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It’s no secret that real estate prices have gone through the roof over the last few years. Many potential investors have struggled to justify investing in real estate due to higher mortgage rates and inflated housing prices. The good news is that there’s a solution to this dilemma. If your municipality allows it, you could build another home/rental property on your existing land. It could be an ADU to house your aging parents, a separate office, a gym, or even a source of income.
This is exactly what we are doing. My husband and I are currently building a detached ADU in our backyard that I’ll be using as an office for now but we are also open to letting one of our kids live there when they get older. We would also have the option to rent it as a short term rental in the future giving us income in retirement.
The Short Version:
- Accessory Dwelling Units (ADUs) have grown in popularity as the housing crisis continues.
- These dwellings can be a cottage in the backyard, a garage turned into a loft, or an attachment to an existing home.
- Many families have invested in ADUs to have a place for their aging parents or adult children to live temporarily.
- ADU real estate investing can allow you to grow your real estate portfolio without trying to find a new property.
Pros and Cons of Building an ADU
- House your family: you could provide housing for an aging relative or allow your children to save up after college so they don’t have to deal with astronomical rent prices elsewhere.
- Rental income: One of the main benefits of ADU real estate investing is that you’re creating an additional stream of income. You have many options when it comes to how you choose to monetize this new space.
- Increased your property value: It goes without saying that adding a whole new property to your existing land will increase your property value. While this does come with tax implications, you also increase your property value so that you can earn more money for your home when you’re ready to sell.
- Costs: It can be very expensive to do an addition or add a separate structure to your property. Plus, you will likely have ongoing costs for additional taxes, insurance, and utilities.
- You can’t sell it separately: If you want to have a rental property and purchase a separate house or condo on it’s own lot you can sell it at any time. If you build something on your own lot you are stuck with it for as long as you own your house.
- Potential loss of privacy: If you will be renting out your ADU that means someone will be living in your backyard.
What are ADUs?
What exactly is an ADU? Accessory dwelling units, or ADUs as they’re commonly referred to, are smaller homes that are built on the same lot as the primary residence that one lives in. These smaller homes go by different names, like laneway homes, in-law apartments, carriage houses, casitas, or granny flats.
For example, putting a tiny house on your lot would be considered and ADU. Building a loft over your garage, or even turning your garage into a studio apartment would also be an ADU. Of course, you can also build a separate detached structure on your property.
There are roughly 1.5 million ADUs across the country, with about 100,000 units going up yearly. The top states for ADUs are California, Florida, Texas, and Georgia. Los Angeles, Portland, and Houston are the most popular cities nationwide for ADUs. Interestingly, the number of ADU permits in Los Angeles skyrocketed from 80 in 2016 to 5,064 in 2021. This means that one in every four new homes that went up in the city in 2021 was an ADU.
The introduction of zoning led to the construction of these tiny homes in backyards being prohibited. There was a time in history when these units were more common since they allowed folks to live in communities they usually couldn’t afford.
What are ADUs Used for?
You may wonder what happens with an ADU once the homeowner sets up this additional unit.
>You Can House Your Aging Parents
According to a 2021 study conducted by Homelight, 61% of homeowners built an ADU to house their aging parents, while 32% did so to house tourists on short-term stays for additional rental income. Instead of placing your parents in a retirement home, you could build them a retreat in the backyard.
>An Alternative Option for Your Adult Children
Due to housing affordability issues, young adults stay at home with their parents longer. You could add an ADU to your property if you want to help your adult children without having them live under your roof.
This is an option we will also consider as our two teenagers become adults. With housing prices they way they are I like the idea of giving them a more private space while still allowing them to save money on rent.
The third most common use for this space is rental income. You can build an addition or separate space to rent out. This could be a long term rental, where someone actually lives there full time. Or a vacation home where you rent it out on a nightly basis.
There is also an in between, where you use it as a corporate rental. Traveling nurses or business people often need a place to stay for a few weeks or even months.
If you want to see how much income you could generate from short-term rental income, check out Airbnb or Vrbo to see what similar units in your area are going for. Keep in mind there are ongoing costs associated with vacation rentals.
>>Related: Pros and Cons of Real Estate Investing
A Separate Space for an Office
According to a government census, the number of people working from home tripled between 2019 and 2021. If you’re one of the over 27 million people working from home, you could want to switch up your space instead of trying to find coffee shops or office space to work out of.
