As ADUs are becoming a major part of the real estate landscape in Los Angeles and Southern California, many homeowners believe building an ADU (ADU definition) is a good opportunity. There are many reasons people are building ADUs, but the most common purpose is to achieve rental income by creating an ADU rental unit. New ADU laws allow so much flexibility, almost any single-family property can build an ADU or convert their garage to an ADU for rental purposes.
Here at GreatBuildz, a free service that connects homeowners in Los Angeles, Orange County, Ventura or San Diego with reliable general contractors, we get inquiries every day about building rental income ADUs and garage conversions – here are some tips and guidance to get you started.
Guide to Building an ADU Rental for Extra Income in Los Angeles
Let’s start with a quick discussion about the benefits of an ADU for rental units. Although some renters may lease a home or condo, the majority of tenants rent apartments. When you compare an apartment unit to an ADU, there are some pretty significant benefits to an ADU.
Why build an ADU For Rental Income?
Whether you’re an investor or a homeowner, building an ADU is often an appealing idea. Since you already own a property with a home on it, building an ADU adds a second home (almost like a duplex) to your property which can provide a rental income stream from a tenant. There are many positives to creating an ADU for rent:
The first is they don’t share any walls with neighbors, unlike an apartment where you may have adjoining units to your left, right, above, or below. Even if you’re building an ‘attached’ ADU (adjoining your main home), you’re still only sharing one wall.
Another benefit of an ADU is the potential to have your own private yard space, which is uncommon in apartment living. You’re also likely to have direct access to your unit, rather than walking through a maze of corridors, etc. One negative to mention might be parking: while most apartments come with dedicated parking, many ADUs require the tenant to find street parking.
Considering the above, you can see why an ADU would be appealing to tenants. In addition, upon completing an ADU, all the interior finishes are nice and new which is attractive to prospective tenants. Renting an ADU is more like renting a small house than renting an apartment. For all these reasons, the rents for ADU units are reasonably high and compelling to landlords.
One major advantage of building an ADU on your property for rental purposes is the ability to switch its use down the road. If you decide one day you no longer want to be a landlord, you can convert that space to house a relative, create a dedicated office or man cave, or even just use it as a guest house.
Similarly, future buyers of your home can view the ADU in the same way…they don’t necessarily need to rent the space to a tenant.
Things to Consider Before Building an ADU
If you want to invest in building an ADU, make sure to first research a few things. First of all, you’ll want to make sure you that you have the financing lined up for the project; whether that’s cash in savings or an appropriate loan secured. Also, when building an ADU for investment purposes, make sure to call your home insurance agent to discuss what kind of policy you might have to add to ensure the ADU and any tenants you’ll have in the unit.
Whether you’re a seasoned investor or a homeowner making your first property investment, keep in mind that once you rent your ADU, you’ll take on the responsibility of the landlord and have the duty to take care of any issues that arise with the ADU.
Next, let’s discuss the financial costs and benefits of building an ADU rental for income purposes in LA.
What are the costs of building an ADU or garage conversion?
The cost of an ADU will depend on a few factors including whether it’s a garage conversion or a newly built detached/attached ADU, For a comprehensive guide to costs you can check out our remodeling cost guide, but a good rule of thumb is as follows:
- Garage conversion (300-400sf): $90,000-$120,000
- New ADU: $300-$400 per square foot. The bigger the ADU size, the lower the cost per square foot. ADUs over 1000sf could even cost less than $300/sf.
The numbers above are construction costs, but they don’t include architectural plans and city permits & plan check fees (approx.. $5,000-$20,000)
Rental ADU Construction
Building a rental ADU is an expensive undertaking, and it might be enticing to find ways to save costs on your ADU. But keep in mind that you are building an entire ‘mini’ version of a home, so some cost-cutting measures are probably ill-advised. For example, it’s wise to only hire a licensed ADU contractor to build your rental ADU.
This pro would have a general contractor B-license as well as General Liability and Workers’ Compensation Insurance. Hiring an unlicensed contractor or a handyman to build your rental ADU would be a huge mistake.
Alternatively, some people think they can ‘play’ the role of contractor and hire all the necessary sub-contractors to build an ADU; thereby saving themselves the general contractor’s profit markup. In a majority of cases, this too is a huge mistake.
First of all, you will be taking on an immense number of headaches if you are inexperienced with construction or project management.
