What Is an Accessory Dwelling Unit? How to Score Free Housing with ADUs

Heard the acronym ADU thrown around, and wonder what it means? Or for that matter, what “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 ADUs: 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 as in-law units to house relatives 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 additional income to help cover their mortgage payment. More on that shortly.

Types of ADUs

You can of course build a standalone ADU, such as a carriage house or the classic backyard cottage. But a detached unit is far from 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 an accessory 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 and livable square footage of your home.

Uses & Benefits of ADUs

 Why bother setting up an accessory dwelling unit at your home?

Use as Flexible Living Space 

You can, of course, use an accessory dwelling unit yourself as additional living space. 

You’ve heard every joke in the book about mancaves and she sheds, so I won’t add any groaners here. But I wouldn’t judge you if you just need somewhere to retreat to when the kids get too rambunctious. 

Put Up Family Members & Guests

Before we as a society started using awkward monikers like “accessory dwelling unit,” people just called these extra living spaces in-law suites or granny flats. Because that’s precisely what they used them for: putting up pesky in-laws in a separate living space so their snores and complaints didn’t annoy you as much. 

You can still use an ADU to put up in-laws. It’s just less fun than earning cash flow on it. 

House Hack as a Long-Term Rental

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 passive 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. 

Plus you get to pat yourself on the back for providing an affordable housing option. 

That said, if the tenants fail to pay or cause damage to your property, you have to go through the long, expensive eviction process.

House Hack as a Short-Term Rental

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.

What the #%& are real estate syndications, and do they really earn 15-30% returns?

Downsides of ADUs

For all those advantages of ADUs, they aren’t a free lunch. In fact, there’s nothing free about them. 

Consider the following cons before building an accessory dwelling unit.

Construction Costs: At the risk of stating the obvious, it costs money to build an ADU. Often tens of thousands of dollars, sometimes hundreds of thousands. More on the cost of building and ADU momentarily. 

Permits & Red Tape: Depending on where you live, you might face an uphill battle to get the permits or zoning approvals to add an ADU to your property. 

Maintenance Costs: All buildings require repairs and maintenance. By adding to your home’s livable space, you add to your ongoing maintenance costs. 

Loss of Space: If you build a new structure on your property, you lose the use of that ground. Likewise, if you convert your basement to an ADU, you lose the use of the basement for storing Christmas decorations or dead bodies or whatever else you were using it for. 

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 adding an ADU to your home.

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 LendingOne for purchase-rehab loans, but you can compare investment property loan terms here.

Or you could just buy a property with an existing ADU, or which lends itself to adding one inexpensively. You may even be able to get a 0% down payment mortgage through a VA loan, USDA loan, or NACA program. If you don’t qualify for any of those, borrowers with strong credit can use Fannie Mae’s 3% down payment program, and those with weaker credit can use the classic 3.5% down FHA loan. 

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.

Accessory dwelling units can deliver two types of returns: adding property value to your home and cash flow. Assuming you rent it out rather than using it as a granny flat or she shed, that is.

ADU Cash Flow

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.

Does an ADU Add Value to Your Home?

Beyond the rental cash flow you earn from an ADU, it could bump up your home’s value. 

Buyers typically pay more for homes with ADUs that provide ongoing rental income, of course. Or at the very least somewhere to stash a henpecking mother-in-law.

The higher the rental income, the more value your ADU adds to the property. You typically can’t include the square footage of outbuildings as part of the livable square footage in an MLS listing, but you can still list the ADU’s square footage in the property description. Who wouldn’t want more living space and potential income streams? 

Even so, building an accessory dwelling unit could cost more than it adds in value to your home. Do some market research in your neighborhood, and when in doubt, talk to a real estate agent about it.

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Want to compare investment property loans?

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How about fix-and-flip loans?

We compare the best purchase-rehab lenders and long-term landlord loans on LTV, interest rates, closing costs, income requirements and more.

Property Tax Implications for ADUs

If you pull permits to add livable square footage to your home, you better believe your local assessment office will raise the assessed value of your home, and with it your property tax bill.

Of course, if you only modify the interior of your home — with no outward evidence of renovations — you might be able to complete the project on the sly. Deceive your local permit office at your own risk however.

But if you add a detached ADU to your property, your local property assessor is bound to notice. And almost certainly increase the assessed value of your home.

Include any potential increases in your property tax bill when you calculate the cash flow on an ADU.

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.

FAQs About ADUs

Still have questions about ADUs? We’ve got you covered.

Does an ADU require a kitchen?

Yes — to be a self-contained living space, an accessory dwelling unit requires its own kitchen. Or, at the very least, a kitchenette including a small refrigerator and ways to cook food such as a huge toaster oven and hot plates.

How does an ADU access utilities?

Accessory dwelling units use your main home’s utilities.

You can theoretically install separate water and electric meters, but often that requires rezoning your property as a multifamily property. Read: more trouble than it’s worth in most cases.

That said, you can set up separate cable TV and internet access for an ADU without those zoning hassles.

What’s the minimum lot size for an ADU?

That depends on your city’s local zoning and code requirements. In general, minimum lot sizes only apply to stand-alone unit buildings.

Is there a maximum size for ADUs?

Some cities do impose a maximum square footage on ADUs built on single-family lots. Check your local building codes to confirm the rules in your municipality.

Final Thoughts

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 real estate investor and cofounder of SparkRental who spends 10 months of the year in South America. His mission: to help 5,000 people reach financial independence with passive income from real estate. If you want to be one of them, join Brian and Deni for a free class on How to Earn 15-30% on Fractional Real Estate Investments.