An accessory dwelling unit (also known as an ADU) is simply a secondary, smaller living area that is constructed on the same plot of land as a primary single-family home.
An ADU can definitely add value to your property and increase your wealth overall. If done right, a full-sized (1,200 square feet) 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.
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 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 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 would be making a profit of $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 destination or tourist 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 ADU’s
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 and create a source of rental income.
An 800-square-foot ADU in Portland can easily bring in about $1,800 per month in rental income. As long as the rental market remains relatively stable, therefore, the ADU will pay for itself in less than a decade and 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 1-3 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 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 anywhere between $60k to $250k, depending on the type of ADU that you are building and the location of your property.
For instance, converting an existing garage into an ADU is much cheaper than building a backyard cottage 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 conversion ADUs.)
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.
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 definitely a perfect entry-point for those who are new to real estate investing and 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 totally worth it though if you hang on to just 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 do the research to find out the condition of the rental market in your area, local zoning and HOA restrictions, and all other information that can help you determine whether or not building an ADU will increase your wealth and add value to your property.