Chapter 02: Are Accessory Dwelling Units a Good Investment?
Do you live in a city where rents for small units are high?
If so, you can boost your income with an accessory dwelling unit, or ADU. As long as rents for 450 sf – 1,200 sf apartments or comparable units can support the new debt and increased property tax assessment from your new Accessory Dwelling Unit you will be cash flowing from day 1. To figure this out, you will need to run the numbers.
To run the numbers, add up the building costs and calculate the monthly payments you will have on the project. Then calculate what your increased property taxes you will be paying every month and any other operating expenses of the property. Then take your projected rent and subtract the mortgage payment, taxes and operating expenses and you will see if it cash flows.
Let's look at a real life example:
Property owners in Pleasant Hill, California are now realizing a positive cash flow after debt payments of $686/month by financing their unit with a Home Equity Line of Credit at 5%. Their project yield (total annual net income divided by total cost of the project) is 11.50%. Compare that to typical multifamily apartment project yields of 5.00% - 5.50% for new construction and 4.00% - 4.50% if you were to buy an existing apartment building in the Bay Area.
When comparing an "ADU for rent" investment to an apartment/multifamily investment, the ADU project above blows the socks off apartments. Institutional investors would line up all day long for this type of yield. They would try to buy a thousand of these units, if they could!
Our 2019 ADU Guide has a pro-forma spreadsheet that you can use to analyze your project as an investment.
First, you will need to get estimates for construction costs of your project. Construction costs should be divided up by hard costs and soft costs. Hard cost estimates come from your contractor and consist of building materials and labor. For reference, there is a contractor estimate from the Bay Area in 2018 included in Chapter 10. Soft costs include other services and fees, such as architects, engineering and permit fees.
If so, you can boost your income with an accessory dwelling unit, or ADU. As long as rents for 450 sf – 1,200 sf apartments or comparable units can support the new debt and increased property tax assessment from your new Accessory Dwelling Unit you will be cash flowing from day 1. To figure this out, you will need to run the numbers.
To run the numbers, add up the building costs and calculate the monthly payments you will have on the project. Then calculate what your increased property taxes you will be paying every month and any other operating expenses of the property. Then take your projected rent and subtract the mortgage payment, taxes and operating expenses and you will see if it cash flows.
Let's look at a real life example:
Property owners in Pleasant Hill, California are now realizing a positive cash flow after debt payments of $686/month by financing their unit with a Home Equity Line of Credit at 5%. Their project yield (total annual net income divided by total cost of the project) is 11.50%. Compare that to typical multifamily apartment project yields of 5.00% - 5.50% for new construction and 4.00% - 4.50% if you were to buy an existing apartment building in the Bay Area.
When comparing an "ADU for rent" investment to an apartment/multifamily investment, the ADU project above blows the socks off apartments. Institutional investors would line up all day long for this type of yield. They would try to buy a thousand of these units, if they could!
Our 2019 ADU Guide has a pro-forma spreadsheet that you can use to analyze your project as an investment.
First, you will need to get estimates for construction costs of your project. Construction costs should be divided up by hard costs and soft costs. Hard cost estimates come from your contractor and consist of building materials and labor. For reference, there is a contractor estimate from the Bay Area in 2018 included in Chapter 10. Soft costs include other services and fees, such as architects, engineering and permit fees.
The 2019 Guide to Building an ADU in California
(Including Financing Options)
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For homeowners who want to make the smartest investment when building a backyard cottage, granny flat, accessory dwelling unit, or garage apartment.
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Chapter 01What is an ADU? |
Chapter 02Are Accessory Dwelling Units a Good Investment? |
Chapter 03How to Build a Mother-In-Law House |
Chapter 04Why Build an ADU? |
Chapter 05Top 3 Ways to Finance Your ADU Renovation Loan, FHA 203K, & HELOC |
Chapter 06Do Cheap Pre Fab Homes Really Pencil Out? |
Chapter 07Can ADU Housing Solve the Current Crisis in California? |
Chapter 08Mother-In-Law Apartment Floorplans, & Design |
Chapter 09How to Choose a Small Home Builder |
Chapter 10Cost to Build a Cottage in the Backyard |
Chapter 11East Bay & Contra Costa County ADU Requirements |
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