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An accessory dwelling unit (also known as an ADU) is a secondary, smaller living area constructed on the same plot of land as a primary single-family home. As an investor, before building an ADU, the main question you’ll have is, “Will building an ADU add value and increase your wealth?”
An ADU can definitely add value to your property and increase your wealth. If done right, a full-sized (1,200-square-foot) ADU can add as much as 20 to 30 percent to the current value of your property.
To maximize the return on your investment, you do have to be careful with the design, construction, and location of your ADU. In other words, you will have to keep the rest of your property in mind when building your ADU.
The ADU must not clash with the rest of the property in terms of design or placement. Instead, it should blend perfectly into its surroundings – including the primary residence and the rest of the neighborhood – to ensure that it will not diminish your property value by looking jarringly out of place.
As long as the ADU is sturdy, spacious, and aesthetically appealing, it will almost certainly lead to a significant increase in the value of your home.
How Much Value Does an ADU Add to Your Property?
Now that you know an ADU adds to your home value, what’s the actual value?
The actual value addition of an ADU depends on factors such as location, size, purpose, and type.
That said, most accessory dwelling units add between 20% and 30% of the home’s value, depending on type, size, location, and purpose.
In terms of size, the number of square footage the ADU adds to your property is essential in determining the added value.
For instance, let’s assume homes in your area are selling at $650 per square foot. If your ADU is 2,000-square-foot, it’ll likely be appraised at $1,300,000.
Based on the above example, adding a 600-square-foot ADU could tack on another $390,000 to your property’s value.
Detached Vs. Attached ADU: Which One Adds the Most Value?
Detached and attached units are the most common types of ADUs.
As the name suggests, a detached ADU is one that’s separate from the primary residence.
On the other hand, an attached ADU is attached to the primary residence—they share things like separation walls.
Detached or separate accessory dwelling units add more value than their attached counterparts because they increase the property’s inhabitable square footage. Appraisers use this fact to calculate the property’s increased value.
Moreover, detached accessory dwelling units guarantee more privacy, something guests and renters prefer. Therefore, separate ADUs are an excellent source of passive income when rented out.
Another crucial point worth noting is that the ADU ordinance limits the square footage you can add for an attached option. In most cases, the addition can only extend your property by 50%, disadvantaging you in terms of the additional living space you would have achieved.
Garage and Basement ADU Value Addition
If you decide to convert your basement or garage into an ADU, it will still add value to your primary residence.
However, value addition from garage and basement-based ADUs is lesser than that of their attached or detached counterparts. Why?
This is because the space already exists as part of your primary residence. Moreover, they offer less privacy for renters and guests.
Garage and Basement ADUs have a solid return on investment because they’re cheaper to construct.
Prefabricated ADUs and Property Value
Prefabricated ADUs are partly or entirely manufactured in a factory before being transported to the site for installation. This approach reduces the construction time and material wastage, saving more money.
Since they are pre-built, prefab ADUs have a shorter inspection and permitting process, making them a quick and convenient way to increase your home’s value.
However, before going that route, it’s worth noting that in as much as prefabricated ADUs are quicker and easier to build, they also depreciate much faster. This is especially true if they’re exposed to the elements.
Therefore, before building prefab ADUs, consider your location and be prepared to care for them properly.
How Does Current Property Value Affect ADU Value Addition?
Now that we’ve discussed how an ADU’s size and type affect value addition, how does the current property value come in?
Well, I did mention that most ADUs add between 20 and 30% of the primary residence’s value. This means you must know the value of your primary property before selling your ADU.
To put that into perspective, let’s assume that after appraisal, it’s determined that your primary home’s current value is $1,000,000. In this case, you can expect the ADU to increase this value by roughly $300,000, or 30%
Some Examples of How ADUs Can Increase Property Value and Wealth
To help you better understand exactly how an ADU can add value to your property and increase your wealth, we have compiled a list of examples that will hopefully help illustrate the point.
Building Wealth with an ADU in Los Angeles
In Los Angeles, building a 1,000-square-foot (92.90-square-meter) ADU on your property will increase your property value by about $470,000 at an average rate of $470 per square foot.
This is because building an ADU adds livable square footage to your property, which is then considered by the appraisers who are trying to determine the final value of the property.
A 1,000-square-foot (92.90-square-meter) ADU would cost about $250,000 to build, or $250/sq ft) in most parts of Los Angeles.
If you need to undertake 10-12 months of construction work to build the ADU, you will profit $220,000 in less than a year. That’s an 88 percent return on investment for a relatively straightforward project.
Moreover, you can also use the ADU to generate supplemental income by renting it out on a long-term lease or as a temporary vacation home.
If you live in a popular holiday or tourist destination town, it will not be hard for you to rent out your ADU at premium rates for a weekend every now and then through a service such as Airbnb.
Portland, Oregon Loves ADUs
According to a Portland Homeowner survey conducted by Pro.com, 84 percent of all homeowners in Portland, Oregon, believe that an ADU will help increase the appeal (as well as the resale value) of a residential property.
ADUs provide homeowners with an opportunity to leverage the unused land that they own to increase their wealth by creating a source to generate rental income.
An 800-square-foot (74.32-square-meter) ADU in Portland can easily bring in about $1,800 per month in additional rental income.
As long as the rental market remains relatively stable, the ADU will pay for itself in less than a decade in terms of rental income. It will then continue to generate additional income for the homeowners.