Also, it’s very likely that you don’t already have a deep network of sub-contractors that will be required…framing, foundation, stucco, drywall, electrical, plumbing, painting, HVAC, and on and on.
The best options for building a rental ADU at a reasonable cost are:
- Keep the design simple and efficient.
- Use budget-priced finish materials
- Limit the use of tile
- Choose a laminate flooring material
- Use basic ‘builder grade’ doors and windows
- Meet with three to five contractors to get bids. Negotiate the price as best as possible.
What rental income can I get for an ADU?
ADU Rental income is going to vary significantly by the size and location of the ADU, so let’s separate this analysis into sections based on unit size, specifically the number of bedrooms.
Studio (0 bedrooms): 300-400 square feet (sf) (most likely a garage conversion):
According to MLS info, in the past year, the rental rates of studio units were $1,200 for ADUs in lower-cost areas and up to $2,500 on the high end for ADUs in portions of LA like Venice and West Los Angeles. Below are a few examples of the currently available ADU rentals at the lower & higher range:
Studio ADU Rental in Beverly Grove | Credit: apartments.com
Studio ADU in Rancho Park | Credit: apartments.com
One bedroom: 400-700sf
One-bedroom units have been rented for between $1,400 for ADUs in lower-priced areas up to approx. $4,000 for areas such as Studio City, Santa Monica, and Sunset Strip. A few current listings are below:
One Bedroom ADU Rental West Hills | Credit: trulia.com
One Bedroom ADU in Santa Monica | Credit: trulia.com
ADUs that have two bedrooms range in their rent from $1,800 on the low end to $4,500 in areas such as Westwood & Hollywood Hills. Current examples below:
Two-Bedroom ADU Rental in Reseda | Credit: coldwellbankerhomes.com
Two-Bedroom ADU in Mar Vista | Credit: trulia.com
Three bedrooms: 800-1,200sf
Three-bedroom units have been ranging from a low of $2,400 up to $5,000 in areas like Valley Village and Topanga. Sample listings below:
Three Bedroom ADU Rental in South Los Angeles | Credit: apartments.com
Three Bedroom ADU in Sherman Oaks | Credit: apartments.com
What are the Returns On An ADU Rental?
Let’s look at the financial returns on a few examples. Below is the annual return analysis of investing in building an ADU for rental income, but doesn’t even consider the increase in your property value by having an ADU when you go to sell your home.
Studio (garage conversion)
Let’s estimate the all-in costs including construction and soft costs are $100,000. And let’s presume the location is ‘mid-tier’ and we can achieve a monthly rent of $1,500. I would suggest the expenses of operating an ADU are reasonably minimal, so let’s assume they are 15% of annual revenue (and the tenant pays their own utilities).
- $1,500/month x 12 months = $18,000 annual ADU rental income
- $18,000 income – $2,700 expenses = $15,300 net annual revenue
- $15,300 net revenue / $100,000 investment = 15.3% annual return
Two Bedroom (700sf)
Let’s assume the total cost of this unit is $225,000 ($321/sf) and the rent we can achieve for this nice, new 2-bedroom ADU rental is $3,000 per month. Again, the tenant pays their own utilities and expenses are 15% of revenue.
- $3,000/month x 12 months = $36,000 annual ADU rental income
- $36,000 income – $5,400 expenses = $30,600 net annual revenue
- $30,600 revenue / $225,000 investment = 13.6% annual return
When you’re considering building an ADU for rental purposes, one major consideration should be deciding what size to build and which amenities to include to maximize your rents. Let’s start with size. The types of units most in demand are one and two-bedroom dwellings; that’s why most apartment units are also this size. A studio unit is good for a single occupant, so that’s an option if you prefer a smaller household. Three-bedroom units are less common and are good for a small family.
As we saw from the section on local rents above, a two-bedroom unit will garner higher rents than a one-bedroom unit (which is pretty obvious). So, if you’re considering an ADU in the 500-800sf range, you may want to create a plan that includes 2 bedrooms to maximize your rent. An extra bedroom might only require an additional 100sf, so it might be worth investing in this extra space for the increased rent. Also, remember that the cost per square foot to build an ADU goes down as the size gets bigger. In the same vein, if you’re building 400-500sf, you might consider a one-bedroom over a studio to maximize the rents.
What tenant amenities should I include in an ADU rental?
