What is an ADU and how can it increase your home value?

With housing in short supply and the pandemic shifting real estate preferences, accessory dwelling units (ADUs) have seen a spike in popularity of late.

Costing roughly $25,000 to $150,000 to construct, according to the National Association of Home Builders, an ADU can take many different forms, whether it’s a small detached building, a basement apartment, converted garage or some other area that’s been turned into living quarters. AKA granny flats, in-law suites, garage studios or carriage houses, ​​these extra living spaces can be a cost-effective way to update your property to suit your family’s current needs, and can boost the value of the real estate you own. They can also be a source of extra income by renting out the space or listing it on services like Airbnb.

According to Freddie Mac, at least 1.4 million properties had ADUs as of 2019, and more homeowners have been interested in creating such units on their properties since that survey came out. This growth matches information from National Association of Homebuilders (NAHB) 2019 survey data, in which approximately one in five remodelers noted they had completed at least one ADU development project in the prior 12 months. Natalia Siniavskaia, NAHB assistant vice president of housing policy research notes that NAHB members have reported an increase in projects that could be ADU conversions in the last year.

Here’s what you need to know about ADUs and what goes into creating one.

What is an ADU?

“It’s sort of funny but there’s no precise definition of what it is,” says Natalia Siniavskaia, assistant vice president of housing policy research at the National Association of Homebuilders. “The definition is fluid.”

Indeed, different states define it differently, but generally an ADU is a second small dwelling right on the same grounds as your regular single-family residence; it can be either a separate building or attached to the main house or adjacent structure on the property.  You could set up an apartment in the basement of your home, build one over your garage, or have a tiny house built with a foundation set in your backyard.

“Most people associate ADUs with at least a separate entrance, providing an opportunity for independent living,” Siniavskaia says. Generally, that means it has its own kitchen and bathroom facilities, as well.

No matter where you it’s located or what it contains, the ADU is considered a part of your property and your real estate lot. It has no separate address, and you cannot legally sell it on its own (even if it’s a separate building). It only goes on the market when your residence does, and it’s considered part of the property being offered.

ADU vs duplex

An ADU is different from a duplex. With a duplex, you also have two units next to each other on the same lot: They could be single-story or two-story models, but they’re usually in the same building. However,  they’re considered distinct properties, with separate mailing addresses (even though there’s only one owner of record); in contrast, with an ADU, the tenant and the homeowner share the same address.

Also, duplexes can only be built on lots or parcels zoned for multifamily construction. It’s important to make sure that your ADU is classified correctly, lest it run afoul of local zoning laws  (for more on the legalities, see below).

What’s involved in creating an ADU?

First and foremost, the most important thing is ensuring that your ADU conversion or creation is legal, “making sure you can obtain the permits, meet legal requirements,” says Siniavskaia. “There are a lot of unpermitted ADUs across the nation,” Holtz  notes. “If you’re a potential buyer, you’re going to want to go through and see if it’s permitted.”

If your paperwork isn’t in order, it could cause complications when you’re ready to sell your house. An unpermitted ADU could result in costly renovations to get things up to snuff before closing, and a seller might not agree to shoulder those costs.

Individual municipalities will have their own regulations when it comes to ADUs, so it’s important to know what rules will govern your project before you start the work. Regulations vary about whether you can add one and if so how close an ADU can be to the property line, how large it can be, or any number of other factors.

Plus, Holtz says if you live in a homeowners association (HOA), you may have another level of complexity to deal with, because HOAs may have stricter rules than the municipality. You’ll need to review their guidelines for construction.  Even without HOAs, not all neighborhoods are open to ADUs. “It might not be a legal restriction, but it might not be welcome in the neighborhood,” Siniavskaia observes.

Local laws

If your HOA approves it and your neighborhood is on board, you next need to check with your local government for permits. Generally, many counties allow ADU permitting in single-family zoning districts, provided they meet specific standards imposed by the municipality. These can include having the owner occupy one of the buildings on the property, designs that are compatible with other homes in your neighborhood, minimum lot sizes, parking spaces and occupational limits. States can impose these by the bedroom (think two people per room max.) You also need to take fire safety laws into consideration by adding smoke and carbon monoxide detectors to the ADU. There may also be regs about access: having to provide a certain number of doors or windows.

A contractor’s expertise can help you with all of this. They’ll take care of permits for you and should be well-versed in the local government’s guidelines for ADUs.

How do you build an ADU?

