The Effects of ADUs on Property Value and Financing
February 5, 2023
The impact of an ADU on property value can vary depending on a number of factors, including the location of the property, the size and quality of the ADU, and the local real estate market. In general, however, having an ADU on your property does increase its value, as it provides additional living space and can generate rental income.
In the Bay Area, where real estate values and rents are high, ADUs can generate substantial ROIs, as both property values and rental rates are high, and even if a buyer doesn’t wish to be a landlord, California has the second-highest percentage of multi-generational families in the U.S., generating additional demand for homes with ADUs here.
According to a study by the National Association of Realtors, about 20% of homebuyers said that they would be willing to pay more for a property with an ADU. However, it's worth noting that the exact increase in value will depend on a number of factors, such as the cost of building the ADU, the rental income it generates, and the demand for rental units in the local market.
Financing:
If you are building an ADU(s) and plan to finance it with a loan, the lender will likely require an appraisal of your property before approving the loan. The appraisal will take into account the value of the property with the ADU and without the ADU to determine the overall value.
If you plan to rent out the ADU to generate rental income, the lender may consider that income when evaluating your loan application. Rental income can be used to offset some of the costs associated with the loan, which could make it easier to qualify for financing.
In some cases, homeowners may be able to use the equity in their property to finance the construction of an ADU. For example, a homeowner could take out a home equity loan or line of credit to pay for the construction costs. This can be an attractive option for homeowners who have built up equity in their property and want to use it to generate rental income or provide additional living space for family members.
If you are purchasing a home with a (permitted) ADU(s), 75% of the income (estimated or actual) from that unit(s) can be used to qualify for the loan. Often, this results in a lower net mortgage payment after renting the unit whilst having more purchasing power.
Something that is a huge advantage with ADUs that often gets overlooked is that, while ADU income can still be used to qualify for additional funds, it doesn’t trigger the additional unit in underwriting criteria. This means that a Single Family Home with an ADU is still considered a Single Family Home, a Duplex with an ADU is still considered a Duplex, a Triplex with an ADU is still considered a Triplex, and a Fourplex with an ADU is still considered a Fourplex.
The implications of these classifications is that a Single Family Home with an ADU(s) will still qualify for SFH financing, a Duplex with an ADU(s) will still qualify for Duplex financing, so on an so forth. This underwriting quirk doesn’t matter much if you have 20% down for an owner occupied purchase or its an investment property, but it does matter if you have a 3.5% downpayment (FHA loan) or 5%-20% down payment (conventional loan), as conventional loans require at least 15% down for 2+ units, and FHA loans require self-sufficiency (75% of total rents must be equal to or exceed the PITI payment, which is hard to achieve in the Bay Area) for 3+ units. 5+ units also usually require commercial financing at a significantly higher interest rate with at least 25% down, but an ADU or two may allow you to purchase 5+ units with residential financing in the form of a tri- or four-plex with ADU(s).
It's worth noting that the specific impact of an ADU on property financing can vary depending on the lender, the location, and specific circumstances of your situation. If you are considering financing an ADU, it's a good idea to consult with a financial professional or lender to better understand your options.
