Additional Dwelling Units, (ADUs, a.k.a granny flats) have been around for a long time—several decades to be sure. Depending on local laws as well as deed restrictions, building codes, etc. some areas of the country have many ADUs, while other locales have few if any. For example, ADU-related laws in the largest population state in the nation, California, were recently changed by the state legislature. Where prior to the new law, individual government entities (cities, counties) had imposed restrictive laws to effectively prevent or limit ADUs in many cases, that has all changed—some would argue radially so. Now, many if not most, California municipalities have made it much easier, faster and cheaper to get plans approved, permits issued and construction completed in the Golden State.
Changes in ADU laws, across the US, are being precipitated by several factors. One is that the price of houses, as well as monthly rental costs, have both been rising faster than the inflation rate for several years. This is often due to a shortage of affordable housing. While some government entities have initiated new rent control laws to mitigate rent increases, that itself can lead to other problems such as delayed maintenance, less new units going up, conversion to condos, etc. Simply put, more ADUs means more available housing stock, as well as new potential income opportunities for homeowners and investors. For example, in California, it is now legal to convert a garage into a rental by putting up drywall and meeting certain food prep and sanitary conditions (i.e. new bathroom and kitchen). Further, it is possible to divide a current home in half (Jr. ADU) and rent out one or both halves to different renters, assuming it meets the new rules, such as bathroom and kitchen issues. It is even possible (in California) to build a separate, free standing ADU on the same property, assuming the lot is big enough and meets code requirements.
ADU Investor Advice
The ideal circumstance for investors who wish to invest in one or more ADUs is to wind up with new positive cash flow, even after taking into account all the costs involved to create one or more ADUs on the property. What follows is a brief primer on the subject. Go online to find much more helpful info.
A. Thoroughly research all ADU-related expenses including: architectural plans, permits, construction costs, debt service, etc. Inquire about utility, impact and other potential fees; they can, in total, run into tens of thousands of dollars. Seek out professional advice from knowledge realtors, lawyers, CPAs, etc.
B. Ascertain the estimated annual potential income you can realistically expect to collect from renting out the (new) ADUs. Make sure your numbers are accurate since a bank loan may depend on it.
C. Ensure that your plans pass scrutiny with the city/county in which you anticipate putting up the ADUs. Government entities can make or break a project, especially if they drag their feet and create time problems that cost you money. Contact utilities to make sure your project does not break any of their rules, i.e. underground or overhead power lines, etc. On the flip side, utilities may offer tax breaks or rebates if you adhere to their recommendations concerning appliances, insulation, roofing, toilets, windows, etc.
D. Study different financing options. Most investors need to obtain funding in order to pay for all the ADU-related costs. A HELOC (Home Equity Line Of Credit) loan is one option. Refinancing your first mortgage is another. Keep in mind that there are two basic ways to qualify for the needed funding: It can be based strictly on the asset value alone, i.e. the FMV (Fair Market Value). A second method is based on the total rental income you can potentially derive once all units on the property are fully rented out.
E. Know what you are getting into from a risk/benefit standpoint. For example, comps (current comparable sales) should be studied carefully for how much local properties are worth BEFORE ADUs go up and AFTERWARDS. Also, when applying for a loan, you will probably need to order an appraisal. If the appraiser cannot justify the real value of the property, getting the loan you need can prove to be problematic. If necessary, be prepared to provide the appraiser with the addresses of local ADUs so they can make appropriate comparisons based on square footage, etc. You should start your search for nearby ADUs as early as possible.
F. Reach out to your lender early in the process and go over with them what you are planning on doing with the property. Ask them for advice. Inquire if there are any special requirements as they pertain to ADUs. For instance, some lenders have been known to add on extra fees, tack on additional LTV requirements, etc. that can burden the property with extra costs.
G. Do a careful study of rental rates in your immediate area in general and ADUs in particular. Make sure when you are penciling out the costs, and projected rental income for the project, that you will be able to generate positive cash flow from the get go, including all costs; if not, that could be a deal breaker.
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