What Is an Accessory Dwelling Unit (ADU)?
For many aspiring real estate investors, having enough money to put down on a property can be a barrier to entry. But real estate investing doesn’t have to start with buying a house. A more affordable way to get started can be by buying or building an accessory dwelling unit (ADU).
What Counts as an ADU?
To be considered an ADU, a structure must have all the amenities necessary for living. That includes a bathroom and kitchen as well as standard utilities like water, electricity, and heating. It must also have a separate entrance from the primary home.
Types of ADUs
Now that you know what an ADU is, here are the three main types of ADUs:
- A detached ADU (DADU) is structurally separate from the main home. This could be a tiny house, a backyard cottage, or a detached garage that’s been renovated. Most detached ADUs are somewhere between 400 and 800 square feet.
- An attached ADU (AADU) is connected to the main home. It could be an apartment built onto the back or side of the house, for example. Attached ADUs can be a good option for smaller lots that may not have space for a detached ADU.
- An internal ADU (IADU) is an ADU that exists entirely within the primary property. This could be a basement apartment, attic apartment, or any interior space that has been converted into its own living space with a separate entrance.
As an aspiring investor, building an ADU can offer many benefits. Here are some to consider:
Potential Rental Income
ADUs can be a great source of rental income if your zoning laws allow them.
If you’re able to use an ADU for rental income, you can either rent them out to a long-term tenant via a traditional 12-month lease or put it up as a short-term rental (STR) on platforms like Airbnb and VRBO (make sure to check your local STR regulations since some areas place heavy restrictions or even bans on STRs).
Potential Property Appreciation
How to Comply with Local ADU Regulations
Before you start building an ADU, it’s important to check your local zoning laws.
The Growing ADU Trend and What’s Driving It
ADUs are on the rise.
According to a July 2020 study by FreddieMac, first-time MLS listings of ADUs have increased an average of 8.6% year-over-year between 2009 and 2019. During that same period, ADU listings as a percentage of total active listings also rose from 3.5% to 6.6%.
ADU rental listings have gone up, too. From 2003 to 2019, the number of active rental listings increased from 1.8% to 4.1%, and the number of leased rental listings increased from 1.2% to 2.9%.
So what’s driving these trends? Several things:
The average American household is shrinking. In 2021, the average number of people living in one house was 2.51, down from 3.33 in 1960. At the same time, the average U.S. house size has increased from 1,500 square feet in 1970 to 2,496 square feet in 2019. Many homebuyers today simply don’t need all that space and prefer to buy something smaller instead.
Additionally, many baby boomers are beginning to downsize as they retire and become empty nesters.
There’s a nationwide housing shortage. As of the fourth quarter of 2020, the U.S. had a housing supply deficit of 3.8 million units. That’s partly because new construction is down due to labor and supply issues brought on by the pandemic. However, construction of entry-level homes below 1,400 square feet has been down since 2008 and hasn’t recovered since. Now, it’s at a 50-year low. With fewer listings on the market, many are choosing to stay with family in multi-generational homes and ADUs.
Housing affordability is down. Across the country, housing has become less affordable due to inflation and rising mortgage rates. Many would-be homebuyers are getting priced out of their market and are choosing to rent instead. For some (especially millennials and younger generations), an ADU rental can be an attractive option because it can offer more privacy and outdoor space than an apartment can.
Short-term rentals are becoming more popular. More and more travelers are choosing to book stays on short-term rental (STR) platforms like Airbnb and VRBO instead of hotels. According to a 2021 U.S. Short-Term Rental Outlook Report by AirDNA, available STR listings are expected to continue rising as they have since 2019 (aside from the minor slump in 2020 brought on by the pandemic). In addition, many STR guests are interested in properties like ADUs that offer unique experiences. Case in point: The fastest-growing STR property type in 2021 was the tiny house (with a 27% year-over-year change).
Government restrictions on ADUs are loosening. In response to many of the economic trends listed above, many state and local governments have passed laws and ordinances that eliminate previous barriers to building ADUs. For example, California has passed S.B. 1069, A.B. 2299, and most recently A.B 2221 to encourage ADUs and prevent local governments from exploiting loopholes to exclude them. This has led to a 1,421% increase in California ADU permits from 2016 to 2021. Other states that have helped lead the adoption of ADUs include Florida, Texas, Georgia, and Oregon.
Whether you’re just getting started as a real estate investor or a seasoned pro, ADUs present an exciting new opportunity with no shortage of ROI potential. If you use an ADU for passive income, don’t forget to follow your local zoning regulations, research your market and do your due diligence.
If the numbers add up, this could be just what you need to get your real estate investing career off the ground or take one you’ve already built to the next level!