Properties with an accessory dwelling unit, or ADU, can be a goldmine for investors in the real estate business.
ADUs are highly valuable additions to any property, be it one’s primary residence or part of one’s personal vacation property.
What Is an ADU in Real Estate?
You may be asking, “What is an ADU?” Simply put, it is any home that has an additional self-contained living space on the property. The terms for ADUs vary widely from location to location, and by type of ADU. Some terms used to describe accessory dwelling units are the following:
In-law suite
In-law apartment
Granny unit
Granny flat
Carriage house
Tiny home
Tiny house
Casita
Related: What Types of Real Estate Investments Are Best for a Beginner?
Types of Accessory Dwelling Units
Built-In ADUs
Accessory dwelling units take many forms. For example, some have been carved out of larger homes. A separate entrance and exit are created, and the ADU is a part of the main home but separated by an interior wall or walls. This is typical of what many call a “mother-in-law” apartment. These types of ADUs, in particular, must be inspected by any real estate investor for compliance with all fire safety requirements. Have you have ever seen a huge ugly wooden staircase affixed to the rear of a large home? You can bet an accessory dwelling unit is inside and the owner had no other way to create a legal egress solution.
Above Garage ADUs
Another popular type of ADU is an apartment built over an attached or free-standing garage. Your author owns such a property. Small business owners love investment properties that are set up this way. Contractors like plumbers, electricians, and HVAC specialists become prime renters or buyers. This is because they use ADUs over garage space to be the headquarters of their home business. The garage houses their work vehicles. The living space affords them the ideal home office setup separated from the primary residence.
And it is not just blue-collar trades that love the idea of an accessory dwelling unit. Free-standing or attached ADUs are perfect for tax consultants, lawyers, and other professionals. These groups use ADUs as a separate space for their home business. These types of buyers eagerly seek out ADUs – and pay sellers a premium. Upgrades to your ADU real estate investment can add equity targeting either type of future buyer.
Carriage Houses
Other types of ADUs are free-standing small dwellings located on the shared lot of the primary home. In the East, these are often called carriage houses. They were built for domestic employees in the past. However, today these buildings make ideal small residences for renters. Carriages are located near the entrance to the property. That makes the dwelling private from the main home.
Casitas
In the West, and particularly in the Southwestern U.S., small free-standing homes are often called casitas. This translates to “small house” in Spanish. They are exactly that. They make ideal artist or musician studios and small offices, but can be large enough to be a rental property or granny flat.
Investing in a Property with an ADU
Investing in a property that has a permitted ADU is a sound strategy should such an investment property be available. If the main home fits your budget and the neighborhood suits your search criteria, an accessory dwelling unit is a valuable added bonus. There are many types of investment properties and a home with an ADU is a special subset of multi-family dwellings. We recommend that real estate investors look closely at the tax burden the ADU carries. That can sometimes be a spoiler for rental return on investment.
Related: Why Multifamily Real Estate Investments Are Great for Beginners
Investing in ADUs – Codes and Permits
The term ADU has a legal definition. Investopedia says an ADU is a “…secondary house or apartment that shares the building lot of a larger, primary house.” Notably, an apartment or added house such as this is typically found in an area zoned for single-family homes. That differentiates it legally from a “multi-family” home. There are two important legal aspects to any ADU. First, the accessory dwelling unit should be a permitted living space from the local municipality. Second, it should be a separate dwelling in many lawful ways, but will often share utilities with the main investment property.
Since an ADU is a living space, and since it may be rented or used as an Airbnb, there are many laws to consider. The first are zoning laws and permitting discussed above. Ensure any ADU-equipped property you purchase is legally established by the local town or city government. When investing in an ADU, ask to see the permitting paperwork from the seller and have a lawyer review the documents. Ensure it is proper and complete.
Second, an ADU must meet building codes for a dwelling. It must have its own lockable entrances and exits. Any sleeping rooms must have legal egress windows or secondary doors that open to the outside (for fire safety). The kitchen must meet codes and the bathroom must be properly plumbed and ventilated. Heat must be to code. If you plan to rent out an ADU, ensure these and all other local safety and sanitary codes are met.
Renting Out an ADU
Before investing in an ADU, be sure that you have a strategy in mind for how it can be legally put to use. Start locally. Ask your town hall representatives for information on how ADUs in your municipality can be rented. Find out two things first; Can the two units be rented separately if the property owner does not live on-site? If not, what are the restrictions?
Related: What to Consider When Renting Out a House as an Investment Property
Many local governments limit the way in which an ADU can be rented. For example, some will only allow an ADU to be a rental unit if the primary home is owner-occupied and used as a primary residence. That means you need to live in the home in order to rent the smaller ADU. Some municipalities allow the reverse. Real estate investors should verify which is the case. Find out if you might be allowed to occupy the smaller space as your primary residence and legally rent the larger main home. This is important because it defines your options. In addition, when you later sell the home you need to understand its value as a sale.
Airbnb rentals have special zoning restrictions. If you are planning to rent your ADU as an Airbnb rental property, ensure that this is legal where your investment property is located. If it is allowed, take the next step and consider how well such a rental works with the primary home and its occupants.
How to Find an ADU
Accessory dwelling units are a valuable addition to any investment property. Just be sure you do your homework. If you need help finding a property with an ADU, Mashvisor has the perfect search tool. Mashvisor can also help you determine your ROI on such a real estate investment. Click here to get started using Mashvisor’s valuable tools today.