This is how we will be using our ADU. Anyone who works from home understand the pro and cons of this arrangement. While it’s great to keep your loved ones close it can also be a big distraction. Having a totally separate space in the backyard will give me the best of both worlds.
Also, if you see clients in person having a separate space could save you a lot on office rent. Therapists, massage therapists, accountants, hair dresser, real estate agents, even personal trainers could do business out of an ADU and not pay rent for office space. The options are endless.
How Much Does It Cost to Build An ADU?
How much does it cost to build an ADU? The short answer is that it varies on many factors. A garage upgrade is much cheaper than adding an entirely new structure to your backyard, but the pricing will depend on many things.
Call a few contractors and get some quotes. They will come and take a look at the space and you can explain what you are looking to build. They will be able to give you a rough verbal quote during the appointment.
To give you a quick idea, I live in Phoenix and ours cost about $400 a square foot. But of course what exactly you are looking to do will affect that tremendously.
>Hiring the Right Help for Your ADU Construction
You’ll want to consult with the following professionals before starting with ADU real estate investing:
- Real estate agent. You want to see your options and what kind of ADUs are common in your community.
- Surveyor. You have to ensure that you can make the necessary changes on your land.
- Contractor. You have to find a company that will construct this new residence for you.
- Designer. You may want to work with some sort of designer to ensure that your new place is aesthetically pleasing.
It appears to be essentially impossible to give an average price for building an ADU because it all depends on what kind of structure you’re looking to add and the size of the space. We also can’t ignore the role of current prices of raw materials along with labor costs.
According to research done by BuildingAnADU, the closest we could find to an average price of an ADU was about $180,000. These costs will include:
- Design work
- Applying for a permit
- Connecting new utilities to give the space adequate electricity and plumbing
- All of the construction costs
- Your sweat equity
If you hire a contractor they will take care of everything for you. Including hiring an architect and dealing with the city for permits and inspections. They will also hire, coordinate, and pay all the subcontractors, such as electricians and carpenters.
>Additional costs to consider with building an ADU
Tax consequences: Your property will be worth more when you add another unit to it, so you’ll probably have to spend more on property taxes. Depending on your area, this could be a little or a lot.
Increased homeowners insurance: With more property, you’ll have to spend more money on homeowners insurance.
Furnishing the new place: Unless you will be renting out as a long term rental you will need to fully furnish and decorate the ADU. Even with a long term rental you will still need little extras like blinds and appliances.
Increase in utilities: Depending on your zoning laws you may or may not be able to add a separate set of utilities. This means your new ADU may be added on to your main home’s electric, water, and trash.
How much will an ADU increase the property value?
How much your exact property will increase is impossible to say. A local real estate agent can give you an idea of how much value your project will add to the house.
When I contacted a real estate agent they said it should increase by the average price of the square footage. So if your house is worth $200 per square foot and you are adding 500 square feet it should increase your property value by about $100,000.
Of course, it might not be that simple. If buyers in your area highly value the ADU then it may add more than that; if they don’t then it may add less. Not everyone works from home or wants to be landlord.
If knowing exactly how much an ADU will increase your property value is an important factor to you definitely work closely with a real estate agent to make sure you aren’t spending more than you’ll get back when you sell.
Are ADUs Legal Everywhere?
Every state and municipality has different laws regarding residential zoning and construction.
Your contractor or local zoning ordinance will give you the information that you need on whether building an ADU is legall where you live. You want to ensure that this additional unit is legal so that you don’t create issues for yourself in the future. The onus is on you to figure out if it’s lawful for you to build this dwelling.
For us, the big roadblock was that we are not allowed to add 220 volt electricity. This is the power that an oven uses. They feel that adding an oven make the property a multi-family lot and that is not allowed in our zoning.
We also had to be mindful of the legal setbacks. We living a traditional suburban neighborhood so our lot isn’t huge. These setbacks restricted the size and location of the structure.
Is ADU Real Estate Investing Worth It?
Many feel that ADUs are the solution to the housing crisis and the perfect option for the environment as we look to add more homes. By building an ADU, you could be helping out with the housing crisis with minimal environmental impact while creating a passive income stream for yourself.
You’re going to have to sit down and crunch the numbers, but it’s clear that if your city allows for it, ADU real estate investing could be a unique way to become a real estate investor without purchasing a new piece of property.
Many experts are touting ADU investing because you don’t have to purchase new land and they provide you with flexibility. If you already have the property and are looking to get into real estate investing, you’re going to want to take a serious look at ADUs.