Additional dwelling units (ADUs) have grown drastically in popularity in the past few years for various reasons. Not only do they offer extra living space, but they also offer solutions to many issues such as the housing crisis, finding homes for aging loved ones, and even offering space for home offices. ADUs have a lot of applications, but did you know that they can be used as a potential source of passive income too?
ADUs can be used to either rent out or live in while you rent your primary house (house hacking). Both present you with extra income you can utilize for other aspects of your life. The big question, however, is not only whether ADUs are a viable financial investment in 2024 but also if you can make money with ADUs. Read on to learn about whether the passive income from ADUs is worth the initial investment.
An ADU is essentially a smaller residential unit built on a single-family lot that has an existing, often larger, primary home. These units have been around for hundreds of years, being primarily used as a place for workers to sleep, and recently gaining renewed popularity during the mid-twentieth century.
There are 4 main types of ADUs:
- Attached ADU
- Detached ADU
- Garage Conversion ADU
- Internal ADU
The most popular types are detached ADUs but the most affordable are usually garage conversions. These units go by a plethora of other names, including guest houses, granny flats, and In-law suites. Many homeowners have begun to invest in them because they offer several benefits including:
- Multigenerational housing
- Income Opportunity
- Affordable Housing / Local Community and Economy Benefits
- Environmental Benefits (less material and space than large homes)
- Non-living space opportunities (offices, pool houses, she-sheds, etc.)
Plus, there have been several legislative changes, especially in California, that make it easier than ever to build an ADU yourself. As we face a very serious housing crisis, ADUs offer a lucrative option to combat the effects and provide homeowners with income opportunities.
Earning Potential of ADUs in 2024: How Much Can You Earn?
Like all investment opportunities, ADUs are affected by current market trends. ADU market growth is primarily affected by rising urbanization, the increasing cost of traditional housing, and favorable regulatory changes in many regions. Some key trends in the market to keep an eye on are eco-friendly designs, the adoption of smart technologies, and the integration of ADUs in real estate investment strategies.
Investing in an ADU can bring a substantial return on investment (ROI), typically ranging between 7% to 15%, influenced by local market conditions and specific property circumstances. For instance, consider the average cost of constructing a new ADU in 2024, which is between $146,500 and $216,500. If you rent out this ADU in an area like Los Angeles County, where the expected rental income is approximately $2,053 per month, you could see significant financial gains.
For a practical example, let’s say you build an ADU for $180,000 (a median figure within the provided range). At a monthly rental rate of $2,053, your annual rental income would be $24,636. To calculate your ROI, you would divide this annual income by your total investment, resulting in an ROI of approximately 13.7%. This figure is close to the top general estimation, highlighting the profitability of ADUs in certain regions.
Additionally, conducting a break-even analysis helps determine when your investment pays off. Using the same example, with fixed costs of $180,000 and an annual rental income of $24,636, you would break even in about 7.3 years, aligning with the general observation that homeowners usually pay off their ADU in 6 to 10 years. This break-even period can vary based on rental income and initial costs, but it provides a tangible measure of when your ADU investment becomes purely profitable.
ADU Rental Income Expectations in LA for 2024
Rent prices have been rising nationally by about 11% to 13%. These rates are predicted to continue into 2024. Although these numbers are not great for people looking to rent, they are incredible for homeowners looking to rent out their ADUs, especially as people look for more affordable housing options (ADUs will provide more affordable housing options during these times of high rent, making them more popular to rent).
Whether you decide to long-term rent or short-term rent (through platforms like Airbnb), you can expect a decent return. Which option is right for you is highly dependent upon where you live and how much work you want to put into the rental. It’s important to research and comply with local regulations regarding short-term rentals and calculate the potential income from short-term rentals versus long-term leases, factoring in associated costs such as cleaning fees and increased management responsibilities before deciding which is right for you. ADUs work quite well for either option though.
To help you understand how much you can make off an ADU rental property, here are a few expected long-term rental incomes for ADUs in various California counties.
|Expected Rental Income
|Los Angeles County
|San Diego County
Real-Life ADU Rental Success Stories
Selma Hepp from Burbank
Selma Hepp‘s journey to transforming a former garage into an ADU in Burbank, California, is a testament to the potential of ADUs in addressing housing needs. Initially intended as a residence for her parents, Hepp, a chief economist at CoreLogic, faced unexpected challenges in the renovation process. The garage, already converted into a living space by previous owners, required significant alterations to meet building codes, including foundation leveling and structural changes, which initially seemed daunting.
Despite a set budget of $50,000, Hepp encountered difficulties such as finding affordable and reliable contractors and navigating the complexities of the building process, exacerbated by the pandemic’s impact on the construction industry. However, her persistence and connections in the real estate sector played a crucial role in overcoming these hurdles.
The completed 500-square-foot studio features a courtyard and a separate office space, staying within the budget. Although her initial plan was to rent it out long-term, the proximity of her home to major film studios and a Hollywood writers’ strike led her to pivot to Airbnb. This decision proved fruitful, with the unit almost constantly occupied and generating about $3,000 a month in rental income, covering her mortgage expenses of $2,700.
