What is an ADU, and should you have one?

Are you considering adding an accessory dwelling unit to your property? ADUs are a valuable (and flexible) upgrade for homeowners. They can boost home value, create passive income, and even provide a comfortable living arrangement for family or friends. They're in demand now more than ever, increasing an average of 8.6% annually in the past decade.

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However, a common barrier for many homeowners is the cost and time of building an ADU. In this post, we'll explore the pros and cons of ADUs, how to finance the costs, and factors to consider when deciding if it's right for you.

What is an ADU?

Also known as granny flats, in-law units, backyard cottages, or accessory apartments, ADUs are secondary housing on a single-family residential property. They have a separate entrance, kitchen, and bathroom.

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These smaller, independent living units can look very different from one another and take on sundry designs, floor plans, and sizes.

Types of ADUs

ADUs fall into two main categories:

Attached ADUs

Also known as a bump-out conversion, attached ADUs connect along an existing wall of the main house, for instance, along the back or side. Perks of building an attached ADU include shared walls and access to utilities and shared walls. These might have a shared or separate entrance.

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When a part of the home — the entire basement, attic, or second floor — is cordoned off to create a separate living unit — that is an internal ADU.

Detached ADUs

As the name implies, these are stand-alone dwellings on the same lot. Common detached ADUs you might've encountered include converted barns, garages, or backyard bungalows.

What are the advantages of an ADU?

There are pluses and minuses to having an ADU on your property. Let's start with the pros:

Versatility and flexibility in use

‍ADUs can be modified to accommodate different living situations and residents of varying lifestyles and needs. Would-be dwellers can be anyone: in-laws, young expectant parents, or recently graduated college grandchildren, to name a few possibilities.

Income opportunity

‍You can create another revenue stream through rental income and make more on rent than offering a shared room. ADUs typically need fewer resources to build and operate than full-sized counterparts and have reduced utility bills.

Increased property value

‍An ADU can potentially increase your property value by a staggering 35%. Detached ADUs can offer the most significant increase in property value.

Encouraging multi-generational living and aging in place

‍ADUs are situated on the same property, making them conducive for family members and multi-generational living. You can have fledgling grandchildren, in-laws, or young parents residing in the ADU. Empty nesters can also consider living in the ADU on their property and renting out their primary residence.

What are the disadvantages of an ADU?

Now, let's look at the cons:

Initial cost and financing challenges

‍While many advantages come with having an ADU, the upfront cost of an ADU construction project can be substantial. The average cost to build an ADU can be anywhere from $54,000 to $160,000. Getting started can be a big hurdle if you don't have that money in the bank – especially if you are still paying off your mortgage.

Zoning and regulatory restrictions in some areas

‍ADUs aren't immune to zoning laws in your area. You'll need a building permit before building your ADU from the local jurisdiction. It's best to visit the government website in your city or county to start your process. They might have a section that lays out the zoning code.

Management and maintenance responsibilities for rental ADUs

While renting an ADU can boost your monthly income, you're responsible for managing and maintaining the property. Managing a property can eat up some of your time and add stress. You can hire a property manager, and they usually charge anywhere from 8% to 12% of the value of the rental, plus fees. No matter how you run your property, a good rule of thumb is to keep a minimum of 3% of the unit's value to cover needed repairs.

How much does an ADU cost?

Before you can reap the benefits of an ADU, there's the hefty price tag to consider. Let's look at the costs of an ADU:

• Construction: $90 to $160 per square foot ($54,000 to $160,000).
• Maintenance: Depends, but 3% of the value of the unit is typical.
• Utilities: Depends, but the average cost of utility bills – water, power, gas, garbage — in the U.S. is $133.34 a month, or about $1,600 a year.

Financing options for an ADU

• Personal loan: A personal loan gives you a lump sum upfront to build and maintain your ADU. In return, you promise to repay the loan in installments over a set timeframe. While a personal loan offers you the flexibility to use the funds for any ADU expenses and get all the money at once, it can lock you into a loan that can take years — even decades — to pay off and with interest.

• Home equity loan/HELOC: Two of the most common ways homeowners tap their equity is with a home equity loan or HELOC. Rates are typically more favorable than a personal loan or credit card. The downside of a home equity loan or HELOC is requirements can be strict. Eligibility criteria usually include having 15% to 20% equity in your home, a good credit score, a low debt-to-income ratio, and a solid, steady income. Both have fees and interest associated with their costs.

• Home Equity Investment (HEI): A HEI is a partnership you have with an HEI company like Point. In a shared equity agreement, it works like this: You get the money upfront for a portion of your home's future appreciation. A significant advantage of an HEI is you control the partnership during the 30-year term and when you exit it. You can access cash through an HEI to fund the construction of your ADU. Locking in the funds through your equity for your ADU construction efforts will help create a smooth process and handle any hiccups. There are no monthly payments, income requirements, or need for perfect credit. Reach out to one of Point's team members to see what you might qualify for.

Is an ADU a good idea?

There are many benefits of homeownership — and having more than one dwelling on your property could prove a boon. Adding an ADU to your homestead could be a great option if you want a versatile dwelling, a multi-generational housing arrangement, or a rental income stream. Depending on your situation, an ADU addition can be in-step with your house goals, financial goals, and long-term strategies.