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What is an accessory dwelling unit and how can homeowners benefit from having one?

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

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.

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

What is an ADU?

“It’s a great question and it’s sort of funny but there’s no precise definition of what it is,” said Natalia Siniavskaia, assistant vice president of housing policy research at the National Association of Homebuilders.

An ADU can take many different forms, whether it’s a small detached building on a larger property, a basement apartment, converted garage or some other area that’s been turned into an apartment.

“Most people associate ADUs with at least a separate entrance and it’s located on the same lot as the main house, but provides an opportunity for independent living,” Siniavskaia said. “The definition is fluid.”

ADUs can also be called granny flats, in-law apartments, carriage houses or any number of other names.

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. Siniavskaia said that NAHB members have reported an increase in projects that could be ADU conversions in the last year.

“What’s driving it is the pandemic, people are home more and need the space. Looking around, there’s not a lot of inventory out there,” said Dan Holtz, co-CEO of Sovereign Lending Group. “Having an ADU can provide an office setting and you can go work there” without having to trade up to a bigger house.

What’s involved in creating an ADU?

Both Siniavskaia and Holtz said the most important thing is making sure your ADU conversion is legal.

“Making sure you can obtain the permits, making sure you meet legal requirements,” said Siniavskaia. If your paperwork isn’t in order, it could cause complication when you’re ready to sell your house.

“There are a lot of unpermitted ADUs across the nation,” Holtz said. “If you’re a potential buyer, you’re going to want to go through and see if it’s permitted.” 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 said, if you live in a homeowners association, you may have another level of complexity to deal with, because HOAs may have stricter rules than the municipality.

Even without HOA restrictions, not all neighborhoods welcome ADUs equally. “It might not be a legal restriction, but it might not be welcome in the neighborhood,” Siniavskaia said.

How can you finance your project?

Prior to the pandemic, ADU conversions cost about $100,000 to $150,000 on average, according to NAHB. Now those costs are even 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.

What are the benefits of an ADU?

ADUs can raise your property value and may also be part of the solution to the country’s ongoing housing shortage.

Legal ADUs, especially, can go a long way to boosting property values.

Holtz said that creating an ADU on your property can also be a good way to dip your toe into the pool of real estate investing.

“For a lot of real estate investors, they 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.”

Bottom line

Accessory dwelling units have grown in popularity over the last decade, and especially in the last year. They can be a great way for homeowners to increase the functionality of their property, and can be a big boost to value when it comes time to sell.

If you’re considering creating an ADU in your home, or are looking to purchase a multi-unit dwelling, it’s crucial to make sure the project was permitted correctly, or it can become an expensive headache down the road.

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Written by
Zach Wichter
Mortgage reporter
Zach Wichter is a former mortgage reporter at Bankrate. He previously worked on the Business desk at The New York Times where he won a Loeb Award for breaking news, and covered aviation for The Points Guy.