What Is An Accessory Dwelling Unit (ADU) In Real Estate?

The term "Accessory Dwelling Unit" (ADU) might seem unfamiliar to many. Yet, for those in the know—property owners and savvy investors—ADUs represent a hidden opportunity with immense potential within the real estate industry. These versatile structures can transform a property's value and provide a unique housing solution for countless scenarios, which begs the question: What is an ADU?

In their simplest form, accessory dwelling units are supplementary, self-contained living spaces often situated on the same property as a primary residence. That said, it’s not enough to know the literal definition of an ADU; investors need to know everything about them to capitalize on their benefits.

Understanding the ins and outs of ADUs can be a game-changer, whether you're a homeowner looking to make the most of your property or an investor seeking a smart exit strategy. As a result, we’ve developed this article to answer the most pressing question about ADUs and offer valuable insights. This comprehensive guide will equip readers with the knowledge they need to make informed decisions about accessory dwelling units and ADU housing fundamentals, including:

• What Is An ADU?
• 6 Types Of ADUs In Real Estate
• Is Adding An Accessory Dwelling Unit Worth It?
• How Much Does It Cost To Add An ADU?
• Pros & Cons Of Accessory Dwelling Units
• Accessory Dwelling Unit FAQs
• Final Thoughts On ADUs

*Before we begin our guide on Accessory Dwelling Units, we invite you to view our video on How To Get Into Real Estate With No Money! Host and CEO of Real Estate Skills, Alex Martinez, provides the perfect guide for beginners to invest in real estate using no capital of their own!

What Is An ADU?

Accessory dwelling units, otherwise known as ADU units or granny flats, are self-contained living spaces attached to or located on the same grounds as a primary residential property. The ADU meaning most people are familiar with is akin to a building existing in addition to another one.

Consequently, these units are designed to be secondary to the main dwelling and come in various forms, such as basement apartments, garage conversions, or standalone units. ADUs typically feature their own entrance, kitchen, bathroom, and living areas, making them fully functional living spaces.

Homeowners and investors alike appreciate ADUs for several reasons. First, they provide a practical solution for multigenerational living arrangements, enabling family members to stay close while maintaining independence.

Additionally, ADUs offer opportunities for rental income, as they can be leased to tenants, serving as a passive revenue source. Their versatility and ability to enhance property value make ADUs an attractive addition to most homes in today’s high-priced landscape.

6 Types Of ADUs In Real Estate

What is an ADU? The answer isn’t as cut and dry as the average person assumes. While all ADUs share essential characteristics and are defined by the same fundamentals, several differences are worth noting. For example, ADU homes come in several different types, not the least of which include:

• Detached: A detached ADU home is a self-contained living unit separate from the primary residence and typically located on the same property, often in the backyard. It is an independent dwelling (like a backyard cottage, guest house, or carriage house) with its entrance, kitchen, bathroom, and living spaces.
• Garage Conversion: A garage conversion ADU is created by converting an existing garage or part of a garage into a separate living space that can serve as an accessory dwelling unit. What sets it apart from other ADUs is that it often utilizes an existing structure and can be more cost-effective than new construction or detached ADUs.
• Above Garage Workshop: An above-garage workshop ADU is a unique type of accessory dwelling unit constructed above an existing garage and designed primarily as a workspace. What distinguishes it from other ADUs is its emphasis on providing a functional workshop or studio area, making it a versatile addition for homeowners requiring both living space and workspace.
• Additions: An addition ADU is an accessory dwelling unit integrated into a primary residence's existing structure. Its seamless incorporation into the main house sets it apart from other ADUs, often resembling a separate but connected living space.
• Basement Conversions: A basement conversion ADU is created by renovating or finishing the basement space of a primary residence to create a separate living unit. What distinguishes it from other ADUs is its location within the lower level of the house, providing a cost-effective way to maximize space and create additional rental or living space.
• Internal: An internal ADU, or a junior ADU or JADU, is a compact living unit within a single-family home's existing structure. Its smaller size and the fact that it often shares common areas like kitchens or bathrooms with the primary residence offers a more affordable and integrated housing option.

