Rental Investor Starter Kit

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An accessory dwelling unit (ADU) is a great way to increase your property’s value, generate passive income, or provide housing for family members or guests. 

They’re particularly popular in areas where real estate is more expensive because they’re an opportunity to invest in real estate where doing so may be cost-prohibitive. 

ADUs also have the advantage of having many financing options, making them accessible to many types of investors. 

What is an accessory dwelling unit ADU

What is an Accessory Dwelling Unit (ADU)?

When you build an additional structure on a property that already has a central unit, then you’ve got yourself an accessory Dwelling Unit (ADU). Also known as Granny Flats, Casitas, or In-Law Suites, an ADU can be built on a single-family property, multi-family property, or duplex. 

An ADU has everything a resident needs:

  • An entrance separate from the main unit
  • A kitchen
  • A bathroom
  • Living space

For this reason, ADUs can be rented all year. They also add significant value to your property

ADUs can be:

  • Garage conversions
  • Stand-alone units
  • Attic conversions
  • Basement conversions
  • Attached to the main property

What Are the Benefits of an Accessory Dwelling Unit?

Passive Income Stream + Increased Property Value

An ADU can generate passive income by being a short-term or long-term rental.

Alternatively, a property owner could choose to live in the ADU and rent out their primary residence instead. Either way, an ADU will also increase the value of your property.

Home for Aging Relatives

Not everyone feels comfortable with their older relatives in a nursing home or retirement community. There's visiting hours to navigate, a high quality of life isn't guaranteed, and it may be expensive. With an AUD, you can have your aging family member (or members) nearby or provide a residence for a caretaker. You can also build the ADU to fit its occupants’ needs, such as ramps, lower countertops and cabinets, and wider corridors for wheelchair access.

An AUD also doesn’t have to be for an elderly family member. It’s also ideal for an adult child.  

What’s the Difference Between a Tiny House and an Accessory Dwelling Units?

ADUs are permanent and sit adjacent to, near, or in conjunction with the main dwelling structure. Tiny homes usually have wheels or exist on small plots of land that have no other buildings. 

ADUs can be anywhere where there’s already a pre-existing structure, but a tiny house needs a special permit or a small parcel of land just for themselves. As a result, it’s easier to construct and approve an ADA than most tiny houses. 

The laws vary and are evolving on how big a tiny house can be, but they’re generally much smaller than ADUs. Meanwhile, the size of ADUs is only constrained by the size of the land they’re on.

What Are the Different Types of Accessory Dwelling Units?

Detached Structure

This is an AUD that’s in the back or side yard of a primary residence. They’re usually tiny houses with the sole purpose of creating more living space. They can also serve a second function, like a second-floor unit above a detached garage. These structures must sit on foundations, which means RVs and mobile homes don’t count.

Since these ADUs are detached, residents can do as they please with little effect on the main property. This is especially appealing for tenants who want a sense of independence. Occupants can come and go as they please and have privacy from the main house. 

With a detached ADU, however, you do have extra building and maintenance costs. This includes utility hookups, mechanical appliances (furnace, water heater, etc.). A detached ADU also takes more raw materials to put together. 

Attached External Apartments

These units share at least one wall with the primary residence. They still have separate entrances and don't share any internal connections with the main unit. They tend to have their own utility hookups, although connecting them is less expensive since the distance traversed is less. They may share mechanical appliances like a furnace or water heater, but not necessarily. 

Attached Internal Apartments

This sort of ADU is entirely a part of the primary residence. You might not even be able to tell it's an ADU at first glance. These units are usually in a finished basement or attic. They might not have their own entrance, although they will have separate, secured doors that one enters from an internal foyer or hallway. They tend to share utilities and mechanical appliances with the main unit. Since they require less construction and fewer appliances, they're the most affordable iteration of an ADU.

How Much Does it Cost to Build an Accessory Dwelling Unit?

What does it cost to build an ADU

The cost of building an ADU depends on the cost of labor and materials. Given that an ADU is smaller than a house, you have to make the most of every cubic foot. That means an increased cost per square foot because you don’t get as good of a deal on materials.

Geography will determine the cost. Building a stand-alone ADU in Portland, Oregon, for example, has a median cost of $90,000, according to the Oregon Department of Environmental Quality. An attached ADU is less but still has a median cost of $40 to $50k. 

While it’s the case that the Portland real estate market is pricier, given all the expenses, an ADU can be an expensive endeavor wherever you may live. 

How to Finance an Accessory Dwelling Unit?

These financing options are ideal for ADUs that are built concurrently with the main house or independently.

Fannie Mae HomeStyle Rehabilitation Mortgage: 

These loans are for major renovations.

  • Down payment as low as 5%.
  • Private mortgage insurance until 80% loan-to-value (LTV), which is the amount of the loan divided by the appraised value of the property expressed as a percentage.
  • Credit score greater than 650.

FHA 203(k) Renovation Loan: 

Let’s homebuyers combine the cost of major home improvement with purchase loans. 

  • Ideal for first-time homebuyers who don’t have excellent credit.
  • Mortgage insurance of 1.75% of the loan’s value.

Construction-to-Permanent Loan (All-in-One Loan): 

Financing for every part of the home building process from purchasing land to completion then converts into a 30-year loan. 

  • Only one closing necessary.

Short-Term Construction Loan: 

Covers ADU construction.

  • One-year terms
  • Variable interest rates that are higher than long-term loans.
  • Once construction is done, the loan converts into a permanent mortgage.
  • Second closing is required.

Cash-Out Refinancing Loan: 

This is when you refinance for more than your home is worth so that you get a large lump sum of cash.

  • Ideal for those with significant equity.
  • You may get better rates if they’ve fallen since your initial mortgage.

Home Equity Line of Credit: 

This is a credit line secured by your equity and has a low-interest rate because it’s guaranteed.

Unsecured Personal Loan: 

Short-term loans ideal for people who plan to sell their homes after building the ADU.

Bottom Line on Accessory Dwelling Units

With so many advantages to owning an ADU and routes to constructing one, it’s no wonder ADUs are becoming so popular. They’re becoming an increasingly viable investment option for many people, so consider an ADU when contemplating what your real estate investment strategy should be. 

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