Now let’s move on to the amenities you might consider in your ADU to maximize tenant desirability and ADU rental income:
- Storage: ADUs are generally pretty small and usually don’t include a garage, so it’s important to include areas for tenants to store their belongings. Storage areas can include built-in cabinets, closets, attic space, and even outdoor sheds, etc.
- Laundry: Including a laundry area and machines is a big bonus for tenants, as they compare that with apartment living where they would have to use common laundry machines that require payment.
- HVAC: Make sure to include an effective dual heating & air-conditioning system to service the ADU, so your tenant is comfortable in the unit.
- Kitchen island: It may be difficult to squeeze in a kitchen island in a small ADU, but it’s a big bonus if you can make the space. An island makes the kitchen and the ADU feel elegant and upscale. Beyond that, it’s extremely practical as it can double as a kitchen prep area as well as an eating table.
- Outdoor area & patio: As I mentioned above, there are a few major benefits to an ADU over an apartment, and a dedicated outdoor space is one of them. Ideally, you should consider creating an outdoor private space just for the ADU, even if it’s a small uncovered area. Pouring a concrete patio or installing pavers makes the ideal surface so the tenant can put out some seating, etc. A few potted plants are nice, but a lawn is probably unnecessary. If you want to splurge and add a patio cover, that’s a nice touch, but it’s not cheap.
- Privacy: Make sure to create separation and privacy between the main home and ADU by constructing solid fencing in the appropriate location. Ideally, create a separate gate to be used just by the ADU tenant to access their unit.
- Natural light: ADUs are small and one of the best ways to make these spaces feel bigger is to ensure lots of natural light is flowing into the unit. This can be achieved with well-placed windows, skylights, and glass patio doors.
- Soundproofing: Especially in the case of attached ADUs, make sure there is appropriate insulation and soundproofing material between the homes so that each occupant doesn’t have to hear noise from next door.
Below are a few more specific things to consider when building an ADU rental:
What do I need to know about building an ADU?
- Tenant address/mailbox: The city will assign your ADU a specific address when you’re done building it. Consider adding another mailbox with this number for the postman.
- Utilities: There are multiple ways to charge your ADU tenant for their portion of the utilities. During construction, you can request separate meters for electrical & water service, but that comes along with an increased cost. Alternatively, you can have your contractor install ‘sub-meters’ to measure their utility usage. Or, you can come up with a formula to split the bill with your tenant based on the size ratio of the ADU vs the main home. Finally, you can set a specific monthly utility reimbursement your tenant pays you along with their rent (especially once you know how much higher your utility bills are with an ADU tenant)
- Parking: Most ADUs require the tenant to find street parking. This works in some parts of Los Angeles but is very difficult in other areas. If street parking in your neighborhood is a challenge, consider including a parking area for the tenant, even if it’s a portion of the driveway, etc.
- Rent Control: Some people wonder if adding an ADU could make their property subject to rent control. The answer is that we don’t know for sure yet…it’s still unknown exactly how this will play out. Because the ADU is new, it shouldn’t be subject to rent control, however, the main house (if it was built before 1978) could be subject to rent control if it’s rented out.
- Renter’s Insurance: Although a landlord’s insurance is not liable for any damage to a tenant’s personal property, it is a good idea to require your tenant to get a renters insurance policy to mitigate any potential risk.
- Trash cans: You’ll need a second set of trash cans for the ADU, which you can request from the trash collection company. They may require you to provide them with a copy of the Certificate of Occupancy before they deliver the cans. You’ll also need to consider where the ADU tenant will store the garbage cans.
The good news is you’re already taking the very first step by doing some research on the benefits, costs, rental revenues, etc.…you can find much more specific info in my other renovation blogs. The next step after that is deciding how you might finance that ADU. After that, I suggest finding and speaking with several architects and contractors with ADU experience to get their opinions and guidance.
Other ADU questions we missed? Call or text us at 818.317.3567
When it comes to planning and coordinating an ADU for your home, you shouldn’t have to go it alone – GreatBuildz can help simplify your renovation experience. GreatBuildz is a free service that connects homeowners in Los Angeles, Orange County, Ventura or San Diego with reliable, thoroughly screened general contractors and provides project support from start to finish. Call now (818.317.3567) to chat with a real person about your next renovation project or visit our website for more information: www.greatbuildz.com