Common Features Of Accessory Dwelling Units

Standard features associated with various types of ADUs include:

• Living Space: ADUs typically include a living area, which may consist of one or more bedrooms, a living room, and a kitchenette or full kitchen.
• Bathroom Facilities: Most ADUs have a bathroom with a toilet, sink, shower, or bathtub.
• Entryway: ADUs have a separate entrance or access point, ensuring privacy and independence from the primary residence.
• Utilities: They come equipped with their own electrical, plumbing, and HVAC systems, often independently metered.
• Appliances: ADUs usually have kitchen appliances like a refrigerator, stove, and microwave.
• Storage: Adequate storage space, such as closets or cabinets, is standard in ADUs.
• Privacy: ADUs offer separation and autonomy from the primary dwelling, providing residents with privacy and a sense of independence.
• Parking: Many ADUs come with dedicated parking spaces, either on-site or nearby.
• Safety Features: ADUs typically have safety features like smoke detectors and fire exits.
• Compliance: They must adhere to local building codes and zoning regulations to ensure safety and functionality.

What is an ADU home if not for a smaller version of a primary residence? Therefore, as an accessory dwelling unit, an ADU will have many features most living arrangements have become synonymous with. These features make ADUs versatile and suitable for various purposes, whether housing family members, generating rental income, or accommodating guests.

Is Adding An Accessory Dwelling Unit Worth It?

Determining the worth of an accessory dwelling unit (ADU) involves multiple factors. The quality, purpose, location, and local regulations can all influence the value an ADU adds to your property.

To shed more light on this topic, we turn to Ryan Zomorodi, Co-Founder of Real Estate Skills and a Multi-Million Dollar Real Estate Investor with extensive experience in ADU investments.

Let's take a look at a few examples of his accessory dwelling units:

"An ADU is a great stepping stone for house flippers or landlords to transition into property development. They are one of the best ways to increase your property value, especially in markets where you can build for a lower cost than you can buy existing homes." - Ryan Zomorodi, Co-Founder of Real Estate Skills

Ryan's extensive experience in ADU investments and his success as a real estate investor make him a valuable source of knowledge for those considering the addition of accessory dwelling units to their properties.

"Garage conversion ADUs are one of the most cost-effective ways to add another unit to your property and the ROI can be exceptional." - Ryan Zomorodi, Co-Founder of Real Estate Skills

To make the most of your ADU investment, Ryan advises, "Thorough research and ensuring compliance with local regulations are vital steps. Understanding the intended purpose of your ADU is crucial, whether it's for rental income, housing extended family members, or enhancing your property's value."

When done right, ADUs can be incredibly worthwhile investments!

*For in-depth training on ADUs and house flipping, Real Estate Skills offers extensive courses to get you ready to make your first investment! Attend our FREE training and gain insider knowledge, expert strategies, and essential skills to make the most of every real estate opportunity that comes your way!

How Much Does It Cost To Add An ADU?

The cost of installing an accessory dwelling unit can vary widely and is influenced by numerous factors, making it impossible to put a universal price tag on the average project. At the very least, several factors impact the overall cost, including:

• Construction Costs: This includes materials, labor, and construction fees. Costs will vary depending on the ADU's size, design, and complexity.
• Building Permit Fees: Most municipalities require permits for ADU construction, and these fees can vary widely depending on local regulations.
• Architectural & Design Fees: This will add to the overall cost if you need architectural plans or design services.
• Utility Connections: You may need to connect the ADU to water, sewer, gas, and electricity, which can incur additional expenses.
• Site Preparation: Clearing the site, excavating, and grading can contribute to costs.
• Foundation Type: Different foundation types (slab, crawl space, basement) have varying costs.
• Materials: The choice of building materials, fixtures, and finishes will impact costs.
• Labor Expenses: Labor costs can vary based on location and availability of skilled workers.
• Landscaping: You might need to modify or landscape the area around the ADU to make it look good and function properly.
• Additional Amenities: Features like a kitchen, bathroom, heating/cooling systems, and appliances will affect the overall cost.
• Accessory Structures: If you plan to build a detached ADU, costs may include a separate foundation, utilities, and construction.
• Project Management: Hiring a project manager or general contractor will add to the expenses.
• Demolition & Removal: If existing structures need to be demolished or removed, this will incur costs.
• Insurance: Your homeowner's insurance may need to be adjusted or supplemented.
• Financing Costs: Interest, fees, and loan costs, if you're financing the project, should also be considered.
• Property Taxes: Additional taxes may be incurred depending on the ADU unit.

