As ADUs become a significant part of the Orange County and Southern California real estate scene, many homeowners view the construction of an ADU as a lucrative option. There are numerous reasons why people develop accessory dwelling units, but the most prevalent reason is to generate rental revenue. For rental, practically any single-family home can construct an ADU or convert its garage into an ADU under the new State ADU legislation.
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 Constructing an ADU for Additional Income in Orange County
Let’s begin with a brief review of the benefits of ADUs for rental purposes. Although some renters may lease a house or condominium, the vast majority of renters reside in apartments. When compared to an apartment unit, an ADU rental offers a number of important advantages.
Why build an ADU for rent/income?
Whether you are an investor or a homeowner, the concept of constructing an ADU is frequently intriguing. Since you already own a property with a dwelling on it, constructing an ADU adds a second residence (similar to a duplex) that can generate rent revenue from a tenant. There are numerous advantages to constructing an ADU for rental:
- The first advantage is that they do not share any walls with neighbors, unlike apartments where you may have units to your left, right, above, and below. Even if you create an ADU that is “connected” to your primary residence, you will only share one wall. In contrast to apartment life, it is possible to have your own private yard space with your accessory dwelling unit. You may also have direct access to your unit, rather than having to navigate a labyrinth of corridors, etc. One potential drawback is parking: although most apartments come with designated parking, many ADUs force tenants to park on the street.
- Considering the preceding, it is clear why ADUs would appeal to tenants. In addition, after the completion of an ADU, the interior finishes are brand new and enticing to prospective tenants. Renting an ADU is more comparable to renting a modest house than it is to rent an apartment. Due to these factors, ADU rents are comparatively high and an enticing income for landlords.
- The possibility to change the ADU’s use in the future is a significant advantage of constructing an ADU for rental reasons on your property. If you decide you no longer want to be a landlord, you can modify the room to house a relative, establish a specialized office or man cave, or use it as a guest house. Similarly, prospective buyers of your property might view the ADU in the same manner; there is no requirement for them to rent out the space.
Considerations Before Constructing an ADU
If you intend to invest in the construction of an ADU, you should first conduct some research. First, you’ll need to ensure that you have the necessary funding for the project, whether that’s cash in the bank or a suitable loan. Also, when constructing an ADU for investment purposes, contact your homeowner’s insurance agent to discuss what type of coverage you may need to acquire in order to ensure the ADU and any renters who will occupy it. Whether you’re a seasoned investor or a homeowner making your first property investment, bear in mind that if you rent your ADU, you’ll assume the role of landlord and be responsible for any tenant-related issues.
Next, let’s examine the financial expenses and benefits of constructing an ADU rental property in Orange County.
What are the costs associated with ADU construction?
The cost of an accessory dwelling unit will depend on a number of things, such as whether it is a garage conversion or a newly constructed detached/attached ADU. For a thorough guide to pricing, see our ADU cost guide, however, a decent rule of thumb is as follows:
- Garage conversion (300 to 400 square feet): $95,000 to $120,000
- New ADU: $300-$450 per square foot for a new ADU. The larger the ADU size, the lower the cost per square foot. For example, ADUs over 1,000 square feet could possibly cost less than $300 per square foot.
- The stated construction costs do not include architectural blueprints, city permits, and plan review fees (about $5,000 to $15,000).
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How much rent can an ADU generate?
ADU rental revenue will vary greatly based on the size and location of the ADU, therefore let’s divide this analysis into sections based on the number of bedrooms in the unit.
- 300-400 square feet for a Studio (no bedrooms, ie, garage conversion):
- According to MLS data, studio rental prices for ADUs in lower-cost neighborhoods were $1,300 per month and as high as $2,600 in high-end areas.
- One bedroom: 400-700sf
- One-bedroom ADUs have been rented for between $1,500 and $4,000 a month, again depending on the location.
- Two-bedroom: 600-1,000sf ADUs with two bedrooms go from $2,000 to $4,500 a month.
- Three bedrooms: 800-1,200sf, the rent price range for three-bedroom apartments is from $2,400 to $5,000.
What is the return on investment (ROI) of renting an ADU?
The annual return analysis of building an ADU for rental income is presented here but does not account for the rise in your home’s resale value that will result from having an ADU.
Studio (garage conversion)
- Let’s assume that the total construction and other expenditures amount to $100,000. And let’s assume the location is “middle-tier” and we can attain $1,500 per month in rent. I would estimate that the operational costs of an ADU are rather low, therefore let’s assume they account for 15% of annual revenue (and tenant pays their own utilities).
- $1,500 per month multiplied by 12 months equals $18,000 in yearly ADU rental income.
- $18,000 income – $2,700 costs = $15,300 net annual revenue
- $15,300 net revenue / $100,000 investment = 15.3% yearly return
Two Bedroom (700sf)
- Let’s say that the entire cost of this unit is $225,000 ($321/sf) and that the monthly rent for this two-bedroom ADU is $3,000. Again, the tenant is responsible for utility costs, and expenses account for 15% of revenue.
