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Financing the Construction of an ADU in Central Austin

We recently embarked on a construction project to build a garage apartment behind our Hyde Park home. 


Any process that takes us out of our normal workflows can add stress to our lives. It helps to have a professional managing that process so I don’t have to. I have managed my share of construction and have the ability to do so, but just like hiring a CPA to do my taxes or hiring a realtor to sell a home, I believe in hiring professionals to do what they do best - so we hired a builder. They are likely to have processes that save them time and mistakes. We do not paint in our homes either; we know the professionals will do it better than we will.



When we started

We started the building process for our garage apartment when Code Next was a hot topic of discussion in central Austin. We have kept ourselves informed on the evolution of the code that resulted in the H.O.M.E. initiative and paid particular attention to how the new code will impact the neighborhood feel and land values.


At various neighborhood meetings, I have heard homeowners discuss their desire to build another unit, but they need clarification on financing the process. I have overheard homeowners discuss their concern that they would have to pay cash for the ADU, but that isn’t the case. Financing is available, and the math is very straightforward.


We found the financing process to be very manageable. We have a first mortgage on our property and were quickly able to finance the construction with a loan from Frost Bank. (Contact us for our lender's name.) When the construction is complete, our loan will be paid off over a 20-year period. 


The Math

A generic example plausible from Hyde Park's pricing history follows.

A home purchased 20 years ago for $300,000 with a current balance of $100,000 on the loan could be worth $550,000 in 2024. This homeowner has $450,000 in equity. The bank will appraise the finished project, current home + garage apartment, and will lend based on the current equity in the home. In our above example, the finished product could be worth $900,000, and the bank would lend the $400,000 required to build the garage apartment as the homeowner has $450,000 in equity; thus, the bank is lending only 44% of the total value of the property with a first mortgage that is approx 12% of the property overall value. The first mortgage would remain in place, and the new construction loan would be a second mortgage on the property. At a cost of $400,000 to build and current interest rates (~5.8%), the payment on the second construction load (without property taxes) would be +/-$2,300.


In this example, the equity in the property would be the downpayment for the loan, and the homeowner would bring no additional funds to the project.


Garage apartment rents in the area can be as high as $2,000/month for long-term rentals. Current rents would not cover the cost of the build currently. However, it is important to remember that very few, if any, homes sell at a price that is cash flow positive in this current Austin Market.


With a modest 4% annual increase in rents, the rent will be above the $2,300 payment in 5 short years.


Why do we care about this?

We are passionate about educating homeowners on this process. Homeowner-built infill will result in better-designed, more liveable infill development and give homeowners more options to financially age in place within a familiar, supportive community.


When a spec builder in Austin executes infill, it is cost-effective by necessity and frequently far less detailed than the historic homes surrounding it. If a homeowner builds a custom home or an addition to their home, the outcome tends to blend better with the historical nature of Central Austin. This isn’t a moral judgment on speculative building, just an observation after being in thousands of homes in the Austin Area. The business model for speculative building requires the builder to make mainstream modern choices and keep costs low to lower their market risk.


Why add an ADU?

There are so many reasons that a homeowner may want to build an ADU.


An ADU gives the homeowner more flexibility to use the space when needed and then rent it out when they don’t. In contrast, a large addition means the homeowner always uses the space and doesn’t have the rental options they would with an ADU.


Building an ADU can help the homeowner age in place financially. As we age and children move out, homeowners may not need the space they once did. An ADU in the backyard can allow the homeowner a smaller financial footprint, allowing the homeowner to rent out the front large home when their needs change, and yet not change their community as they age.


As with any rental property, an ADU can also provide rental income over the years. 


Why did we do it?

Our decision came from a need for more space when our family visits and a desire to have a garage that could work as a pottery studio and craft space for me. I wanted more space and didn’t want to move. We are also chronic real estate investors, and I purchased our Hyde Park home in 2014 to add more units in my 50s. The long-term goal was to increase the number of rental units we own to hedge against inflation as we age.


Spending the same amount on an addition would have been less helpful for us. We need the ability to rent out the extra space for a year or more when we don’t need it. With aging parents, we never know what our needs will be, and this configuration gives us the maximum flexibility. (My beloved new screened-in porch expands our space for entertaining, which is so limited in our 100-year-old home.)


What’s next?

If you have questions, we would love to chat. If you want a tour of our ADU, give us a call. We would be delighted to set up a tour with the builder. We love to discuss these details and make real estate more accessible to the public. We are ridiculously nerdy about city code, building, and real estate math, and we would be happy to discuss any of these details with our neighbors. 

 

We are delighted to be your guides to Austin and Austin real estate!


Cheers,

Jen & the team



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