ADU Financing

When financing the construction of an accessory dwelling unit, several options are available, each with its advantages. Here are some of the best financing options for building an ADU and why they can be beneficial:

• Home Equity Loan And/Or HELOC (Home Equity Line of Credit): If you have built enough equity in your primary residence, a home equity loan or HELOC allows you to borrow against it. These equity-based loans usually offer lower interest rates than their personal loan counterparts, making them a cost-effective choice for ADU financing.
• Cash-Out Refinancing: This involves refinancing your existing mortgage for a higher amount than you owe and receiving the difference in cash. Cash-out refinancing often provides a lower interest rate than other unsecured loans.
• Personal Savings: Using your savings to fund the ADU project eliminates the need for loan repayments and interest costs. It can be an excellent choice if you have a substantial savings cushion.
• Construction Loan: A construction loan is specifically designed for building projects and can cover the costs of ADU construction. Once the ADU is complete, you may need to refinance the loan into a more traditional mortgage.
• ADU Financing Programs: Some regions offer ADU financing programs or incentives to promote the construction of ADUs. These programs may give homeowners low-interest loans, grants, or tax incentives.
• ADU Builder Financing: Some ADU construction companies offer financing options or partnerships with lenders. These arrangements can simplify the financing process and provide tailored loan options.
• Local Government Loans & Grants: In some areas, local governments provide loans or grants to homeowners looking to build ADUs, especially for affordable housing initiatives.
• Home Improvement Loans: These loans are similar to personal loans but are specifically designed for home improvement projects, including ADU construction. They can offer competitive interest rates.

Pros & Cons Of Accessory Dwelling Units

Having an ADU on an existing property offers numerous benefits to both homeowners and investors:

• Rental Income: One of the most significant advantages is the potential for rental income. Homeowners can rent out the ADU to tenants, providing a steady stream of additional revenue to help cover mortgage payments or supplement household income.
• Increased Property Value: ADUs can significantly increase the overall property value. The additional living space and potential rental income make the property more attractive to potential buyers, leading to higher resale value.
• Multigenerational Living: ADUs offer the flexibility to accommodate multigenerational living arrangements. Homeowners can house aging parents, adult children, or other family members while maintaining privacy.
• Home Office Or Studio: ADUs can be a dedicated home office or creative studio, allowing homeowners to work from home more comfortably or pursue their hobbies and passions.
• Short-Term Rentals: Homeowners can explore short-term rentals through platforms like Airbnb, generating substantial income while having the flexibility to use the space when needed.
• Diversified Portfolio: For real estate investors, ADUs offer an opportunity to diversify their investment portfolio. ADUs can provide consistent rental income and appreciate over time.
• Cash Flow: ADUs can generate positive cash flow for investors, as rental income often exceeds the additional expenses associated with ADU construction and maintenance.
• Reduced Risk: Investing in ADUs on existing properties can be less risky than acquiring entirely new properties. Investors are already familiar with the neighborhood and property conditions, reducing uncertainty.
• Higher Returns: ADUs typically have lower construction costs than standalone properties, which means investors can achieve higher returns on their investment, especially in high-demand rental markets.
• Tax Benefits: Investors may benefit from various tax incentives and deductions related to ADU construction, improving their overall financial position.
• Flexible Exit Strategies: Investors can choose to sell the property with the ADU or retain it for long-term rental income. This flexibility allows for various exit strategies to maximize returns.

Read Also: Rental Property Calculator: How To Calculate Your ROI

While accessory dwelling units offer several benefits, they also come with some drawbacks when added to existing properties:

