Real estate has long been the go-to investment for those looking to build long-term wealth for generations. Let us help you navigate this asset class by signing up for our comprehensive real estate investing guide.
As housing affordability becomes a growing concern, many cities are relaxing rules on single-family zoning. This is leading to opportunities not only for developers but also for individual homeowners who may want to add a guest house to their properties. Accessory dwelling units (ADUs) are smaller homes that can be used for guests or renters. Some ADUs have complete plumbing and kitchen facilities while others may have only a kitchenette or half bath.
The combination of the tiny house movement and a growing interest in prefab construction have led to a plethora of attractive options. It's easier than ever to put an ADU on your property, whether you want to build one yourself using prefabricated components or have a complete module delivered to your property. In fact, you can even buy a house on Amazon and have it shipped to you.
However, putting an ADU on your property isn't quite as easy as simply placing an order and then collecting rent. There's a lot to consider before you make the leap. Not all ADUs are detached, and in fact, adding on an addition or semi-detached dwelling may be less expensive than a completely independent ADU.
Putting in an ADU may be more complicated and expensive than you think
Prices for prefab ADUs can range from under $10,000 to over $100,000, but the cost of the building isn't your only concern. You will also have to hook up plumbing and electricity as well as prepare the land for a new structure. Depending on where you live, you may need to pull permits. Before you click "buy" on that cute prefab house online, go to your city government website to see the rules on ADU construction in your area.
Financing an ADU can be complicated, especially if you are considering a modular building. Some homeowners may opt for a home equity loan or HELOC to fund the down payment or the entire construction process. A 203k loan can be an option, although there may be considerations depending on the type of foundation used. Construction loans are available, but some lenders may charge a high rate.
It could raise your property taxes
Adding an ADU to your property could increase your property taxes. After all, you are adding to the value of your property, and the local accessor will see that as an opportunity to raise your taxes. One way to get ahead of this is to reach out to the assessor's office in advance to find out what your potential liability could be. You will want to make sure that the rent you can earn will offset the additional costs you may incur.
While you will need to pay taxes on any rental income you earn, there are also tax benefits to operating a rental property. You can potentially deduct some of the costs associated with the upkeep of the ADU, but if the ADU is located on the same property as your primary residence you will likely only be able to deduct some costs on a percentage-use basis.
You may not be able to earn income from it the way you want to
Many people put an ADU on their property to earn additional income, either through long-term tenants or by listing their unit on a short-term rental site. However, cities including Los Angeles are now cracking down on how homeowners can use their ADUs. The city made the move to keep the ADUs available for long-term renters, and other municipalities may follow suit. After all, the reason that cities relaxed zoning laws in the first place was to help ease rental vacancy rates.
The growing rent reform movement may also restrict what you can charge and how you can evict tenants. There can be a lot to learn, especially if you are a new landlord. Having an ADU on your property may also mean that your tenants will knock on your door anytime something goes wrong. You will also lose privacy because you may have to share your outdoor living space with your tenants.
ADUs may be part of how cities cope with growing housing needs
It's likely that in 2020 more cities will relax rules on adding a second dwelling, paving the way for more ADU adoption around the United States. Some areas are incentivizing homeowners through special programs that promise a reduced cost of construction if the homeowner agrees to rent the property to a low-income tenant. In 2018 Portland, Oregon, launched a pilot program to test this out, and other cities have launched similar initiatives. Cities are also creating programs with lists of preapproved ADUs to speed up the process of approval for homeowners.
The bottom line is that while installing an ADU can take time, it can also add value to your property over the long term. As cities continue to explore ADUs as solutions for the housing crisis, many more homeowners may take advantage of the opportunity to add an income-generating addition.
Got $1,000? The 10 Top Investments We’d Make Right Now
Our team of analysts agrees. These 10 real estate plays are the best ways to invest in real estate right now. By signing up to be a member of Real Estate Winners, you’ll get access to our 10 best ideas and new investment ideas every month.
Find out how you can get started with Real Estate Winners by clicking here.