An accessory dwelling unit (ADU), also known as a “mother-in-law” or “granny flat,” is a regulatory term for an additional living quarter within the same lot as an existing single-family home. To be classified as an ADU, a space must include permanent living, sleeping, eating, cooking, and sanitation facilities, making it a self-sufficient dwelling for a tenant.
ADU units have been widely associated with housing close family members or friends during economic or housing instability. However, ADUs have recently become powerful income-producing tools within the real estate rental market. The opportunity to generate further passive income from existing investment properties seems a no-brainer. However, accessory dwelling units have their fair share of potential drawbacks and considerations.
Below, we’ll explore the pros, cons, and most common challenges for real estate ADU investing:
The Pros of Adding an ADU to an Investment Property
There is a reason ADU real estate is considered advantageous. Some of the top benefits include:
Increased Rental Income
ADU investments have become popular among real estate investors because of their rental income potential. By redesigning a single-family home to create multiple rentable units, investors generate more cash flow and higher returns on investment.
Maximizing Property Use
As mentioned, ADU real estate enables investors to make the most of an investment without purchasing more property. Investors renting out single-family homes can add additional rental units simply by:
With U.S. housing affordability at an all-time low and the average monthly rent costs over $1,600, ADU units enable investors to offer below-market rental costs.
- Finishing basements to meet housing and rental requirements
- Converting attached or detached garages into livable spaces
- Redesigning a home floor concept to create multiple self-sustainable areas
- Inserting an accessory dwelling unit prefab (ADU prefab) on the property
- Many ADUs are built with energy-efficient designs, eco-friendly materials, and sustainable construction practices, reducing the environmental footprint compared to larger housing units.
With U.S. housing affordability at an all-time low and the average monthly rent costs over $1,600, ADU units enable investors to offer below-market rental costs.
Enhanced Property Value
In addition to the extra cash flow, ADUs typically increase your property’s resale value. In most cases, a property with an ADU unit sells for premium prices because they provide the homebuyer with a future revenue stream option. This is especially true in highly populated cities where studies show properties with ADUs sell for 35% more than similar properties.
Not to mention, single-family homes with ADUs expand your homebuyer pool beyond families to ADU real estate investors and entrepreneurs.
Not to mention, single-family homes with ADUs expand your homebuyer pool beyond families to ADU real estate investors and entrepreneurs.
Diversifying Tenant Types
By maximizing space and creating affordable ADU units, you attract a more diversified tenant pool. With today’s rental costs, accessory dwelling units’ affordability appeals to many demographics, including:
ADUs provide more affordable housing options in highly desirable but pricey locations. And, with multiple units in a single property, you reduce the risk of total vacancy–helping you maintain a steady, ongoing cash flow.
- Singles
- Students
- Small families
- Young professionals
ADUs provide more affordable housing options in highly desirable but pricey locations. And, with multiple units in a single property, you reduce the risk of total vacancy–helping you maintain a steady, ongoing cash flow.
Flexible Living Options
ADUs provide flexible living options for extended families and can be an ideal solution for multi-generational families. Families can live together with privacy, maintaining independent living spaces.
The Cons of Adding an ADU to an Investment Property
While ADUs can generate financial benefits and help facilitate business growth, there are several factors investors must consider before venturing into the ADU real estate market.
Upfront Costs and Financing Challenges
The average accessory dwelling unit costs around $180,000 ($260 per square foot). Additionally, you’ll need to consider the inherent increase in property taxes, permitting fees, and any additional expenses. That number can change drastically depending on your property’s location. In more popular cities–like San Francisco and Austin–ADU construction costs can jump to $300k.
While the long-term rental income stream justifies these costs, securing ADU financing for a non-owner-occupied property can be difficult. Traditional lenders, like banks and credit units, come with substantial governmental oversight, strict guidelines, and lots of requirements. These lenders often lack the flexibility, speed, and freedom to tailor and approve beneficial ADU construction financing options for investors.
Zoning, Regulatory, and Permitting Hurdles
Navigating the evolving regulatory challenges in residential rental real estate is hard enough. ADUs add another layer of complex zoning laws and building codes for you to circumvent. Non-owner-occupied ADU zoning laws and building codes vary from city to city and typically come with strict guidelines and lengthy approval processes.
Do your due diligence and communicate with local officials regarding specific ADU requirements and laws.
Operational and Management Complexities
Managing two units within the same property can generate more work and tenant challenges for a landlord. Additional occupants create more property management tasks overall, including:
- Marketing and tenant screening
- Maintenance responsibilities
- Tenant communication and assistance
- Rent collection
- Conflict between tenants sharing common spaces
These complexities further emphasize the importance of thorough tenant screening processes and communication to avoid unnecessary headaches.
