Accessory dwelling units (ADUs) have grown in popularity as home prices rise along with the cost of living. Accessory dwelling units are helping people adapt to these trends by allowing them to share common living spaces with other people. Before building an ADU, it’s important to factor in considerations like the cost to build, investment analysis, and pros/cons of an ADU. Below are some things to know before taking on a substantial project such as an ADU.
What is an ADU?
Also known as a granny flat or mother-in-law suite, an alternative dwelling unit (ADU) is an additional place to live located on the same property as an existing single-family home. Accessory dwelling units can be either attached to the home or detached and their primary purpose is to prove it’s residents (short term tenants, long term tenants, or family guests) their own separate living area. They must include amenities (kitchen, bathroom, sinks, stoves, dishwashers, etc) that allow residents to be fully independent from the main living area of the property.
What are the benefits of an ADU?
If space on a property and funds allow for it, there can be many benefits to building an alternative dwelling unit:
- Space for hosting guests: If a person has a lot of friends and family members that like to visit them, then having an alternative dwelling unit can add to overall comfort for guests. They’ll have their own private space with all of the amenities an apartment has which will add value to their visit.
- Passive income opportunities: Adding an ADU to a property is a great way to earn passive income. Since ADUs have their own separate entrance, bathrooms, kitchens, etc, it’s easy to build an ADU and rent out the property to long term tenants or even list it on popular short term rental sites like Airbnb. This is especially true if your ADU is in a bigger city like that attracts short term rentals.
- Increased property values: An ADU will increase property values. By adding more liveable square footage and the fact that it has the possibility of generating passive income, naturally the property value will also increase.
Downsides of an ADU
As with anything that has so many benefits, there are downsides to building an alternative dwelling unit:
- Significant upfront costs: While ADUs are a way to create affordable housing and passive income opportunities, their upfront cost to build can easily cross the $100,000 marker. However, if the plan is to rent out the unit on a short term rental website or to a long term tenant, it can be advantageous to secure a loan to cover the upfront costs and simply pay a monthly payment on the loan.
- Potential restrictions: In some areas, An ADU must be owner occupied and this restriction is typically written within the property’s deed. An owner occupancy requirement can be the main thing stopping someone from turning their backyard into a secondary property
- Higher property taxes: When someone decides to construct an alternative dwelling unit on a property, there will be a decent rise in the property’s assessed value which will inherently increase property taxes. Depending on where a person lives and the type of ADU constructed, this could add a three or four figure number to the annual property tax bill.
- Less usable outdoor space: On a normal size plot of land, ADUs can encroach on outdoor space that would normally be used for other outdoor activities. When the weather is nice, people like to use their backyards for other purposes than generating a passive income. This is something to consider before enhancing real estate with an alternative dwelling unit.
Is an ADU a good investment?
To determine if an ADU is a good investment or not, a person needs to follow standard real estate rules when conducting an analysis. The first rule is to ensure market conditions are favorable. If the market is declining, it may not make sense to pump more money into a property by adding on to it.
The second thing to consider is the upfront cost needed to construct the ADU which can be covered by a loan or simply paying all cash for it. Additionally, the investment strategy associated with ADUs is one that falls into the long term commitment category. Profits will not come immediately because it takes time to construct one and find the renters to occupy the space.