Is an ADU a financially sound decision? Find out about rental income, price per square foot, taxes and more by reading this informative article!
As a homeowner, your property is probably one of the biggest – if not THE biggest – investments that you have. It’s important to keep it in top shape and not do anything that compromises its value (bye bye shag carpet and peeing boy statue). So will an ADU (accessory dwelling unit) add value or will it detract buyers when you’re ready to sell? Find out the answers here!
ADUs (also called backyard homes, tiny homes, prefab homes, and granny units) are becoming more and more popular as California’s housing crisis increases. A huge demand in conjunction with a painfully low supply is causing housing prices to skyrocket. Moreover, COVID-19 has brought changes to the way we live that aren’t going away any time soon: working from home, homeschooling, and caring for elderly parents are just a few of the ways that this world pandemic has altered our lives.
With the flexibility of an ADU as a tiny home or home office, many people are considering this convenient option. However, is it worth the investment and how will it affect your property value?
Here are a few ways that ADU’s are a financially sound investment:
- Rental Income – California is in a major housing shortage and we’re not just talking about people wanting to purchase traditional homes. This overlaps into affordable rental housing, too. One question that is commonly asked is, “Is California in a housing bubble like 2007?” and the answer is a resounding “no.” First of all, we don’t have the crazy mortgage options including adjustable rates like we did in 2007. Secondly, more people have a fair amount of equity in their homes. While there are many other reasons, let’s talk about rent. Back in 2006/2007, rent was about half of what a mortgage payment was. Today, rent costs approximately the same as a mortgage payment.
So let’s talk numbers. If you purchased an ADU for $100,000 at an interest rate of 3.92% over 10 years, your monthly payment would be $1,009. If you used this building as a rental property, consider that the average one bedroom apartment in California costs $1,436/month. (Of course, these numbers vary by location and other factors, so please contact your financial advisor and real estate specialist to determine your specific investment potential.) Not only could your ADU pay for itself, but it can provide long term options for you or the next homeowner!
- Cost Per Square Foot – According to the California Association of Realtors®. “The statewide average price per square foot for an existing single-family home remained elevated and improved solidly on an annual basis. At $338, February’s price per square foot was the highest since July 2007. The price per square foot was $283 in February a year ago.”
This means that if you built an ADU that was 1,000 square feet (you can build up to 1,200 square feet depending on your local government regulations), your property value could increase by $338,000! (Please discuss this with your real estate professional before making any major decisions.) Even if you spent $125,000 on building your ADU, your return on investment could be 63 percent!
As Benjamin Franklin so poignantly said, “in this world, nothing is certain except death and taxes.” So let’s take a moment and discuss the tax implications of adding an ADU to your property.
Will your property taxes go up? The easy answer is yes. Your new building will be assessed but your existing home won’t be reassessed. The good news is that California has Prop 13 which means that the property tax rate is set at 1% for all California property and annual tax increases are limited to no more than two percent set by the Consumer Price Index (CPI).
Additionally, your rental income will also be taxed. According to the State of California Franchise Tax Board, you’ll “report your rental income and expenses on Part I, Income or Loss From Rental Real Estate Royalties on Supplemental Income and Loss, Schedule E (IRS Form 1040)… Your rental income after expenses will be included in your adjusted gross income once you file your federal return.” Furthermore, if you do use your ADU as a rental income, consider forming an LLC. Not only are your startup costs tax deductible, but if your renter gets injured on the property, your personal assets aren’t at risk if a lawsuit ensues. At this point, it’s critical to discuss these options with your financial advisor or legal counsel to determine how to best pursue this option and the benefits that are available to you.
While ADUs are a significant investment, you should consider the various government grants that are available to help alleviate the burden of limited affordable housing in California. On the California Department of Housing and Community Development website, you’ll find a variety of options available. For example, Santa Cruz County offers forgivable loans up to $40,000 to homeowners who rent ADUs to low-income households at affordable rents for up to 20 years and the Housing Trust Silicon Valley provides funding to support homeownership, rental housing, development financing, and offers programs for homeowners.
Is building an ADU a smart financial choice for you? Call ADU Warehouse to discuss your options! ADU Warehouse can help you to determine your budget, timeline, model, file permits, and they’ll go over every step of the process to ensure that you have a successful project outcome. Their team consists of professional and experienced contractors, real estate specialists, and project managers so you never have to worry about the details. Contact ADU Warehouse today!