Have extra space on your property? Utilize it to bring in extra cash flow by building an accessory dwelling unit (ADU).
Follow along and I will detail how I did just that and brought in the highest cash flowing single family unit in my real estate portfolio.
Finding the Right Property
When looking to purchase a home more central to our work in the state of Washington, we also focused on maximizing future returns. We wanted a large shop and extra land for future expansion. I researched articles and podcasts, including some found on BiggerPockets, on ways to maximize returns on real estate investing. Options included renting out unused space or house hacking, renting out extra storage space, and renting out ADUs.
We found a large home with just under two acres of land that included a 2,000-square-foot shop with several RV bays and fenced, level grounds. The space was ideal for future development projects. The property is in one of the top school districts, just outside the city in a rural area.
By utilizing profits from past real estate investments, we were able to put more than 30 percent down, setting up a mortgage that is not much higher than the home we currently owned. I previously refinanced and paid down the home we lived in, setting it up as a high cash flow rental. Our previous primary residence now brings in more than $500 per month after expenses, maintenance, mortgage, insurance, and homeowners dues.
Financing Your Accessory Dwelling Unit
I researched the finance options and cost to build an ADU. Here is what I found.
Several credit unions offered lines of credit, but many used third-party valuation or semi-appraisal processes, leaving the borrower an undervalued asset to borrow against. This is common after the 2007 to 2009 real estate crash. Appraisals and valuations seem a bit tighter now.
I found that WSECU was the only credit union that used Zillow to assess a value and give the credit line based on that value for my primary residence. I was like, “WHAT?”
Zillow’s valuations are high compared to other online assessments, such as Realtor.com or Trulia. In fact, I found that the way WSECU assessed the value was higher than any other bank, including but not limited to BECU, Chase, or Bank of America.
The cost to build was around $148 per foot, or a total of $190,000. This included permits, building, septic, landscaping, additional fencing, and all the basics. The home is a 1,250-square-foot single story, three-bedroom, two-bath ADU with a two-car garage on about a third acre of land that I already own.
It took almost four months to complete, and I had the unit rented before I finished the project. I did not subdivide the property, as this was not allowed per the county code (at least for now), but I did get a second address assigned for the ADU.
I put $35,000 cash down and used a credit line for the balance of $155,000. The credit line payment was around $875 for three months while building—three months because I did not need to pull the cash at the beginning of the build.
Renting the Unit
We charge the following for this unit:
- Rent: $1,895
- Water, trash, septic: $180 (The water and trash are on our primary residence account, keeping the cost down.)
- Landscaping: $50
- Pets: $25 per month for each pet (currently, 2 pets equal $50 per month)
The total rental income is $1,945. This is under market value, so we had several qualified individuals to choose from to live on our property.
The tax is estimated to be around $106 per month on the $155,000 of additional insured property. The assessors did not re-evaluate after the build, meaning we are still paying taxes at the assessed value of our primary residence. I will include it now in this example, so when they do raise the assessed value, there are no surprises later.
Mortgage added to the primary residence loan amount is around $155,000. But we refinanced it into the original loan at 5 percent on a 30-year fixed. We paid off the original credit line in the refi using a cash out loan, where the bank paid all closing costs. We then turned around and paid closing to refi again on a 10-year adjustable just 90 days later. This lowered the payment significantly and created more cash flow.
This move dropped the payment by $425 per month and lowered the rate to below 4 percent. We will put all the rental income toward the loan but wanted the higher cash flow just in case. To illustrate this in simple math, we are bringing in about $561 in net rental income and $425 on the refi for a total cash flow of $986 per month.
ADU by the Numbers:
- Insurance: $25 per month
- ADU portion of the loan: $1,131 per month (on the $155,000)
- Cap X at 5%: $97 per month
- Vacancy at 5%: $97 per month
- Maintenance at 3%: $59 per month (new home, so this is lower)
- Total expenses: About $1,384
Take all the expenses at $1,384 and deduct them from the rent of $1,945 and you have a net positive cash flow of $561 per month. This $561 per month annually is a 19.2 percent return on the $35,000 originally invested.
While we may not see as much appraised value for the ADU as we will the primary residence, we are getting a huge return on our cash investment and using space we otherwise had no use for.
We also built the maximum size allowed of 1,249 feet for two reasons. One, we wanted a house big enough to max the rental. Two, we wanted a house big enough to sell off if we are granted the opportunity to subdivide in the future. I highlight this because many ADUs are smaller and not built with these two points in mind (from my research and experience).
Bonus Rental Space
We also rent out one of the storage bays of the shop for $250. This is well below market value.
Considering an ADU? Do you have any questions for me? Have you looked into the regulations in your area?
Let’s discuss in the comment section below.