Add Property Value and Income with an Accessory Dwelling Unit

If you’re considering buying a home with an Accessory Dwelling Unit (ADU) or a property with ADU potential, or even adding one to your existing property, this is the article for you. Many Gen Z and millennial homebuyers are loving the idea of an Accessory Dwelling Unit to offset their mortgage with rental income through house-hacking. Other people may be interested in ADUs to gain extra living space for family, or with so many American’s working from home, added office space! There are tons of benefits to an Accessory Dwelling Unit and we’ll consider those and how you might go about owning one in this article.

What is an ADU?

ADUs are smaller secondary residential units on a single-family property. They typically feature a separate kitchen, bathroom, and entrance from the main house.

Types of Accessory Dwelling Units:

• Apartment over garage
• Garage conversion
• Mother-in-law quarters
• Backyard cottage
• Granny flat
• Prefab detached unit (Tiny home)

Who’s Building and Buying ADUs?

In today’s low-inventory housing market, ADUs are a great option for many people. Here are some reasons people build or buy properties with ADUs:

• • Expand living space: Create more space for family or extended family. Maybe a parent can live nearby with some privacy, or a grown child can return home without feeling cramped.

• • Downsize living: Move to a smaller space while staying on your property.

• • Home office or studio: Have a dedicated workspace conveniently located at home.

• • Offset mortgage or generate rental income: Some homeowners live in the main house and rent out the ADU to help pay the mortgage. Others choose to live in the ADU and rent out the main house.

Why are ADUs so Popular?

Making the Most of an ADU

ADUs are versatile spaces that can serve various purposes depending on your goals. Consider if you want more internal space (like a basement conversion) or more yard space. Do you aim for rental income? Maybe you want to downsize and live in the ADU while renting the main house?

• • Multigenerational Living: Many homeowners build ADUs for aging parents or adult children who need a place to live. ADUs offer privacy and independence while keeping loved ones close.

• • Rental Opportunities: With high housing demand, building an ADU for real estate investment can provide a steady income stream. Whether you choose long-term tenants or short-term vacation rentals, an ADU can help offset your mortgage or provide extra cash flow.

• • Short-Term Rentals and Airbnb: Especially in tourist areas, short-term rentals are a popular option for ADU owners. Listing your ADU on platforms like Airbnb allows you to tap into a growing market for unique accommodations. Short-term rentals offer flexibility and potentially higher rental rates during peak seasons. However, be sure to check local regulations and HOA rules regarding short-term rentals before pursuing this option.

• • Home Office or Workspace: If you work from home or need a dedicated space for hobbies, an ADU can be the perfect solution. Design the space to meet your specific needs and enjoy a separate area to focus on work or passions.

• • Guest Accommodations: An ADU can also function as a comfortable and private space for guests. Whether you have out-of-town friends or family visiting or want to offer a unique Airbnb experience, an ADU provides a welcoming place for guests to stay.

Does an ADU Add Value to Your Home?

Home improvement projects like kitchen updates, bathroom additions, and energy-efficient windows can increase your home’s value. Building an ADU is another great way to add value.

ADUs can be profitable in smaller cities and towns as well as urban areas, but provide another great benefit of affordable housing in places where it is highly sought after. A study from Porch showed that in large cities, properties with ADUs typically sell for 35% more than similar homes without them.

Increased Property Value and Rental Income Potential

• • Property Value: Constructing an ADU on your property typically increases the resale value of the property. An appraiser will consider the value of other homes with ADUs when appraising yours. Properties with ADUs often sell for a premium because they offer an income-producing unit and more total living space.

• • Rental Income: In addition to the added value of increased property value, ADUs can provide a steady stream of rental income, helping offset mortgage payments or providing extra cash flow. They can also offer more privacy than simply renting out a room in your main house.

Are There Downsides to an ADU?

There can be a few drawbacks to consider depending on the type of ADU you have, how you use it, and your expectations going in:

• • Space Limitations: ADUs are inherently smaller spaces, which may not be ideal for everyone.

• • Construction Costs: Building an ADU can be expensive, especially if it includes a kitchen, bathroom, and separate entrance.

• • Building and Zoning Regulations: There are zoning regulations and permitting processes to navigate when building an ADU.

• • Privacy Concerns: Depending on the layout of your property and ADU, there may be some privacy considerations for both you and your tenants.

• • Maintenance and Upkeep: Like any additional structure, an ADU requires maintenance and upkeep.

Does Adding an Accessory Dwelling Unit Increase Property Taxes?

Adding an ADU may increase your property taxes because it increases the value of your property. It’s recommended to reach out to your county assessor’s office beforehand to determine the potential tax impact. Consulting with an accountant or tax advisor can also be beneficial to discuss your specific situation.

