Landlording & Rental Properties

What Exactly Is an Accessory Dwelling Unit?

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Interest by real estate investors in accessory dwelling units (ADUs) has risen recently to combat the nation’s affordable housing crisis. But what, exactly, is an accessory dwelling unit? Accessory dwelling units have been around for years and have gone by a variety of names: casitas, pool homes, in-law suites, granny flats, guesthouses, and secondary dwelling units, among others.

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Defining ADUs

They are fully independent living units that include a bathroom, kitchen, sleeping, and living area. ADUs are generally located on the same lot as a detached single-family home, but, depending on zoning laws, could be situated on the property of a duplex, a triplex, or farmhouse. They might also be considered smaller “internal” units or JADUs (junior accessory dwelling units) incorporated within the existing structure such as a converted garage or attic apartment.

Technically, a detached ADU could be considered a tiny house, but the tiny home movement is a completely different animal. Tiny homes are often built on wheels or built to be the primary home on a lot, not a secondary unit. These units are also considered personal property and typically regulated under the same rules as RVs.

However, ADUs can be stick-built, manufactured homes, tiny homes, and even 3D printed homes if it aligns with your state’s building code and you follow the rules of your municipality.

ADUs, under most circumstances, cannot be sold separately from the primary property. So, building a detached 1,200-square foot ADU behind an existing 1,600-square foot primary residence is not a duplex. It’s a primary residence with an ADU. You won’t be able to sell the unit separately.

Related: Is Building an Accessory Dwelling Unit a Worthwhile Investment?

Where to Start with ADUs?

researching-ADU

Real estate investors interested in ADUs should start their research at the municipality where they want to build or invest. You’ll want to know how a city defines an ADU, whether they are allowed, where, and what restrictions govern them. Utilities, school districts, and fire and safety departments may all have a say with impact fees to match.

ADUs are not a “pay-and-pray” strategy.  It’s extremely local and can even change within the same city due to health and safety concerns, utility availability, and environmental issues. Do your homework before you buy!

Berkeley’s Terner Center produced a report, “Residential Impact Fees in California,” and found some cities in California charged upward of $50,000 in impact fees!

The American Planning Association notes that ADUs have the potential to increase housing affordability while expanding housing options, such as allowing seniors to stay near family as they age. As a result, cities, counties, and states have been signaling support of ADUs and adopting new regulations to allow them.

Some municipalities, the APA notes, have an existing supply of illegally created ADUs and are considering amnesty—a waiver of inspection and development fees—in exchange for residents registering their units. If they can pass health and safety inspections, you might finally be able to have a pathway to include that hideous glop-on addition you inherited as appraisable square footage.

Free Money for ADUs?

Investors should pay close attention to national, state, and local incentives around affordable housing. You may find “free” money for housing seniors, veterans, and the homeless. Yes, it’s not free. You’ll likely encounter covenants and restrictions around ADU usage by accepting the funds, but it may be worth it.

You may find even more funds with your local utility willing to rebate you for including energy efficiency into your new ADU, including rebates for energy-efficient windows, appliances, ceiling fans, and controls. You won’t know until you get local and do your homework. If you’re lucky, you may find a few sources of funding and rebates.

The Risks Involved

  1. Appraisers will likely have an issue finding like-kind comparable sales.
  2. Throw together an awkward design that impacts the livability, and you may run the risk of screwing up property value.
  3. If you’re in a tight labor market and ADUs get popular, expect labor to get more expensive.
  4. Start talking to local lenders ASAP. You’ll need a creative ally in the lending world, especially if you plan to mix a stick-built primary with a manufactured ADU.

You’ve been warned! And, for the record, the investor community needs everyone to do them well and correctly. This may be one of the coolest gifts handed to our community.

Related: Where to Find Private Lenders to Fund Your Investments

ADU Strategy Session

home-renovation-adu

Investors looking into ADU strategies must research what’s possible at the local level but may include:

  1. Purchase a flip property, renovate the primary, add an ADU.
  2. A landlord with a large lot could convert the garage into a JADU and rent it out separately.
  3. A landlord could build a detached ADU and furnish it to use as a 30+ day rental for professionals (professors, nurses, etc.).
  4. A developer could buy a residence on a large lot. Fix the primary to use as a vacation rental while splitting the lot. Add an ADU to the existing lot while you construct a new home on lot split.
  5. Co-living investors could build an ADU to house medical experts for co-living special needs, with seniors or recovery tenants in the primary residence.
  6. An apartment owner could reconfigure existing units into smaller units to add doors.

ADUs are likely here to stay and the investor community has the know-how, skills, and access to private capital that will make them possible if states and municipalities play ball. Let’s get to work!

Have you invested in ADUs, and what has your experience been like? If you haven’t, do you think you would?

Share with a comment below!

Aaron Norris is vice president of The Norris Group, a California-based hard money lender specializing in flips, rentals, new construction, and accessor...
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    John Arendsen Developer from LEUCADIA & VISTA, CA
    Replied 9 months ago
    Aaron, so very well thought out and stated. I've never heard it put more articulatly and accurately. 2020's going to be a fun run for anyone getting into the game. Can't wait until February 22nd!
    Aaron Norris Lender from California and Florida
    Replied 9 months ago
    Thanks John! I'm having a ton of fun researching these and hoping I can attend the International Builder Show this month to get an update about prefab and 3D printed homes. I'm expecting some movement this year.