for Every Homebuyer
The Plan:
With the meteoric rise of home prices across the US in recent years, the popularity of affordable housing solutions such as ADUs has been steadily increasing. Think of them as tiny, self-contained homes typically constructed in the backyards or other empty, convertible spaces of preexisting residential properties. While a smaller unit in the backyard of a home is one of the more common forms of ADUs, they can be converted from unused garages, basements, and any other number of unneeded living spaces that house the necessary accommodations to become self-contained.
ADUs are also referred to as backyard cottages, laneway houses, DADUs, granny homes, guest houses, and other monikers. They serve an important function by providing more affordable housing alternatives where apartment and home rent prices have skyrocketed, leaving many without sustainable alternatives. ADUs are also an excellent way to transform lightly used or unused areas of one's property into income-generating assets. While ADU owners often choose to rent these homes out at low rates to family or friends, organically-sourced tenants can make great occupants for ADUs if vetted carefully enough.
Be sure to carefully research your city and county's ordnances on ADUs before undertaking a project to construct or place one onto your property. It is always best to perform a project in line with your local codes to ensure the safety of the ADU occupants and to prevent headaches down the line. Interestingly enough, however, informal ADUs far outnumber the amount of officially permitted ADUs in the US. There are estimated to be over 13 million ADUs on US residential properties, and with more states introducing legislation that eases accessibility to ADU permits and financing for developers, this number is expected to grow substantially in the coming years.
Process Breakdown
Step 1: Determine the Legality of your ADU Plan
In some jurisdictions, constructing an ADU in your backyard is not legal, and being in violation of local codes can lead to fines or other punitive actions, and can also complicate the sale of the property in the future. Make sure to research your local ordnances regarding ADU construction to ensure that your building plan is compliant. Remember that compliance with codes not only shields you from potential legal ramifications, but also helps ensure the safety and wellbeing of the tenants who will reside there.
Step 2: Determine the Costs of ADU Construction
Costs for ADU construction can vary wildly. In a self-reported dataset containing the total construction costs of 50+ ADUs in a region in Portland, Oregon, the average cost per square foot of a detached (fully isolated building) newly constructed ADU was $305. The average square footage of the detached ADUs reported in the dataset numbered at 676 sq ft, resulting in an average total construction cost of $180,833. For detached ADUs, total construction costs ranged from $100,000 - $300,000.
For basement and garage conversion ADUs, the costs tended to trend lower, with average costs per square foot of $265 and $297 respectively. For both of these categories, total construction costs ranged from $70,000 to $400,000.
There are even above-garage options for ADUs, in which additional living space is built up vertically over an existing garage, keeping the parking space intact while adding rent-producing space up top. Above garage ADUs had the lowest cost per square foot of all categories ($212), but the highest average total construction cost ($220,000). Total construction costs ranged from $130,000 to $440,000.
The costs of your ADU will be contingent on the vision you have planned for the final design. The more luxurious and convenient the ADU, the higher the construction costs (and of course, higher rent potential and attractiveness to tenants). Unless you yourself possess professional experience in residential construction, you will want to enlist the aid of an experienced and trusted residential developer in your area who has a proven background in the creation of ADUs. Only after creating a conservative and realistic itemized budget for costs of materials and labor should you advance to the next step.
Step 3: Design Your ADU
This step is closely tied to the previous step of securing financing. After all, in the course of your design work, you will inevitably make changes to your structure that will either raise or lower the cost of construction. Thus, this step typically plays out in tandem with creating a budget for your ADU, and are only seperate steps in this breakdown for the sake of more structured organization.
Your ADU should first and foremost be constructed with the tenant in mind, not you. Unless you will be the primary occupant, you should be desiging the unit to achieve maximum aesthetic appeal among as many possible demographic groups as you can. Tenant-minded construction also places emphasis on safety and privacy. The ADU should have unobstructed access to the street, and contain a fire extinguisher as well as sprinklers. You should consult with your local building and fire officials just to be sure.
In order to conserve as much square footage as possible for tenant use, wall-mounted accommodations for storage are recommended. For example, wall-mounted TVs or bookshelves help to significantly reduce the amount of floor space needed, and in an ADU, maximum space conservation is key.
Step 4: Secure Financing for ADU Construction
ADU construction can be financed through a variety of different ways. As the construction costs for an ADU are almost always significantly smaller than what would be spent on a full single family residence, the potential for ADU construction to be financed entirely out of pocket is significantly higher.
However, in situations where this would not be possible, or if tying up that much liquidity into an ADU project would be undesirable, financing options can facilitate your ADU construction without fronting all costs out of pocket. Such options include:
Dedicated ADU loans or ADU grants - These can be offered both by the city or county of residence, or by private institutions. Several cities and counties throughout the nation, particularly in HCOL (high cost of living) areas, offer ADU grants that subsidize the construction of ADUs to promote the creation of affordable housing units.
Cash out refinances - Cash out refinances can be used to quickly and efficiently capitalize on your home's built up equity, converting that value into liquid cash to turn your ADU blueprints into a tangible, finished structure.
HELOCs/HELOANs - If cash out refinances are not an option, or are undesirable, a HELOC or HELOAN can be used in a very similar fashion to draw on your home's equity and finance your ADU construction. If you want to know more about these programs, visit our loan program tab to read more about what they entail.
Step 5: Construct ADU
While it is possible to construct an ADU on your own, it is best to leave this to experienced, licensed professionals in your area unless you have solid experience in residential construction. While an ADU project may be smaller in scope compared to a full SFH, the complexities of building a residential dwelling from scratch would be just as formidable to the inexperienced investor. Just a portion of the aspects of construction you would have to consider would be:
Proper grading
Utility integration
Flooding/rainwater pooling potential
Compliance with local building code
Compliance with fire code
Much more
The construction process can take over a year to complete in some cases for highly complex ADU designs, but the average, more orthodox ADU can take as little as two to four months to fully complete.
Summary
Pros:
Turns unused or lightly-used spaces into income-generating assets with high return potential.
Cost barrier is significantly lower compared to traditional modes of investing with full properties.
Creation of ADUs creates more affordable housing alternatives and benefits the local housing market.
If constructed properly, an ADU can significantly boost the value of property it is constructed upon.
Cons:
ADUs not only decrease usable space, but also decrease privacy if built on your primary residence.
An occupied ADU will add substantially onto your utility costs, though ideally this should be covered in whole by rental income.
ADUs require you to act in the role of a landlord, which may not be desirable for some people (especially if the ADU is built on a primary residence).
ADUs, like all investment properties, will incur maintenance costs to upkeep its condition.
Conclusion:
Overall, ADU construction is a great way to enhance the income generation of an existing investment property, or to turn unused portions of your primary property into income-generated spaces. The cost of entry is much lower than that of a full property purchase or construction, thereby granting ease of access for a wider potential range of investors, but involvement during the construction process will be high. Be sure to consult with all necessary professionals in order to fully understand the best manner in which you should approach this investment strategy.