure where a duplex is going to be its own standalone unit, some jurisdictions will make you put a separate meter and all separate utilities on a duplex. If you plan to use some kind of fee simple lot split in the future. They’re still they’re still ironing out some of these codes that I’ve looked at across the country. But a lot of times you’ll have to have independent sewer services and independent water meters for each of those. And both of those are huge costs of impact fees or fees charges to do that. And then another big one that comes up a lot. And I learned this the hard way is financing. So outside of the FHA world. So if you have good credit and you’re, you know, more savvy investor, you’re probably not going to be going FHA. But if you’re looking at just kind of QM loans on this product, a duplex a duplex is going to require 15 or 20% down most of the time, where a single family house that set up just like a duplex, but it’s an adu. It’s an accessory to the primary so it won’t. There’s also a ton of insurance benefits to having the accessory dwelling unit as your primary. There’s there’s examples where a duplex would be a way better strategy, for example, if you live in a municipality that allows a to use but with that adu. There’s a residency requirement, or there’s a restriction to short term rentals. But if you are able to do a duplex, you can go around those rules and you don’t have a residency requirement because it’s a separate standalone entity. So it really just depends on your goals. And you have to become an expert in your local zoning code period. And the the new odds of duplexes being allowed in a lot of single family zones is also really new the past really 24 to 36 months. A lot of cities, counties and states are saying we are eliminating single family zoning in our state or in our city, which means that most lots We’re reserved primarily for low density residential now can allow duplexes triplexes and quad plexes. Or at least duplexes. So those are some benefits if you’re trying to buy something and, and house hack your way into two or three units, you’d want to go with the adu strategy. If you’re an investor and you have no problem putting 20% down and you want to capitalize on big gains right now, in short term markets, you would build that out as a duplex. So it just depends. If you’re a buy and hold investor, I would think that you would want to use the adu strategy. That’s what I use for several different reasons that would be its own show, but a lot of them have to do with costs, resale, taxes, depreciation rental laws are different. If it’s if it’s secondary to a primary as opposed to if its own standalone unit. And in areas where you know, in areas that are very, very landlord unfriendly. There’s some large benefits to that.

Jeff Stephens 

Yeah. I think a little bit about the the resale the perception upon resale to is a house with an adu still pretty much looks like a house that has an additional accessory space. Whereas some a lot of times a duplex looks like a duplex right you see two front doors, you see two separate garages, all of that and I imagine maybe some of the rules around front doors and stuff vary a little bit from municipality to municipality but I know where I do business that the adu front door actually can’t be visible I think from the street so that it because they really intentionally wanted to not sort of quote look like a duplex but to have that additional housing to so I might upon resale even attract kind of a different buyer profile. You know somebody who wants to feel like they live in a house but then there’s this rentable space also rather than somebody wants to feel like they’re living in a duplex I don’t know if that’s just my own little

Yeah, no, that’s that’s that’s a great point. I posted an adu picture every Friday of different types of ad use. Some are mine some are ad use that I run a drive by but yeah, you’re totally right duplexes look alike shared wall two units. an adu is by design by code. It’s very, very common encode language to say that it can’t share the same entry side of the house. So they’re more camouflaged. And when you’re when you’re talking about attached ad, use a great point. I’m glad you brought that up.

Jeff Stephens 

Yeah. And so you mentioned financing. And, you know, there’s a lot of people who have gotten very excited in the last several years about what what’s called the burr method these days. Right. And to me an adu strategy is really, really well suited for a burr method type of approach. First of all, are you familiar with that? That term? Very Yeah,

no, this is a question I get probably the second most. So yeah, go ahead. Shoot. Yeah.

Jeff Stephens 

So yeah, it’s it’s, I guess, maybe the the question is like, do you agree to me, it seems like, you know, it’s one thing to buy a house and sort of upgraded with granite countertops and put a new roof on it and expect that to add enough value, so that you can refinance it in and recapitalize yourself. But something like adding an adu is like a trend. It’s not a it’s not an upgrade, it’s a transformation of a property from what it used to be to what it is now, or what it could be. Right. And so thus, that really justifies a massive potential massive change in value to justify the higher appraisal and to refinance and, uh, you know, get all your cash back. Is that something you see, like, mentality wise, from a financing perspective? Is that something you see people with a lot?