- $3000 per month multiplied by 12 months equals $36,000 in annual ADU rental income.
- $36,000 income – $5,400 costs = $30,600 net annual revenue
- $30,600 in annual revenue divided by $225,000 invested equals a 13.6% annual return
When contemplating the construction of an ADU for rental purposes, determining the size and amenities to include in order to maximize rents should be a primary concern. Let’s begin with the size. Due to the high demand for one- and two-bedroom apartments, the majority of apartment units are also of these sizes. If you prefer a smaller home, a studio apartment is suitable for a single tenant. Three-bedroom apartments are uncommon yet ideal for a modest family.
As we saw in the section on local rents, two-bedroom apartments command higher rents than one-bedroom apartments (which is pretty obvious). So, if you’re considering building ADU between 500 and 800 square feet, you may wish to incorporate two bedrooms to optimize your rent.
An additional bedroom may require only 100 square feet of more space, therefore it may be worthwhile to invest in this additional space for the increased rent. Also, remember that the cost per square foot to construct an ADU decreases as its size increases.
In the same spirit, if you’re developing 400-500 square feet of space, you may want to opt for a one-bedroom over a studio in order to maximize rents.
What tenant amenities should an ADU rental offer?
Now let’s discuss the features you may want to include in your ADU rental to increase tenant appeal and rental income:
- ADUs are typically quite small and do not typically contain a garage; therefore, it is essential to provide locations for renters to store their possessions. Built-in cabinets, closets, attic space, and even outside sheds are examples of storage areas.
- Laundry: Including a laundry facility and machines is a major perk for residents, as opposed to apartment living where they would have to pay to use shared laundry machines.
- Include a good dual heating and air-conditioning system to ensure the comfort of your tenant in the accessory dwelling unit.
- Kitchen island: It may be tough to fit a kitchen island in a small ADU, but if you can do so, it will be a huge asset. An ADU kitchen with an island feels sophisticated and expensive. In addition, it is incredibly functional because it can serve as both a kitchen prep area and a kitchen table.
- Outside area and patio: As previously said, there are a few main advantages of an ADU over an apartment, one of which is a dedicated outdoor space. Ideally, you should consider building a private outdoor place for the ADU, even if it is a small, uncovered area. Pouring a concrete patio or laying pavers is the optimal surface for the renter to set up seating, etc. A few planters are good, but grass is likely unnecessary. If you have the budget to spend, a patio cover is a lovely addition, but it is not inexpensive.
- Create seclusion and privacy between the primary residence and the ADU by installing a strong fence in a suitable location. Ideally, establish a separate gate for the ADU tenant to utilize to enter their unit.
- ADUs are small, and one of the best ways to make these spaces feel larger is to ensure that an abundance of natural light enters the unit. This can be accomplished by strategically positioning windows, skylights, and glass patio doors.
- Soundproofing: Ensure that there is adequate insulation and soundproofing material between the residences, especially in the case of attached ADUs, so that each occupant does not have to hear noise from the home next door.
Listed below are some other factors to consider when constructing an ADU rental:
What do I need to know about ADU construction?
- Tenant address/mailbox: The city will issue an address to your ADU rental unit after construction is complete. Consider adding another mailbox for the postman with this number.
- There are numerous ways to charge your ADU tenant for their share of the utilities. During construction, it is possible to request separate meters for electrical and water service, although doing so would incur an additional expense. Alternatively, you can have your contractor install “sub-meters” to measure the utility consumption of individual tenants. Alternatively, you can devise a formula to divide the expense with your tenant depending on the size/ratio of the ADU to the primary residence. Lastly, you can choose a monthly utility reimbursement that your tenant pays in addition to their rent (especially once you know how much higher your utility bills are with an ADU tenant)
- The majority of ADUs require tenants to park on the street. This is feasible in some regions of Orange County but extremely difficult in others. If street parking is difficult in your neighborhood, include a parking spot for the tenant, even if it’s a piece of the driveway, etc.
- Some individuals ask if adding an ADU would expose their property to rent control. The truth is that we do not know for certain; it is still unclear how exactly this will unfold.
- 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 obtain a renters insurance policy to reduce the risk. Also, call your home insurance broker and add the new ADU rental to your existing policy.
- You will need a second set of trash cans for the accessory dwelling unit, which you can obtain from the trash collection company. Before delivering the cans, they may require you to present a copy of the Certificate of Occupancy. You must also consider where the ADU tenant will keep their trash cans.
The good news is that you have already taken the initial step by conducting research on the benefits, costs, rental revenues, etc…
My other renovation blogs have vastly more specific information.
The next stage is to determine how you will fund the ADU.
After that, I recommend locating and consulting with a number of architects and contractors who have experience with ADUs to obtain their perspectives and advice.
Other ADU questions we missed? Call or text us at 818.317.3567
When it comes to planning and coordinating an ADU rental 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 to chat with a real person about your next renovation project or visit our website for more information: www.greatbuildz.com