Heard the acronym ADU thrown around recently, and wonder what it means? Or, for that matter, what the term accessory dwelling unit means?
They go by many names: guest house, casita, granny flat, granny pod, in-law suite, income suite, or backyard cottage. Whatever term you use, it all boils down to the same thing: an extra living space, separate from the main single-family dwelling.
What Are ADU’s: Accessory Dwelling Unit Meaning
An accessory dwelling unit is a separate living unit on the grounds of a single-family home. It must have a separate entrance and its own kitchen (or kitchenette), full bathroom, and living and sleeping space.
Some homeowners use ADUs to house their in-laws under a conveniently separate roof. That keeps them from stepping on your toes — at least compared to living under the same roof.
Others rent out ADUs for income to help cover their mortgage payment. More on that shortly.
Types of ADUs
You can of course build a standalone ADU, such as the classic backyard cottage. But that’s not the only option for adding an ADU.
Alternatively, you can convert your basement or garage into an ADU. That’s easier in some homes than others, depending on whether they already have a separate entrance, how finished they are, and the existing plumbing and electric lines.
Rather than a garage- or basement conversion ADU, you can also potentially build an above-garage ADU, if you have plenty of vertical space. That lets you keep using the garage for storage space and parking, while adding a small apartment above.
As a more expensive option, you can build an addition to your primary house as an attached ADU. Also known as a bump-out ADU, it adds to the footprint of your home.
How to Use ADUs to House Hack
Instead of letting your deadbeat brother-in-law move in, you could rent out the ADU. It’s a form of house hacking, and the rent might even cover your entire mortgage payment.
You have several options for renting out an ADU. You could sign a long-term lease agreement with a tenant and collect rent each month. On the plus side, you earn stable rental income, and if you screen your tenants well, a quiet and respectful neighbor. You don’t have to furnish the unit and you can charge them for part of the utility bills. But if they fail to pay or cause damage to your property, you have to go through the long, expensive eviction process.
Instead, you could rent out the ADU on Airbnb as a short-term rental property. That comes with its own pros and cons — on the one hand, you don’t have to put up with neighbors every day, and you don’t have to worry about evicting deadbeat renters. But it also means less reliable rental income, the burden of furnishing the unit, and more labor in cleaning the unit and coordinating with guests.
Check out this house hacking case study for how one man covered his mortgage with his neighbor’s rent.
How Much Does an ADU Cost?
$43,286. Just kidding. You should know better than to expect a one-size-fits-all answer to that question.
You can order prefab standalone ADUs in the range of $60,000 to $120,000. Size matters of course, as do the finishes and materials.
Along similar lines, you can also look into tiny homes on wheels. With an electric and plumbing hookup, you could be good to go. And you can take it with you when you move and keep house hacking at your next home.
If you convert your basement or garage into an ADU, the cost depends on how much modification you need. You might update an already finished basement with an existing separate entrance for just a few thousand dollars, to include a full bathroom and kitchenette. Or you could spend $50,000 converting a drab, unfinished garage or basement into a cozy living space.
Bear in mind that if you have to pull permits for the work — which you likely do — the county might bump up your property tax assessment. The better to tax you with, my dear.
Can I Finance an ADU?
You have a few options to finance an ADU.
To begin with, you tap your home equity. That could mean drawing on a HELOC, or taking out a home equity loan, or refinancing your mortgage. Try Credible for competitive interest rates.
You can even take out HELOCs on rental properties if you have equity in one.
But you don’t need equity in your home to borrow against. As a real estate investor, you can open unsecured business lines of credit and credit cards. Check out business credit concierge Fund&Grow, who helps you open between $100-250K in business credit lines as a real estate investor. You don’t even need a legal entity — watch this explanation video of how Fund&Grow works.
If you want to add an ADU to an investment property, whether a flip or a rental, you may be able to roll the costs into your renovation loan. We particularly like Kiavi and Patch Lending for purchase-rehab loans, but you can compare investment property loan terms here.
What’s the Return on ADUs?
You tell me — you’re the one who knows the details of your project. Like asking “How much do ADUs cost?”, it depends on your project.
Run the numbers through a rental income calculator like any other property. Get clear on the costs to build or renovate the unit, and the market rent for it. Count on the market vacancy rate and the same repair and maintenance costs as any other unit (10-15% of the total rent).
If it would cost you $12,000 to convert your basement to a basement ADU, and you could rent it for $1,000, then yes, the gross rent would pay for the project in one year. But adding in all your other ongoing expenses, the 50% Rule suggests that half the rent will go to non-mortgage expenses such as property taxes, insurance, property management fees, repairs, maintenance, vacancy rate, marketing costs, and so forth. That would extend your breakeven horizon to two years.
That said, accessory dwelling units come with some efficiencies, given that they’re part of your home. Your property taxes and homeowners insurance may not go up at all. And if you convert part of an existing structure, such as a garage conversion ADU, you still only have one roof, foundation, and set of walls to maintain.
In other words, ADUs sometimes come with fewer expenses than separate rental properties.
Finally, bear in mind that beyond the rental cash flow, your home may go up in value. Buyers typically pay more for homes with ADUs that provide ongoing rental income, or at the very least somewhere to stash a henpecking mother-in-law.
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Legal & Zoning Requirements
Accessory dwelling units almost always require permits. That includes garage or basement conversion ADUs, unless no new plumbing or wiring is required.
You may also need a building permit, if you plan to build a new structure.
Some city zoning laws also limit the size of ADUs to 500 or 1,000 square feet, or require a minimum building lot size (such as 3,200 square feet). Often cities limit you to one ADU per single-family home.
In some cities, you can build an ADU at your primary residence, but you can’t add them to rental properties. Others have become more flexible in recent years, in an effort to boost affordable housing supply.
Nor are city laws the only ones that might apply. If you live in a neighborhood with a homeowner’s association, they might add their own restrictions on top of city regulations. These often include style requirements in addition to size and safety requirements.
Bear in mind that you may or may not need to apply to rezone your property for two units. In most cases you don’t, particularly if you aren’t installing separate water and utility meters. But large, heavily regulated cities sometimes impose complex laws that make it nearly impossible to build an accessory unit or split your home into two units.
What is an accessory dwelling unit? A gold mine, if you can get it up and running inexpensively.
Beyond construction or renovation costs though, property owners should watch out for permits, zoning, and other regulations that make it harder and more expensive to add an ADU. Expect projects to cost twice as much and take twice as long if you need permits, inspections, and zoning approval.
The less urban your area, the less red tape you’ll likely encounter. But also the less demand you’ll have for a basement apartment or other secondary units, and the lower your rental income.
Try our free house hacking calculator to run the numbers, but don’t stop there. Do some research on how an ADU might impact your home’s value. You might find that it helps justify the expense, even if the cash flow isn’t stellar. Or it could hurt your property value, depending on the proposed project and your market.♦
Beyond accessory dwelling unit meaning, what questions do you have about ADUs? Do you plan to add a separate structure or additional living space to your primary dwelling, or convert non-living space such as a garage apartment?
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About the Author
G. Brian Davis is a landlord, real estate investor, and co-founder of SparkRental. His mission: to help 5,000 people reach financial independence by replacing their 9-5 jobs with rental income. If you want to be one of them, join Brian, Deni, and guest Scott Hoefler for a free masterclass on how Scott ditched his day job in under five years.