What Is an Accessory Dwelling Unit (ADU)?

The real estate space is drenched in unusual acronyms and complicated laws.

Today, we’re going to tackle one of them: ADUs, or accessory dwelling units. Our goal is to explain what they’re all about, why you should care, and how to best use this information for your real estate investing needs.

More specifically, we’ll talk about what an ADU is, what it’s commonly used for, if an ADU can increase your property value, and some of the law changes that work in your favor as an investor.

What are ADUs (accessory dwelling units)?

To put it simply, ADU is a shortcut (acronym) for Accessory Dwelling Unit. An accessory dwelling unit (ADU) is an additional residential building that is located on the same turf or lot as a primary residence.

You’ve probably heard them called granny flats or in-law suites. You know, those add-ons where people sleep above the garage, or in the basement unit.

But ADUs can also be an actual second structure on a residential lot — in addition to the main house.

According to research conducted by Freddie Mac in 2019, there are an estimated 1.4 million ADUs in the U.S. We say estimated because the real number is impossible to know for sure. It’s highly likely there are many more ADUs without permits or simply unreported.

And the truth is, ADUs are nothing new. The phenomenon of someone living in a secondary unit dates back centuries. Even Thomas Jefferson lived in an ADU while Monticello was being built.

Oregon, for example, issued its first seven ADU permits all the way back in 1995.

But the trend is indeed on the rise. Now, due to an increase in population and less restrictive laws in some states, ADUs are very much having their moment.

What are the requirements for an ADU?

If you’re thinking of converting an existing space on your land into an ADU, or want to build a new one from scratch, you need to know what it must contain in order to be legally qualified as one.

On the legal side, an ADU must have these five permanent areas:

1. Living space (living room)
2. Sleeping space (bedroom)
3. Eating space
4. Cooking space (kitchen)
5. Sanitation (bathroom)

Simply put, an ADU is a self-sufficient home that happens to be located on the same property, land, or plot as a single-family home.

And they can be as modern and impressive as anything else you can think of. Check out this stunning “Alley Cat” project for example, or these ADUs from HGTV’s #BroVsBro.

Note that zoning laws will vary between each municipality. And in general, the housing market varies between each state.

What are ADUs commonly used for?

There are six main reasons why someone would like to set up an ADU.

Separate space to work from

With Covid-19 restrictions and their lingering effects, we expect a separate office to be the first thing people might want to do with the extra space. Working from home poses an issue when you have no privacy, or young kids running around. ADUs can take care of that problem.

Increase property value and potential resale value

One of the most common reasons homeowners build an ADU is to increase the value of their property. The ROI is great on many of these projects.

Rental income – short and long term

If you live in a city with high rents, and have a small lot or a separate garage, or even live in a home too big for you, you can rent out an ADU to a tenant. It will gain you some cash flow. Also, if you live in a tourist-popular area, seasonal renting of the ADU can yield great income.

Private guest accommodations

Your parents or distant relatives are coming to visit, and they bring their dog Bono with them. Now you have a dedicated (and roomy) space for this] occurrence without sacrificing your own comfort and privacy.

Low-cost housing for adult children

If you live in a city with exceptionally high costs of living, having your late-teens child live on your property with their own privacy, while letting you increase yours, can be a win-win. Furthermore, this can help you teach them how to save money and become more independent.

Greater enjoyment of your home

ADUs are great for more creative purposes, like using them as a special gathering place for family and friends, a yoga studio, or mini-gym.

How should you approach adding an ADU?

There are several different ways to go about adding or converting an ADU:

DIY

If you have the Midas touch when it comes to Do It Yourself home projects, you might just be able to build your own ADU. A quick Google search will help you find small-scale home kits for the bathroom or kitchen. There are even blueprints available online for purchase. Just don’t forget the permits.

The “copy-paste” method

If you don’t have the time or skills to build your own ADU and don’t have a separate building on your plot, you can compensate with extra cash. You can, for example, buy a shed, modular home, or repurposed shipping container and simply connect it to utilities. Of course, the more dollars you spend, the more luxury upgrades you can add.

Garage or shed conversion

If you already have a small separate building on your property, such as a detached garage, you may be able to turn it into an ADU. It will be cheaper and faster compared to doing so in the primary residence itself. Hiring a contractor will cost you. How much mainly depends on the current condition of the unit you’re converting and the existing utilities connected.

Note: In cities where parking is scarce, eliminating a parking spot from your property can actually decrease the total value of your home. We advise you to consult with an experienced real estate professional in your area.

Addition to your home

This strategy is often used by investors. They want to maximize the cash flow from the property by increasing the amount of “doors” for each property. They do it by dividing walls, converting rooms into bathrooms, and maximizing space. Doing so typically means less privacy, but ends up increasing the number of tenants, therefore the amount of rental income and the overall value of the property.

The easy (and expensive) route

Like with most problems in life, money can help resolve them faster, and more efficiently. Pay an architect and a contractor, and you can have a brand new ADU from scratch within months.

Does an ADU increase property value? Can you sell your ADU?

The short answer is no.

More in-depth: legally speaking, an Accessory Dwelling Unit cannot be bought or sold separately (such as a condominium), and either the main house or the ADU must be occupied by the owner.

Can your HOA prevent you from building an ADU?

While homeowners associations (HOAs) can’t prohibit you from adding an ADU, they can impose some restrictions.

For example, HOAs can impose standards on the design and development of ADUs. The association may require homeowners to follow the architectural style of the community when building ADUs.

Back in 2019, California Governor Gavin Newsom signed bill AB-670: tackling HOAs. The ”Common interest developments: accessory dwelling units” bill basically made it easier for you (if you live within an HOA complex) to construct ADUs.

The bill also prevents banning or unreasonably restricting single-family lots on the construction of these units.

Note that what your HOA can do depends on your state laws, as this example applies to California.

Why should you care about ADUs as an investor?

Recently we see a trend of more lenient ADU laws, nationwide. Extremely tight housing inventory in cities around the country is fueling a push to use ADUs to alleviate the problem.

California, long considered to be more rigid in regards to new living units being built, became more investor-friendly since Governor Newsom signed five ADU-related bills in 2019.

The most notable ones were: AB-881 and AB-68. Without going into jargon territory, these bills made building ADUs in California much easier because they eliminated restrictions on the municipal level.

Most notably, permits are approved or denied much faster: double the speed to be precise, cutting down from 120 days to within 60 days.

In January of 2021, California signed new ADU laws which further accelerate the ease of which its residents can build and use them.

If you’re an investor from a different state, you might think this doesn’t apply to you. But we would advise you to keep an eye on your state’s legislation on the matter. These California decisions will set precedent for other states to follow in order to be competitive and avoid making residents migrate elsewhere.

It could be said that the 2019 laws favoring ADUs signed in California came after seeing how Austin, Texas, did the same in 2015. We think it’s safe to say more examples will follow.

If you’re a beginner investor, try investing in yourself first before spending larger amounts of cash. Start here, by reading one of these 5 fantastic books we recommend.