Landlording & Rental Properties

Is Building an Accessory Dwelling Unit (ADU) a Worthwhile Investment?

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home with white siding and two-car garage with room above

Have extra space on your property? Utilize it to bring in extra cash flow by building an accessory dwelling unit (ADU).

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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.

Related: 10 Things to Consider When Investing in Accessory Dwelling Units

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.

ADU rental

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 asses 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.

Related: 6 Different Ways to Hack Your Housing (Find One That Works for You!)

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)

investment property, reinvestment, 1031 exchange, calculator

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 re-fi using a cash out loan, where the bank paid all closing costs. We then turned around and paid closing to re-fi 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 re-fi 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.

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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.

Chris D. Roberts owns seven rental units including duplexes and single family homes. He started investing in real estate in 2014 and has bought and sold 12 units, including raw land, since his star...
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    Paul Merriwether Investor from Oakland, California
    Replied about 1 year ago
    WONDERFUL!!! We are in the process of a refi where we'll take just enough money to keep payments low for the next 30 yr's as we pass the property to our daughters (we're in retirement). We'll also have funds to convert our Bay area 750 sqft garage to an ADU. Min rent should be at least $1500/mth. That will cover almost the entire note. Should we decide to relocate and rent the main house for $3500/mth that will be a vert nice addition to current income allowing to live almost any where in the world. ADU's IMO is the perfect vehicle at the perfect time in history. I'm looking to buy foreclosures our cheap new homes adding an ADU for additional income streams. The key factor is keeping building costs to a minimum as humanly possible. Anything lower than $100/sqft is a winner!!! Renting both the home & ADU as an option to buy to the renters or a third party could mean at a min. $10,000/home. I just need to complete one / month for $120,000/yr income stream.
    Jason Woolley Investor from Los Angeles, CA
    Replied about 1 year ago
    If you're getting quotes to build for $100/ft in California I'd be very wary.
    Chris D. from Tacoma, WA
    Replied about 1 year ago
    Agreed, 100 per foot is very low. A good number for contactor grade is between $125-$150 not including any land cost.
    Jason Woolley Investor from Los Angeles, CA
    Replied about 1 year ago
    But that's an awesome plan and it looks like you're killing it!
    Sai Kopacek Real Estate Agent from Martinez, CA
    Replied about 1 year ago
    Sounds great! We are thinking about doing the same thing with our house in Martinez, CA.
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied about 1 year ago
    In expensive markets, they definitely can be. We've had good luck in Portland with them and know someone in Austin making a killing on ADU's.
    Kerry Baird Rental Property Investor from Melbourne, FL
    Replied about 1 year ago
    Great idea and interesting path toward completion on the ADU. I’m glad you shared your process, financing and costs.
    Annabelle Lopez
    Replied about 1 year ago
    Was it very difficult to get a new address? How about to get a meter for the electric?
    Chris D. from Tacoma, WA
    Replied about 1 year ago
    The electric was very easy as well. The most difficult part of any of this is first, dealing with the health department and septic build. Second, keeping subcontractors on schedule but the main contractor if hired can do that pretty well dor you.
    Chris D. from Tacoma, WA
    Replied about 1 year ago
    NO, the address second address was very easy and done at the county when applying for the permits. It may have cost $50-$100 or so.
    Gloria Sheridan Rental Property Investor from Marietta, GA
    Replied about 1 year ago
    I absolutely LOVE this idea, and have been considering it for a detached triplex that I own that has room for another unit on it. I think the county would approve the build since there are already 3 separate small houses on the property and there is a dearth of reasonably-priced rental housing in this area. I'm even thinking of using a modular type of construction, rather than stick-built, to speed up the build period. (Not a trailer, but modular construction techniques where the cottage gets delivered in pre-built sections.) Thanks for putting this out there and resuscitating this idea in my mind! Good to hear I'm not crazy for thinking along these lines.
    Bryan Danger Specialist from Nomadic
    Replied about 1 year ago
    Great project and write up! I’d like to add that there’s also a great deal of creativity that can be used in creating an ADU out of existing sqft at a far lower cost (for those who might need a lower upfront cost and/or in jurisdictions where this is allowed). We successfully converted an existing attached garage into an ADU on one project and on another project divided a 3/2house into a 2/1 unit that was easier to rent and a built a studio ADU from the remaining (left-over) space. Both were low investment projects that essentially allowed us to renovate the entire property and a significantly increase rents from “wasted” space we were already paying for.
    Mike McKay
    Replied about 1 year ago