Yeah, you know, it’s not a lot. No, I see it go both ways. It’s like split 5050. And I argue this point a lot with a lot of really smart people. So the bottom line is, if you are in an area that recognises accessory dwelling units, and they have appraisals for them, and the appraisers aren’t surprised when they see one, and you don’t over design and over build it, you can burn your money back out, I tell people to plan to leave, leave 25% of your money in the project, I have no problem building these and they would bear out at 1.5. So it’s not as much does the birth strategy work? It’s does the birth strategy work if you plan design and build one of these, right, because what I see a lot of times is somebody has, you know, a median priced home and a median price neighborhood. They’ve got a B Class Home and a B class neighborhood. And they fill up their backyard with an A plus class property that has price creep as they build and they turn out really, really nice. And they’re super custom. It’s like not many people in their lifetime have a chance to build a custom home. And right now anybody in a lot of states in our country can build a detached small custom home and so it’s really easy to get excited and overspend. So don’t expect to build a really super custom accessory dwelling unit and get all your money back out. But with that being said, if you’re smart and you have a good plan, and you have maybe a little bit of good mentorship, and you stay on budget and you don’t over build, it’s really easy to borrow your money back out. And it is really similar to the birth strategy in the fact that when we think that Are we think buy a distressed property that wouldn’t finance put our own cash in it or our own creative financing or hard money into it? When it’s done. There’s comps all over the neighborhood. We go for a large appraisal and we get all of our money back out. That’s the ultimate Burr. And it’s very similar to an adu being the quickest way to finance an adu is with your own money. So that’s with financial stacks that you put together with your own cash, maybe you’re borrowing from a 401 K or 457. B, or you get applicable federal rate loan from a family member, or you get hard money. There are programs out there for custom construction for home renovation. There’s some products in California where they’re giving like 9590 to 95, LTV on projected finished value of the accessory dwelling unit. But there’s a lot of rules, you have to have a qualified builder, you have to have really, really detailed plans and budgets so you can get draws according. So it’s not cheap and easy to start one of these. But if you have access to say 100k and you plan and design and build a realistic, modest accessory dwelling unit that’s going to rent for, say $1,200 a month, you’re gonna really easily meet the 12% rule, and you’re gonna probably have no problem getting your money back out. But so many times I see people say the adu Max in my area is 1200 square feet, and they build a 1200 square foot house at $250 a square foot and it’s not going to rent for 2800 a month, and it’s probably going to rent for 1800 a month. And so you’re not going to get a good yield on it. And because you overbuilt it, you’re not going to get all your money back out. Yeah,

Jeff Stephens 

yeah. Yeah, that makes good sense. So as we start to wrap it up here, I want to, I want to kind of switch back to the other side of the brain, from the numbers and stuff back to the other side. And I guess maybe drop down into the heart a little bit. One of the things I wrote down that you said, the other day, I wrote, you know, this just really spoke to sort of the overall ethos of what we talked about on this podcast and in this community a lot. But I wanted to hear more about what you meant by this. You said capitalism with compassion. So when you mentioned that the other day, like, can you just tell us what what does that mean to you? And how does the adu concept kind of fit into that in your mind.

So capitalism with compassion is something that just kind of came to me naturally, years ago coming from, like the poor, underdog tenant, and really just a society that’s like, Damn the landlord. And I feel like I have a huge competitive advantage. Because I’ve been like, I’ve had my heels dug in deep on both sides of that, you know, I’m in a really high priced market, a high value market, high rent market, I was a renter in the area that I invest in. And I know what it’s like to take good care of a place and pay top dollar, and move out and get half of my deposit held for scratches in the floor that were already there. I mean, that’s happened to me. So I always told myself if if I can become an investor, and if I can provide needed housing, I want to I don’t want to lose money, but I want to keep it attainable, I want to keep it affordable, I want to have a really nice product, my goal is to have the best product in the market, I want it to be super high demand low supply, and I want to take better care of our customer than anybody else. And it just that’s kind of the root of it is it just bothers me that there’s all these systems for rating tenants, and there’s all these parameters and criteria for getting tenants. And there’s like no accountability overhead for landlords, I mean, they just they don’t care, they just say Next there’s, there’s still 20 applications behind you. And I, I want to at least on a really small scale in my small area, change that. And empower the tenants, by treating them right by giving them the best price that I possibly can, you know, there’s, there’s some people in our markets that gouge and really drive the prices up as high as they can. And I just don’t think that there’s a lot of compassion in that some of the rent raising rules that we have, and some of the limits, I don’t think there’s a lot of compassion in that. So the bottom line is I’m just trying to give a better product and a better service to our tenants because they deserve it.

