Accessory Dwelling Unit (ADU): Definition, Cost, and Value Add

What Is an Accessory Dwelling Unit (ADU)?

An accessory dwelling unit (ADU) is a legal and regulatory term for a secondary house or apartment that shares the building lot of a larger, primary home. The unit cannot be bought or sold separately, but they are often used to provide additional income through rent or to house a family member. For example, an elderly parent could live in a small unit and avoid having to move to an assisted living facility.

Understanding Accessory Dwelling Units (ADUs)

The ADU is also known as an in-law or mother-in-law unit, secondary dwelling unit, granny flat, or carriage house. An ADU usually has its own kitchen, living area, and separate entrance. An ADU may be attached to a house or garage, or it can be built as a stand-alone unit, but it generally will make use of the water and energy connections of the primary house.

After the housing boom that followed World War II, most U.S. residential areas were zoned to set limits on both population density and the size and separation of single-family dwellings. More recently, zoning changes in a growing number of areas around the country allow for the addition of ADUs. These zoning laws generally limit the size and style of any new unit and require that the owner lives on the property.

Accessory Dwelling Units (ADUs) Pros and Cons

While many people build ADUs to house family members, many others do so for rental income. Whether this is a wise investment varies from one landlord to another and depends on a number of factors, including local zoning ordinances, up-front costs, maintenance costs, possible tax consequences, and activity in the rental and housing market more generally.

Investors should first investigate whether building an ADU on their property is lawful. Building an unlawful ADU can create problems if an owner has to refinance the property. Building an unauthorized ADU can also lead to possible code enforcement actions that result in fines. Owners should look to their zoning ordinances and possibly consult with a lawyer specializing in this area.

Then, there is the matter of cost. Will the ADU be attached to the owner’s home, or will it be detached, such as in the case of a carriage house? What renovations will be required, and will the owner need to solicit professional services from construction contractors, engineers, or surveyors?

Financing ADU Construction

The most efficient way to finance an ADU varies depending on the owner’s individual situation. Options include taking out a renovation loan, refinancing if the homeowner has equity in their home, or pulling from available cash on hand.

Some ADUs are prefab models, and in many cases, the manufacturer can offer financing. As ADUs have become more popular, there are even lenders that now specialize in financing ADUs. Keep in mind that these options tend to have higher interest rates than those for traditional mortgages, so refinancing your main mortgage may remain a cheaper option.

Constructing an ADU could increase a homeowner’s tax bill, possibly eliminating a significant amount of the profit. The housing and rental market varies significantly by both state and city.

Potential landlords should consult real estate agents or do their own research by looking at rental listings and assessing rental rates in their local area. Once they determine the likely overall annual income from their ADU, they can consult with a tax professional to gauge whether their financial situation makes an ADU a beneficial investment.

The Bottom Line

If you have someone in your family who you want close but also want privacy from, such as an elderly parent or an adult child who has moved home after college, an ADU is an attractive option. Being able to create semi-passive rental income without having to buy a separate property is another desirable feature. Make sure that you know your local ordinances, especially if you intend to list the ADU on Airbnb, and get a good estimate of the cost of the project before committing.