For this to work from a legal standpoint, the ADU must be an independent living space, suitable for year-round habitation. Along with its separate entrance, it usually needs a bedroom, bathroom and kitchen; it must also have heating, ventilation and air conditioning (HVAC) and plumbing systems.

If it’s an attached unit, such as in the basement or in the garage, the ADU usually shares the same electrical and plumbing facilities as the main home. “I have gone with wall heaters and AC units since they are cheap and safe,” states Eyal Pasternak, founder of Liberty House Buying Group, a Miami real estate investment company that buys, renovates and resells properties. “But this is mostly for smaller ADUs. Otherwise, you can also opt for ductless mini-splits, which are highly efficient and run throughout the year.”

If it’s a separate dwelling, the ADU could have its own systems. Otherwise, you should try to place the attached unit close by, as this can lower labor costs to extend power lines and piping from the main house.

If you’re building a new unit, “locate the site and conduct some essential work on it. For example, looking for any faults, pipelines under the earth, big chunks of rocks, etc,” recommends Ben Fisher, a real estate investor and owner of the Fisher Group, based in Park City, Utah.

Moreover, “Your ADU needs to go somewhere that will allow your tenant to come and go as they please and let you access all parts of your home without going through the ADU,” notes Leonard Ang, CEO of iPropertyManagement Leasing, an online resource for lease and rental agreements.

Noise is also a consideration. Ang adds, “If the apartment is in your home, you should try to have nice, thick walls between your living space and the ADU, and you probably don’t want it to be directly above your bedroom.”

How much does it cost to build an ADU?

Of course, the cost of creating an ADU varies tremendously, depending on the type of dwelling you want to do. A key factor is whether you’re converting an existing internal space ($10,000–$30,000); creating an attached addition ($40,000 – $125,000); or building a whole new structure ($100,000 and up), according to HomeAdvisor estimates. Obviously, the more separate the space, the more expensive it’ll be.

Converting an existing space is the most manageable, with costs ranging from $2 to $5 per square foot. More specifically:

Adding a bathroom to any of these will set you back $30,000.

The size of the apartment also impacts your budget. A 400-square-foot granny pod can cost you between $40,000 to $80,000. A larger living space (750 square feet) comes with a higher price tag of $75,000-$150,000. Of course, the larger the living space, the more you might be able to recoup in rental income.

Given the complexity and extensiveness of an ADU, you probably will need a contractor’s services. The pros’ services usually comprise 30 to 50 percent of your project’s costs, so make sure to budget these accordingly.

With a basement, garage, or attic ADU, Homeadvisor estimates the project to be complete in two months. Building a new dwelling can take four to five months, illustrating how much more you’ll pay in labor costs for new builds.

How can you finance your ADU?

ADU costs are higher as construction material prices have spiked. Soaring lumber prices are a big factor in this.

If you don’t have that kind of money to spend up front, you have options when it comes to paying for your ADU project.

• Tap your equity. Whether through a cash-out refinance, home equity loan or home equity line of credit (HELOC), you may be able to use value that’s already stored in your property to pay for the improvements.
• Construction loans. Short-term financing that’s targeted at home-building projects.
• Grant programs. Holtz said that as more municipalities realize that ADUs can help address housing shortages, they may start rolling out construction incentives.
• Personal loans or credit cards. These can be more expensive ways to finance a large project, but if you’re disciplined about making payments, they can still be a good option.

How much home value does an ADU add?

In the short term, ADUs provide value in the shape of rental income. When determining prices for your tenant, Pasternak suggests “poking around in your neighborhood and seeing what the average rent for an apartment is and creating a range within which you can choose to charge. Although ADUs do increase property tax, you can easily pass this on to renters and make a profit.”

Along with rental income, ADUs can help increase your home’s property value. “A home with an ADU can sell for 20-30 percent more than a comparable home without one,” Ang remarks.

Creating an ADU on your property can also be a good way to dip your toe into the pool of real estate investing, Holtz notes. “A lot of real estate investors like to talk about house hacks,” he said. “For people who want to become a real estate investor, this is one way to do it.”

That’s winning at real estate.

Bottom line on ADUs

Accessory dwelling units can be a great way for homeowners to increase the functionality of their property and can be a big boost to the asking price when it comes time to sell.

But creating an ADU in your home is a complex task, both legally and literally. It’s crucial to make sure the project was permitted correctly, or it can become an expensive headache.

While gaining approval and the investment to build might seem daunting, the end result is you’ll create a living space your family member or tenant can use, and you’ll likely increase your home’s worth down the road.