You & Your ADU: Unlocking a New Source of Passive Income

The hot topic on REI lips these days is Accessory Dwelling Units (ADUs)—independent living spaces located on the same property as a single-family home. In short, there’s a new way to generate more passive income from one lot.

As a private rental space, ADUs typically have their own entrance, kitchen, bathroom, and living area. They come in various forms—basement apartment, garage conversion, tiny house.

ADUs are easy to love. For starters, they increase the local housing stock, providing more affordable rental units for individuals and families. ADUs promote sustainable development by utilizing existing land and infrastructure efficiently, limiting urban sprawl, and increasing energy efficiency. And ADUs keep families closer.

But there’s a simple reason REIs are paying attention: adding a second stream of rental income to a rental property makes it easier to cover mortgage payments and property taxes, and generate income. By being relatively underpriced for a given neighborhood, these units are more likely to rent fast, and stay occupied. And with a built-in stream of income, the property’s value naturally increases: One study on ADUs in Los Angeles found property value increased by 46 percent on average.

You want in, right? Well, it’s not that easy. Here are 5 Things to Know About ADUs.

Eligibility

ADUs are not always allowed. So far, policymakers in eight states have passed laws allowing homeowners to add ADUs to any single family lot. There’s a bill awaiting approval from the Texas State Senate that could add Texas to that list—stay tuned for the results. Even then, ask your planning office directly if ADUs are allowed on the lot you are considering.

Financing

ADUs can be tricky to finance. There isn’t a lending product on the market right now that is specifically designed for ADUs. Few lenders are willing to factor in the income you could collect from the ADU you’re building. Luckily, Backflip is one of the few that will.

Planning

ADUs are easy to overbuild and often go over-budget. Will yours be attached or detached? Attached are easier and cheaper, especially when staying within the current perimeter of the house. Calculate $100/square ft for an attached ADU vs $225/square ft for detached. Either way, getting an appraiser to review your plans and budget before building can save you a lot of disappointment and regret later.

Neighbors

Not everyone is a fan. Avoid HOAs that could shoot down your plan. And factor in the emotional toll that comes from neighbors: When they learn you are building an ADU, first they might report you to the city to slow your project, even when it’s allowed. Then they will envy your completed ADU, and then they’ll build one too!.

Standards

Become an expert in your local zoning code. Be as direct as possible with the planning office: what standards you have to meet for your ADU. Pay particular attention to the building standards; including building height, and side and rear setback standards. Additionally, bear in mind that most single family houses require two off-street, impervious-surface parking spots. Your ADU will require a third.

Whether an ADU is for you or not, they are here to stay and will play an important role in providing attainable and sustainable housing in the coming years – especially in high-cost /high-barrier markets. That’s something that REIs can get behind. For the moment, there are few good options to finance ADUs as part of your investment strategy, but we work with our members to find solutions, so reach out to us to discuss!