John and Athena K. from Grants Pass
John and Athena K. from Grants Pass have owned their home with two Accessory Dwelling Units (ADUs) since 2002. The units, measuring approximately 22’ x 15’ and 20’ x 15’, include bathrooms and kitchenettes. Over the years, they’ve housed about eight tenants, mainly for transitional housing. Their current tenants have been with them for three years and six months, respectively.
The couple emphasizes the importance of careful tenant selection and clear rules, especially regarding shared spaces like laundry areas. They maintain a balance of involvement, often going days without seeing their tenants. While not primarily focused on profit, John recognizes the high demand for housing in their community. He believes that ADUs can offer a significant return on investment, but also values the ability to provide space for people in need. Their experience showcases both the financial and community benefits of ADUs.
Expert Opinions and Predictions
According to Verified Market Research, the ADU market size is projected to reach $10.6 Billion by 2030, growing at a CAGR of 18.6% during the forecast period 2024-2030. Hopping on the trend now can be quite rewarding for individuals. In fact, Moneywise says “Many experts are touting ADU investing because you don’t have to purchase new land and they provide you with flexibility. If you already have the property and are looking to get into real estate investing, you’re going to want to take a serious look at ADUs.”
If you are considering an ADU for income generation, make sure you build your ADU with renters in mind. This means you will need to design with privacy and accessibility in mind, as well as maintenance and repair responsibilities.
You should also consider hopping on the ADU trend now. Catching the rising market early will help you see higher returns on investments as the market continues to grow. The sooner you invest in an ADU, the better off you will be in the future as the ADU market rises. Demand is high now, take advantage of it!
Challenges and Considerations
There are a few challenges you should keep in mind before beginning ADU development. For starters, there are several laws and regulations dependent upon your location that you will need to abide by. The best way to determine what regulations apply to you is to consult with an ADU professional. They can help you tackle legal aspects as well as help you understand zoning requirements (rules about the type of ADU that can be built on your property).
Besides legal and zoning challenges, maintenance and management of the ADU rentals should be considered. Landlords are responsible for all maintenance of the ADUs while tenants live there and will be responsible for keeping everything up to code and functioning properly. This can be expensive and time-consuming depending on the tenants. However, if the ADU is designed with tenants in mind and the longevity of appliances, this shouldn’t be too much of a concern.
We should also note that some individuals have misconceptions about ADUs that can present challenges for them when deciding whether or not to construct one. The main one is that HOAs are able to block the construction of ADUs. This is untrue. HOAs cannot influence your decision to construct an ADU.
Here are a few other considerations to keep in mind:
- The permitting process can take a long time but is very important
- The contractor needs to have experience with ADUs, thus limiting your choices of who can construct the unit
- Financing an ADU can seem difficult at first but there are many options and grants designed to make the process easier.
For a more in-depth analysis of common challenges, you can do a free consultation with an ADU expert.
ADUs are a viable financial investment in 2024. The projected market value is expected to go up and there are many affordable options available to make the investment cost effective. Considering the ongoing demand for alternative housing solutions, ADUs remain a wise investment for homeowners seeking to maximize their property’s potential.
With that being said, we still strongly encourage individuals to conduct further research about constructing and managing an ADU. You can use these resources as a starting point.
- Ultimate Guide to ADU Development With Step-by-Step Videos
- $40k ADU Grant: CalHFA Grant Program Explained 2024
- Garage Conversion Cost in Los Angeles – Updated for 2024
Start your ADU journey today with a free consultation to learn more about your potential ADU income options.
What is an Accessory Dwelling Unit (ADU)?An ADU is a smaller, secondary house or living unit located on the same lot as a primary residence. These units can be attached, detached, a garage conversion, or an internal ADU, serving various purposes such as additional living space, a home office, or a rental property.
What are the benefits of having an ADU?ADUs offer several benefits, including providing multigenerational housing, creating income opportunities through rentals, contributing to affordable housing, offering environmental benefits by using less material and space, and serving as non-living space such as offices or pool houses.
How much can you earn from renting out an ADU?The potential earnings from renting out an ADU depend on local market conditions and the type of ADU. In areas like Los Angeles County, expected rental income can be around $2,053 per month, leading to a substantial return on investment typically ranging between 7% to 15%.
What are the most popular types of ADUs?The most popular types of ADUs are detached ADUs, though the most affordable options are often garage conversions. These preferences are influenced by the specific needs and constraints of homeowners.
What are the key considerations before building an ADU?Before building an ADU, consider legal and zoning regulations, the permitting process, choosing an experienced contractor, financing options, and the overall maintenance and management of the rental unit. Consulting with an ADU professional can help navigate these challenges.
Can ADUs help in addressing the housing crisis?Yes, ADUs can play a significant role in addressing the housing crisis by providing more affordable housing options, increasing the housing supply without the need for new land, and offering a source of income for homeowners to offset mortgage costs or other expenses.