• Initial Construction Costs: Building an ADU can be expensive, including costs for design, permits, materials, and labor.
• Regulatory Hurdles: Zoning and building codes vary by location and can be restrictive. Homeowners and investors must navigate these regulations, potentially facing delays and added expenses.
• Property Space: Not all properties have sufficient space to accommodate an ADU. The availability of land, setback requirements, and the existing layout can limit an ADU’s potential.
• Maintenance & Upkeep: ADUs require ongoing maintenance and upkeep. Homeowners or investors must budget for repairs, renovations, and regular maintenance to ensure the unit remains attractive to tenants or occupants.
• Privacy Concerns: The presence of an ADU may impact the homeowner's and tenant's privacy. Noise, parking, and shared outdoor spaces can be problematic.
• Property Management: Managing an ADU, especially renting it out, demands time and effort. Property owners need to handle tenant-related issues, maintenance requests, and rental agreements.
• Impact On Resale: While ADUs can increase property value, they may appeal to only some potential buyers. Some buyers may prefer larger yards or different features and may not appreciate the presence of an ADU.
• Market Demand: In some areas, the demand for ADUs may be limited, affecting the ability to find suitable tenants or generate rental income.
• Financing Challenges: Securing financing for ADU construction can be challenging, particularly for investors. Traditional lenders may hesitate to provide loans for ADUs, necessitating alternative financing options.
• Evolving Regulations: Regulatory changes can impact ADU use and rental rules, potentially affecting the investment's financial viability.

Accessory Dwelling Unit FAQs

These compact residential structures have been gaining popularity for their versatility, but many people have questions about their construction, benefits, and legal considerations. This section addresses these common questions and provides insights into the world of ADUs.

What Is Considered An ADU?

An ADU is a secondary, self-contained housing unit on the same property as a primary residential structure. ADUs are designed to be smaller and separate from the primary dwelling, with their own kitchen, bathroom, and sleeping quarters.

The primary criteria distinguishing an ADU from other residential structures are its location on the same property as the primary residence, its functional independence, and the fact that it is not typically sold separately from the primary residence.

Are ADUs Legal?

Accessory dwelling units are legal when done correctly and comply with local zoning and building codes. When ADUs are designed and constructed in accordance with these regulations, they can provide a valuable solution to housing challenges in many communities. Additionally, ADUs can be legally rented out, which can help homeowners generate rental income and address housing shortages.

Will Adding An ADU Increase Property Value?

Adding an ADU can increase property value when done correctly for several reasons. First, it effectively expands the living space on the property, making it more attractive to potential buyers or renters. This additional space can be used for various purposes, such as housing a family member, renting it out for extra income, or creating a dedicated workspace.

Furthermore, ADUs can enhance the property's overall appeal by offering versatility and adaptability. The potential for rental income from the ADU is an attractive feature for investors and homeowners looking to offset their mortgage costs or generate extra income.

However, it's essential to note that not all ADUs will increase property value. To maximize the positive impact on property value, ensuring that the ADU is well-designed, constructed with quality, and complies with local regulations is crucial. An improperly built or non-compliant ADU could hurt property value and lead to legal issues, so it's essential to follow local guidelines and obtain the necessary permits when adding an ADU.

How Does An ADU Access Utilities?

The connection of utilities to an ADU can vary depending on local regulations and the specific design of the unit. In many cases, ADUs have separate utility connections from the primary house, ensuring that each unit has its own utilities. There are several reasons for the separation:

• Independence: Separate utility connections allow the ADU to function independently of the primary house. This independence is crucial for tenants who want control over their utilities and billing.
• Legal Requirements: Local building codes and regulations often mandate separate utility connections for ADUs to ensure compliance with safety standards, city ordinances, and zoning laws.
• Fair Billing: Separate utility connections make it fair and transparent for tenants to pay for their actual utility usage. This separation avoids disputes over shared utility costs between the primary house and the ADU.
• Marketability: Having separate utilities can make the ADU more marketable to potential renters, as they can have their own utility accounts and control over their usage.

Do ADUs Require A Kitchen?

Accessory dwelling units do not universally require a kitchen, but the presence of a kitchen often determines whether an ADU can function as a separate and independent living space. Whether or not a kitchen is necessary depends on local building codes, zoning regulations, and the intended use of the ADU.

Final Thoughts On ADUs

Accessory dwelling units are versatile and valuable additions to residential properties. Whether you're a homeowner looking to increase your property's value or an investor seeking additional income streams, ADUs offer a range of benefits when done correctly. However, navigating the complexities of local regulations, building codes, and financing options is essential to make the most of this real estate investment opportunity.

Ready to explore the world of ADUs or other lucrative real estate exit strategies? Contact Real Estate Skills today for valuable insights, expert guidance, and a competitive edge in the real estate market. Whether you're a homeowner looking to maximize your property's potential or an investor eager to seize opportunistic real estate deals, our team is here to support you.