    the Intrigue to us as an ADU manufacturer, they have become an active opportunity not only for the investment income / granny flat but along the west coast we recently had an inquiry as to what we now refere to as "flip the back yard". Leveraging the house to build the ADU since its cost is much less than the average sq ft resale cost of the home and possibly less than a complete remodel. From what I can tell the ADU won't be instantly worth the same sf $ as the main house but will increase the value overall. Discussion has been around investing the $90-100K ( in our case in Southern Cal, installed) for 400 sf ADU broadening the audience and appeal with rental income of $1,500-2,000k a month in key critical housing shortage markets. if one has the time and patience, more $ possibly for Air BNB. Wondering if ADU's cant help but be more appealing to lower home ownership costs via rents and with baby boomer aging population, become more appealing as well. Another reason there has be invigorating interest is nearly all the major cities along the west coast have relaxed code to facilitate the stress on the market. zero lot lines, larger sf ADU, parking restrictions and even height restrictions have been lessened or done away with. City of Seattle will no allow 2 ADU units on a lot. City of LA changed the ADU code jumping from several hundred permits in a year to over 4,000 in just under 2 years since the change. not quite a similarity but worth noting, we recently sold on a JV- 4, 2K sf homes on an infill lot in Phoenix. The four individual investors intend to flip once done. Easier to build new with a decent margin and the latest tech ( solar / net zero energy, NEST, etc) in our case, than the mystery of a fixer upper flip. Can't say it will work every time but with right infill lots and homes expect this to work well. I am not a real estate investor so just an observation from 4 homes we are building this fall for investors. ask me any question on the ADU building world and do my best to answer. we build remotely off site and bring on site, installing in less than a week. use recycled content steel and SIP frames for better structural house and less environmental worries.
    Davido Davido Rental Property Investor from Olympia, WA
    Replied about 1 year ago
    Chris you put together a fine post. Good layout, fine photos, supporting links, informative accounting. Very well done. Enjoyable.
    Chris D. from Tacoma, WA
    Replied 12 months ago
    Thanks!
    Josh Corriveau from Charleston, SC
    Replied 11 months ago
    Hi BP, Great post. My wife and I are considering building an ADU in Charleston, SC. The max size is 850 sqft and we’re considering a modular build. Has anyone had experience with a modular build to reduce cost on an ADU? There’s a company Blue Ridge Cabins that has a Luxe line that seems to align more with the coastal architecture. Most local builders have been in the $200-250/sqft range for an ADU. Looking forward to hearing your thoughts. All the best, Josh
    Chris D. from Tacoma, WA
    Replied 11 months ago
    Wow 200-250 is high, not if that includes land but just to build is high. No module houses experience sorry. Thanks for the comments. That would be a price for premium build but no contractor grade. I’m in one of the hottest markets in the country and I paid 140-145 or so a foot and that included septic.
    Jesse Park New to Real Estate from Denver, CO
    Replied 8 months ago
    Thanks for putting this together. I do have a few questions. Why not buy a $200,000 property with a similar sqft? Wouldn’t this give higher rental income and higher and more secure appreciation potential? I can see a few reasons (there are no $200,000 properties in the area that have this much income potential, you want to manage a property that is close to your primary residence, building home is cheaper than buying a home, financing is easier if it’s in the same property as your primary residence, etc) but I would like to hear from you! Thank you.
    Chris D. from Tacoma, WA
    Replied 8 months ago
    Thanks for your questions. The reasons is simple, I own the land and now that a house is built on the same land as my primary residence my mortgage is paid for by the renters. This also gives me several options when reselling the property especially if the county allowed son deciding by that point. I own several million dollars in realestate and many rentals single and multi family. This was something I had not done before and worked out well. I’m now buying 100 plus unit multi family assets. Yes the market is on fire and the price to buy the same property would be around $250-300k taking it outside of a profitability model as a rental. The land was not being used so it was a great investment to build and rent on it. Hope this feedback helps! Talks care
    Dena Crone
    Replied 3 months ago
    Chris, I also live in Orange County, CA. Thinking of doing an a ADU above our garage and a bit ore, approximately 500 square feet. Any recommendations as far as doing one or two bedrooms? Pros/cons.
    Chris D. from Tacoma, WA
    Replied 3 months ago
    For the square foot cost you bill jennifer financially if you can go 2-3 bedroom because of the higher rents. Bedrooms are not as expensive to build as bathrooms, and kitchens. Go two if you can as it will also open the unit to a broader base of potential renters. Always run your runner through a spread sheet to see what the overall rental return agains the cost will be and use comps like rent one tee and others to come the potential income. I’m in Washington State. And our Adu is drawing about $2000 per month in rent. 3 bed 2 bath woth two car garage. Good luck
    Jon Pierre
    Replied 3 months ago
    One of my properties here in Everett WA had a legal mother-In-law added to the existing footprint back in 1986. I pulled an electrical permit for about $120. to separate the meters. My materials to do this will come to only about $800. (200 amp panel, wire and junctions). The labor I am doing myself. This is a great and affordable step to making this a true ADU or duplex, however if I want the city to put in another meter of the water I need to pay about $10,000. and that is not connected to the building, just an additional meter at the street!! Well I found several meters for only a few hundred which I can install and monitor on my own for billing to the renters. Big savings and still keeping the water separate.
    Chris D. from Tacoma, WA
    Replied 3 months ago
    Yes you need to be careful with the water companies espectiLy f they are not a municipality, they will hammer you. Sounds high for a city owned water service but oh well. They can charge what they want. I tied into my water line and the pressure was fine, but did separate power. I just charge the tenant a flat fee for water and keep an eye on the bill.