Can an ADU Have a Separate Address?

Whether or not an ADU can have a separate address depends on your location. Here are some possibilities:

• • Half address or unit designation: Some homeowners use a ½ address or add “Unit B” or “Unit 2” to the existing main address.

• • Assigned address during permitting: In some states, an ADU is assigned an address during the building permitting process.

• • No separate address: In other states, the ADU may not be assigned a separate address.

ADU Zoning, Rules, and Regulations

Importance of Early Planning

Thinking about building an ADU requires early preparation for a smooth process. Zoning regulations and legal requirements are in place to ensure these projects align with the community’s planning goals. Cities and counties have varying approaches to ADUs;  Some actively encourage them for more housing options, while others have restrictions to protect existing neighborhoods. Understanding the specific rules in your desired location is crucial. Don’t assume what’s allowed elsewhere applies to your area!

• • Contact your local planning department. They are the ultimate authority on what you can and cannot build. Proactive research pays off. Before investing in design plans, consult the planning department to understand restrictions like minimum lot size, height limitations, allowable square footage, and any parking requirements. Some cities even have pre-approved ADU designs to streamline the process!

• • Partner with experienced professionals. Architects and builders well-versed in ADU construction are invaluable. They understand the nuances of the permitting process and can translate zoning code legalese into practical advice for your project. Their knowledge of local regulations can even help you explore creative design solutions that maximize your project’s potential while remaining fully compliant.

Working with Professionals: Contractors and Designers

To ensure your ADU meets all requirements and integrates seamlessly with your property, working with experienced contractors and designers specializing in ADU construction is essential. Here are some qualities to look for in professionals:

• Licensed and insured
• Experience building ADUs
• Provide references and examples of their work
• Understand local zoning laws and permitting requirements
•  

Which Loan Types Allow for ADUs?

Financing an Accessory Dwelling Unit can vary depending on how you plan to use it. If you intend to use rental income from the ADU to offset your mortgage or qualify for a larger loan, many loan types will allow for current or projected rental income to be taken into consideration, while others don’t.

Loans That Allow Rental Income from ADUs

• • Conventional Loans: A conventional loan is any mortgage loan that is not insured or guaranteed by the government (such as under Federal Housing Administration (FHA), Department of Veterans Affairs (VA), or US Department of Agriculture (USDA) loan programs). 

• • FHA Loans: The Federal Housing Administration (FHA) now allows homebuyers to use projected rental income from ADUs to qualify for mortgages on new construction, homes with existing ADUs, or renovations that include ADUs. Learn more about the new FHA financing policies as of 2023.

• • VA Loans: VA loans are offered by the Department of Veterans Affairs to help servicemembers, veterans, and their families buy homes.

• • Construction Loans: build a brand new home and include an ADU in the plans

• • Renovation Loans: From Fannie Mae HomeStyle, Freddie Mac Choice Renovation and FHA 203(k) a renovation loan can act as a bridge between what a property is now, and what it could be with a bit of extra work.

Loans You Can’t Use Rental Income from ADUs to Qualify

USDA Loans: If you’re looking to buy a home outside of a big city, with no down payment, a USDA home loan is a great option. However, you cannot use rental income from an Accessory Dwelling Unit on the property to qualify for the mortgage. With a USDA loan, you would be better off using the ADU for single-family living, multigenerational living situations, or an office/additional space for those residing in the main unit.

Considering the Next Steps with an ADU

If you’re interested in exploring the possibility of adding an Accessory Dwelling Unit to a property you’d like to buy, or purchasing a property with an Accessory Dwelling Unit already onsite, here are some next steps:

• • Get Preapproved! As a home mortgage lender near you, I’m excited to explore if buying a property with an ADU, or building onto an existing property is right for your goals. Together we can determine the budget for your plan and we can guide you through your next steps. We’ll also discuss which loan options are available to you based on your financial situation and how you plan to use the ADU.

• • Talk to an Agent. If you haven’t yet talked to a real estate agent, we are happy to provide a recommendation. Someone who is experienced in buying or selling income producing properties including ADUs will have a ton of knowledge and info to give you. They can guide you around potential pitfalls before you even start searching for the right property.

• • Research local zoning regulations and permitting processes. Contact your local planning department to learn about the specific requirements in your area.

• • Consult with a qualified architect or builder experienced in ADU construction. They can help you assess the feasibility of your project and navigate the design and permitting process.

By carefully considering these factors and taking the necessary steps, you can determine if an Accessory Dwelling Unit is the right fit for you and unlock the potential value and functionality it can add to your current or future property.