Impact on Neighborhood Relations and Market Demand
When venturing into single-family ADU investing, you must consider the neighborhood. Neighbor resistance is not uncommon and, depending on HOA or city regulations, this can create additional challenges or ax an ADU construction entirely.
The most common neighbor objections include:
- Privacy concerns
- Noise and construction disruptions
- Parking and traffic complaints
- Property value concerns
Additionally, ADU units don’t work everywhere. Your investment property’s neighborhood or location may not meet the demand and profitability necessary to justify the added expenses of an ADU.
Financing Options for an ADU on a Non-Owner-Occupied Property
If an ADU makes sense for you, it’s important to find the right financing. As mentioned, the most common lender avenues can be disadvantageous for investors looking to fund a non-owner-occupied property’s ADU construction.
Here are the 5 most notable financing options for ADUs in non-owner-occupied properties:
Here are the 5 most notable financing options for ADUs in non-owner-occupied properties:
Investment Property Loans
Investment property loans are financing options through traditional lenders designed for investment properties. While these specially tailored rental property loans provide lower interest rates than other alternatives, they have a laundry list of requirements, strict guidelines, and long application processes.
Cash-Out Refinance
Cash-out refinancing options are when you borrow against a property’s equity to finance the ADU construction. These loans offer lower interest rates and easier qualifications as long as the property has significant equity built into it.
Unfortunately, cash-out refinancing extends your property’s mortgage term and requires higher closing costs. Not to mention, should your rental units remain vacant for an extended period, refinancing options leave you more vulnerable to foreclosure.
Unfortunately, cash-out refinancing extends your property’s mortgage term and requires higher closing costs. Not to mention, should your rental units remain vacant for an extended period, refinancing options leave you more vulnerable to foreclosure.
Private Lenders
These short-term business loans offer faster approval and funding and more financing flexibility–simplifying qualifications and acceptance rates for investors. While these loans typically come with higher interest rates and shortened term length, they also have no early repayment penalties which can justify rate increases for investors.
Other benefits include:
- Flexible loan structures: Private lenders can create customized loans that fit the unique aspects of ADU projects. This might include creating short-term loans, interest-only payments, and tailored repayment schedules.
- Funding for non-traditional properties: Private lenders are generally more open to financing unique or unconventional ADU projects, such as tiny homes, container homes, or basement conversions, which traditional banks may deem too risky or outside their lending guidelines.
- Willingness to Finance Construction and Renovation: Many private lenders specialize in construction loans, which are ideal for building or renovating ADUs. They can fund the project in stages based on the construction progress, providing the necessary cash flow as needed.
Construction Loans for Investors
Construction rental loans are financing options specifically intended for rental unit constructions on investment properties. Rather than paying out a lump sum, construction loans pay out installments (draws) throughout the project. These short-term loans also come with higher interest rates. However, approval processes are typically more stringent, and investors can be required to pay a higher down payment.
Joint Ventures or Partnerships
Joint ventures or partnerships, where multiple investors share the costs and profits of a rental property, are a great way to access more capital at lower interest rates. While this avenue enables investors to reduce financial risk, it carries all the headaches associated with investment partnerships, including a loss of control, increased negotiations and compromise, and decreased profits and ROI.
Creating Financial Success through Accessory Dwelling Units
For real estate rental investors, adding an ADU to a non-owner-occupied property seems like a no-brainer even though it may come with some hurdles. Accessory dwelling units enable investors to diversify their tenant pool, maximize their investment, add to a property’s value, and increase rental income opportunities.
Before jumping head-first into ADU investing, it’s important to research local ADU building costs, requirements, and regulations. While ADU units provide a plethora of benefits, in some areas the costs and bureaucratic obstacles to rent an ADU addition outweigh the potential gains. Understand the costs and needs of converting your single-family home into a multi-unit rental property. However, if you have a thorough financing and management strategy, ADU’s can be a lucrative addition to your investment portfolio.
If you’re looking to add an ADU unit to your non-owner-occupied single-family property, speak to the experts. CLICK HERE to schedule a FREE consultation with a CIVIC team member today.
Before jumping head-first into ADU investing, it’s important to research local ADU building costs, requirements, and regulations. While ADU units provide a plethora of benefits, in some areas the costs and bureaucratic obstacles to rent an ADU addition outweigh the potential gains. Understand the costs and needs of converting your single-family home into a multi-unit rental property. However, if you have a thorough financing and management strategy, ADU’s can be a lucrative addition to your investment portfolio.
If you’re looking to add an ADU unit to your non-owner-occupied single-family property, speak to the experts. CLICK HERE to schedule a FREE consultation with a CIVIC team member today.
