ADUs as Rental Properties: A Lucrative Real Estate Investment

According to an article from Bigger Pockets, 6% to 10% is typically considered a good ROI for a rental property. With that said, you can potentially make a lot more or a lot less than this.

The decisions you make regarding any investment property can have a huge impact on the profits you make. One decision that a lot of investors face is whether to use ADUs as Rental Properties.

ADUs in California are becoming increasingly popular, presenting new opportunities for real estate investors to generate income. With that said, they're not right for everyone.

In this guide, we'll take a closer look at ADU renting benefits so you can make better-informed decisions. Let's get started.

What Is an ADU?

An accessory dwelling unit (ADU) is an additional living space that's built on the same lot as an existing single-family home. They're often known as "granny flats" or "mother-in-law flats".

ADU is a regulatory term, and a space can only be defined as one if it includes the following facilities:

• Living

• Sleeping

• Cooking

• Eating

• Sanitation

With all of these, it becomes self-sufficient so a tenant can comfortably live there.

ADU construction is common on properties where the family wants to create space for additional relatives or friends. They're widely associated with economic or housing instability as they provide an additional living space without the need for more land.

More recently, people have been building ADUs as a tool for generating income. They can act as a rental unit, allowing the owner to make greater profits from an already existing property.

There are several benefits to adding an ADU to your property, but there are also some drawbacks to be aware of. It's important to consider both when thinking about building or investing in ADUs.

Benefits of ADUs

ADUs are becoming more popular throughout California as a source of rental income. Let's go over some of the key benefits you should think about.

Increased Rental Income

The main appeal of ADUs as rental properties is that they allow real estate investors to increase their income. A single-family home can be a good way to generate money, but the addition of an ADU results in an extra rental unit that can generate more cash flow. This results in a better ROI, especially in the long run.

Maximizing Property Use

In addition to maximizing income, you can maximize property use. It's always possible to grow your real estate portfolio, but generating more income without needing to purchase additional properties can be very beneficial.

There are several ways to turn single-family properties into multifamily properties. Some common approaches that real estate investors take include:

• Converting attached or detached garages into livable spaces

• Finishing basements to meet housing and rental requirements

• Redesigning a property to create multiple self-sustainable units

• Installing an ADU prefab on the property

When constructing an ADU, you'll have a lot of control over the design. Many investors implement things like:

• Eco-friendly materials

• Energy-efficient designs

• Sustainable construction practices

These can reduce the environmental impact of the ADU and make it more appealing to potential renters.

Enhanced Property Value

ADUs can help with rental property strategies, but there may come a time when you want to sell the property instead. You can also benefit here, as ADUs typically increase the resale value of properties.

Homebuyers will see ADUs as a good feature as they can let friends or relatives stay in them, or simply use them as a source of rental income just as you have. This is even more beneficial in highly populated cities with high rental prices.

It's also worth noting that you may be able to sell a home faster if it has an ADU. You'll have a larger homebuyer pool, so you're likely to get more interest when your property is on the market.

Diversifying Tenant Types

Creating additional living spaces will not only help you attract more tenants, but you'll have access to a more diverse tenant pool. The smaller size of ADUs makes them more affordable than traditional rental properties. As such, renters with lower budgets are likely to be very interested.

ADUs can be very appealing to:

• Students

• Young professionals

• Students

• Small families

An ADU can be a great option for someone who wants to live in a specific area but can't afford the standard rental rates.

On top of this, having multiple tenants on a single property can help you avoid a total vacancy. If one moves out, you'll still have the income from the other, helping you maintain a more stable cash flow.

Flexible Living Options

Different properties are suitable for different tenants. ADUs provide flexible options for families, allowing them to house relatives. They can also be ideal for multi-generational families, allowing them to live comfortably on the same property.

Drawbacks of ADUs

The opportunity to make more money is always a good prospect, and all of these other benefits can make ADUs seem like a no-brainer. However, there are also some potential drawbacks that you should consider before making any big decisions.

Upfront Costs and Financing Challenges

One of the main things to think about is the upfront cost of an ADU. According to Angie's List, the average cost of an ADU is $180,000, though they can often vary from $40,000 to $360,000 depending on the size and design.

Note that this isn't the only cost you need to think about. You might face an increase in property taxes, permitting fees, and other expenses.

Many investors can't afford an ADU up-front, and traditional lenders like banks and credit unions often have strict guidelines and requirements when it comes to ADU funding. You'll need to consider your options to ensure you can afford to build an ADU.

With the right approach, your ADU will allow you to recoup the initial cost and make a significant profit. If you can maximize your ADU income, you'll make this money back faster.

Zoning, Regulatory, and Permitting Hurdles

Another challenge you may face is in the form of regulations and California ADU laws. Navigating these laws can be difficult with traditional rental properties, and things only become more complex with ADUs.

Rules vary from city to city, so you need to make sure you understand the laws in your area. The ADU permitting process can also be quite lengthy, so don't expect to be able to build yours overnight.

ADU Help Center is dedicated to helping people with ADU design and installation, providing expert knowledge about every aspect of these units. We can help you understand local laws so you can get your ADU built faster and avoid common pitfalls that set a lot of investors back.

Operational and Management Complexities

Adding an ADU means you'll now need to manage two units on the same property. Naturally, this will create more work for you as a landlord. Some additional tasks you'll need to take on include:

• Marketing

• Tenant screening

• Rent collection

• Tenant communication

• Potential conflict resolution between tenants

Many investors choose to work with property management companies. A property manager can take care of these tasks on your behalf, and their expertise typically means they'll be far more efficient and effective.

Impact on Neighborhood Relations and Market Demand

When making any major property upgrades or adjustments, you should think about the neighborhood. There may be some neighborhood resistance as other residents may not be too keen on the installation of ADUs. This can be even more of an issue in HOA communities, and city regulations may complicate things further.

In such situations, building an ADU can be more difficult, and may even be impossible. Some common complaints that neighbors are likely to make include:

• Privacy concerns

• Property value concerns

• Noise and construction disruptions

• Parking and traffic issues

It's also important to note that ADUs simply aren't suitable for everywhere. It's important to assess the demand and profitability in a specific area before committing to an ADU.

Financing Options for ADUs

If you've assessed all the prods and cons and decided that an ADU would be a good choice for you, the next step is finding the right financing. This can be difficult, but there are several options that you could pursue. Some of the most notable include:

• Investment property loans

• Cash-out refinance

• Private lenders

• Construction loans for investors

• Joint ventures or partnerships

Each of these has benefits and drawbacks, so look into each solution to determine which would be most suitable for you.

Using ADUs as Rental Properties: Is It Right for You?

The above ADU investment tips should help give you a better idea of everything that's involved so you can decide if using ADUs as rental properties is the right decision for you. With that in mind, you need to make sure you understand the entire process and everything that's involved. It can be very complicated, so it's worth seeking professional assistance.

ADU Help Center works to help property owners navigate the complexities of ADUs. Whether you want to generate income, expand your living space, or add value to your property, we have the knowledge and experience to help you achieve your goals.

Our team stays up to date with California ADU laws, and we've already helped countless individuals with the ADU process. Contact us today for help with your project.