How Much Added Value Will an Accessory Dwelling Unit Add to My Property?
Welcome to the real property show where we talk about building, buying, and selling residential real estate. I’m Brian Freeman and welcome to the show. Today, I want to talk about your Return On Investment (ROI) for an ADU, that is, what you can expect to get back as far as value on your property. I won’t discuss cash flow, but I am going to talk about the added value that an appraiser ascribes to an existing residence combined with an added ADU.
How to Determine Your Total Investment Costs
Let’s say your house is currently worth a million bucks the way it sits without an ADU. Sometimes property owners build an accessory dwelling unit for a family member to live in, or use as a rental, several reasons exist to build an ADU. If we spend money to build an ADU on your property, we expect the value to increase once the build is complete. Most often, owners will not get all of their money back. Renting out an ADU can generate cash flow. You must consider what your return on investment is compared to your cost to build and the time it takes to get your investment back. If the costs to build equals $500,000, your total investment would equal $1.5 million on this property.
Evaluating an ADU's Return on Investment
Based on our example above, an appraiser typically gives an appraisal that ranges between 50% to 80% of the actual cost to build the ADU. So if you only get $250,000 in value out of a 50% ROI, you need to decide if you’re going to be in the home long enough to make your $500,000 worth the investment. If you decide to turn around and sell the home in a year, then you are going to lose $250,000 of your initial $500,000. That may be a serious concern when you evaluate your desire to build. On an 80% ROI, the resulting value equals $400,000. If you decide to add an ADU you must consider if it’s worth the value lost, if it’s worth a loan you may need to pull out, and how much time or money it adds to your current mortgage.
Renting Your Accessory Dwelling Unit
Some people choose to rent their ADUs. You could consider what you receive as cash flow to help achieve your desired return on investment. You may gross $2,000 or $3,000 each month. You can calculate how long it may take to pay back that cost through rental income, however, not all of that cash counts as cash flow. Costs, such as mortgage servicing, are associated with that monthly revenue. If you simply want an ADU, and you don’t really care about the costs due to long-term plans of enjoying your property, this may not be an issue. But if you’re looking to turn around and sell your property after completing an ADU, the ROI could be a serious concern. Appraisers do not always consider the potential income from a property in their appraisals, such as the value of owning a duplex.
Appraising an Accessory Dwelling Unit
Appraisers mostly use the sales comparison approach. This often results in losing the dollar-for-dollar value of the ADU compared to the cost to build, which has been known to cause financing issues. So if you have a property that you financed and you were well under the 20% loan value and you go to build an ADU and you lose equity, your equity position drops in the property. You may have to add PMI when refinancing because you’re less than a 20% equity position in the property. You may even lose so much equity in a property that you can’t actually get the loan. If you’re under the 20% equity position, then go and reduce your equity further, you could wind up at the 95% or even 100% loan to value.
Is an ADU ROI Right For You?
Evaluating the financing options on the very front end is crucial before you dive into plans and figure all that goes into the pre-construction efforts, especially if you don’t have much equity in your property. If you have a lot of equity, there are some options. Options can include a HELOC or a refinance. Even if you do lose an equity position, having enough equity at the start allows you to move forward with your project, because you see value in it from another perspective. This is really important, so make sure that you consider your ROI, especially if you plan to sell after completing an ADU. Your project must make financial sense.
Resources for Building an ADU or Custom Home in San Diego County
I hope this helps. If you’d like more information about how we can help you build a custom home, buy land, or build an ADU, our resources page has a ton of information available for download, including pricing and floor plans. We have a ‘How to Buy a Land Guide’ and a FAQ page as well. All of our videos and podcasts have been chopped up and categorized on that FAQ page for your use.
Take a look at our comprehensive collection of similar videos on our YouTube channel, The Real Property Show. Have an excellent rest of your day.
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Freeman’s Construction, Inc. has been building new custom homes and completing whole house remodeling projects in San Diego County for over 37 years. To schedule a project consultation, please call us today at 760-788-6846 or fill out a request form.
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