Jeff Stephens 

Yeah. Well, thank you for explaining that, that that turn of phrase, in the spirit behind it, capitalism with compassion, just it really resonated with me and I wanted to make sure that that came up in this conversation because I have a feeling it will really resonate a lot with, with the people listening to and I try to I try to bring an energy that says like, we can, like kind of a win win is such a cliche, but we can still make money and and be doing right by other people along the way. And that’s our, our, in this community. Our whole acquisition concept is based on that. And now this this applies also then into our relationship with tenants. And so anyway, I just want to make sure that that got highlighted here to do Well, I sure appreciate you bring just this incredibly immense, you know, set of knowledge and experience on this, but then also delivered in, in the wrapper of a lot of heart. And I really appreciate that and just, you are a perfect fit for everything we do here. And I appreciate you coming to share some of that hard and expertise with us today. If people and by if I mean when people want to find out more about you and what you’re doing, what’s the best way for people to keep up with you and your work?

So you can find me that adu guy.com And I’ve got a lot of free resources there. I have a lot of, you know, other people to do adu stuff, kind of a landing page for them, depending on your region. I have a couple of sets of free accessory dwelling unit plans that you can download off of my site. And I’m probably most active on Instagram. I have a YouTube channel on that adu guy, everywhere. But that adu. guy.com is kind of the landing page where I have, you know, links to all of the different stuff that I’m doing, as well as links to other people that are doing the same stuff. So I just again, there’s no competition here. It’s just collaboration, how do we get the most outreach to the most amount of people?

Jeff Stephens 

Yeah, I love that. You know, when when we first met before you present it the night before somebody introduced us, and I hope it’s okay for me to say this. And I know anything. Yeah, share anything, just paraphrase. Because I’m sure this isn’t exactly what you said. But you know, you said something to me that was right along the lines of my goal is always to have financial freedom so that I can have freedom of time, which would then enable me to devote as much of my time as possible to helping other people in ways like what you do now. And so I just want to say, That’s awesome. And I’m so grateful that you achieved that because we’re all now the beneficiaries of you, sharing your knowledge and you having the time to do things like this interview and to do the work you do. So anyway, that’s a heck of a role model for us all. So thank you so much.

Oh, awesome. Yeah, that’s thanks for bringing that up. And that’s not lip service. If you go to that at you guy.com, you can schedule a free hour with me. If you’re a first time buyer, or you’re looking to get into this industry, or you’re shopping for your first house and you want to consider the new strategy, you can call me to schedule an appointment, I’ll give you one hour of my time for free. And I spend probably 20 to 30 hours a week taking those calls. So this is not like a punch line. This is what I do. So I’m glad you brought that up. And I really look forward to helping your listeners. All I ask is this is if you call me just be ready to take action.

Jeff Stephens 

Yeah, boy, that’s that’s the perfect standard. The perfect litmus test right there. Thank you, Derek. I appreciate this so much. Thank you. Well, I hope you enjoyed that interview with Derek, this is one of those really substantive types of conversations where I hope you either had a notepad or maybe you will grab a pen and a notepad and go back and listen to it again. But this is really something that you need to understand because talk about low hanging fruit ways of expanding your portfolio without needing to buy more properties. This is a very, very powerful strategy. And I’ve loved it myself. It continues to be high on my list of priorities as I’m looking at new acquisitions. So that’s it for today’s episode of racking up rentals. Again, show notes can be found at thoughtful rt e.com/e 151. Please do us a big favor by hitting that subscribe or follow button and your podcast app and rating and reviewing the show. Did you know that we have a Facebook group for thoughtful real estate entrepreneurs too. It’s called rental portfolio wealth builders. We’d love to have you join us over there. Just go to group dot thoughtful rt.com. And the magic of the internet will take you right to that page and you can join us if you liked this episode, and I sure hope you did. Please take a screenshot. post it to Instagram you can tag us we’re at thoughtful real estate, all spelled out on Instagram. I’ll see you in the next episode. Until then this is Jeff from a thoughtful real estate entrepreneur signing off. Thanks for listening to racking up rentals where we build long term wealth by being a win win deal makers. Remember, solve the person to unlock the deal and solve the financing to unlock the profits.

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