ADU Value and Market Trends
Current and future trends in the housing market – as well as local market conditions – will help determine the degree to which the construction of an ADU will enhance the resale price of your home.
A 2012 study titled ‘Understanding and Appraising Properties with Accessory Dwelling Units,’ published in The Appraisal Journal, claimed that about 25-35 percent of a property’s value could be attributed to the accessory dwelling unit located on the same plot of land.
The study also said that the construction of an ADU could increase the resale value of a single-family home by as much as 51 percent. However, this data is derived largely from the properties that were included in the study.
Some of the factors that will determine the extent to which an ADU can add value to your home include the availability of housing in your area, population size and density, HOA restrictions in your locality, and other practical concerns.
The Right Property for ADU Construction
The property’s location will also have an impact on the extent to which an ADU can help increase your wealth.
For instance, if your home is the only one in the block with an ADU, then the increase in property value will be greater than if ADUs were a common feature in the area.
Furthermore, if the property is large, located in a top school district, and slightly away from the city center, then the ROI on your ADU would be even higher. This is because more and more families are now looking for small, comfortable, and relatively inexpensive homes in favorable locations.
The latest trends in the real estate market show that one to three-person families now occupy over 75 percent of all homes in America. However, these homes were constructed a few decades ago, when larger families were the norm.
As a result, many tenants are forced to rent large homes with more space than they need, simply because most single-family homes in the US were built to accommodate the larger families of the past.
This is one of the primary reasons for the popularity of ADUs among potential tenants.
An ADU located in a good neighborhood can provide you with more privacy and outdoor space than an apartment while being cheaper than the typical single-family home.
For these reasons, ADU vacancies are filling quickly in (and around) most major cities.
In addition, the most popular ADUs are built on large properties with ample existing outdoor space with fenced, level grounds that make them ideal for future development.
So, if you own a home in a suitable location with sufficient land on which to build an ADU, you can make a significant amount of money by renting it out to an individual or a family. The current housing market ensures that your ADU will fill quite quickly if it is thoughtfully designed, well-made, and located in a desirable area.
Financing the Construction of Your ADU
No matter how beneficial ADUs might be from the perspective of a real estate investor, you can’t invest without first knowing where the money will come from.
If you already have the cash saved up to pay for the construction of your ADU, then you need not worry about financing and can safely skip this section of the article.
For everyone else, finding the right source of financing should be considered the first and most essential step in the ADU construction project.
The ROI on your ADU will depend, to a certain extent, on how you decide to finance its construction.
Financing a real-estate project requires interest payments, closing costs, appraisal fees, and other such expenses.
If you’re not careful, you might end up paying more than necessary to raise the funds you need for your ADU.
Some of the safer financing options you can choose from include home equity loans, cash-out refinancing, construction or renovation loans, personal lines of credit, and local government grants.
Click here to learn more about the different ADU financing options you could choose from.
Ideally, it would help if you went for the financing option that requires the lowest interest payment while offering a sufficiently large loan to cover all the construction costs.
You might have to do some extensive research – and talk to multiple potential lenders – before finding the financing option that will allow you to get the best ROI on your ADU project.
The Cost of Constructing an ADU
The cost of constructing the ADU will probably be between $60k to $250k, depending on the type of ADU you are building and the location of your property.
For instance, garage conversion ADUs are much cheaper than building a backyard ADU from scratch. This is because the garage already has a foundation, walls, and a roof. So, all you really need to do is change the interiors and add a door and some windows to the exterior walls. (Click here to learn more about the pros and cons of garage conversions.)
On the other hand, building a detached ADU in your backyard will cost as much as constructing a small house or studio. You will have to pay for everything, from laying the foundation to designing the layout and the entire construction process. So, naturally, this will require a much larger investment than a simple garage conversion.
You can possibly reduce some of these expenses and build time by choosing to build a modular prefab ADU instead of one constructed traditionally and on-site. Click here to read our other article about modular prefab construction.
Modular buildings are fabricated in factories before being transported to the construction site and assembled there.
Due to the indoor, automated fabrication process, modular buildings are much more affordable than their traditional, site-built counterparts. As a result, they are ideal for affordable housing projects.
Apart from the design and construction costs, you will also need to pay for things like permitting, landscaping, septic, additional fencing, and higher property insurance premiums when building an ADU. So, you should take all of these into account before applying for a loan.
Summing It Up
So, if you are interested in adding value to your property and increasing your wealth over the coming years and decades, building an ADU can be an excellent first step in that journey.
ADUs are a perfect entry point for those dipping their toes into real estate investing, building new, and don’t have the funds (or the confidence) to buy separate rental properties quite yet.
It is a relatively low-risk way to dip your toes into the waters of real estate investing before you dive in.
Just make sure you do your research on the local market! It can be worth it, though, if you hang on one home with an ADU on it in your lifetime.
However, ADUs are also favored by seasoned real-estate investors looking to add value to their fix-and-flip property.
Regardless of your situation, you should research the condition of the rental property market in your area, local zoning, and HOA restrictions.
You should also consider all other information that can help you determine whether or not building an ADU will increase your wealth and add value to your property.
To learn how ADUs can revolutionize America’s housing, How ADUs Can Help Solve America’s Housing Shortage Crisis will surely be an interesting read!
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