Inventory in the housing market remains low, leaving fewer options for potential buyers. This includes real estate investors looking for properties to rent or flip. One solution to this shortage has been to build what is otherwise unavailable. Specifically, Accessory Dwelling Units (ADUs) are emerging as a viable source of rental income in an otherwise depleted market. But what is an ADU? And how can you buy one? Read more to learn about ADUs and their financing options.
What are Accessory Dwelling Units (ADUs)?
ADUs are secondary housing units located on the same property as the main residence. They typically have their own entrance, kitchen, bathroom, and living space, providing occupants with a sense of independence while remaining close to the primary dwelling.
There are many different types of ADUs. Some of the more common include:
Detached New Construction ADUs
Also known as granny flats, in-law suites, or backyard cottages, detached new construction accessory dwelling units entail a completely separate structure. These units are typically located in the back or side yard on the same lot as the main property.
Garage Conversion Accessory Dwelling units
Many homeowners choose to convert their garage into a functional living space by adding plumbing, electricity, and other creature comforts and amenities. In general, garage ADUs are less favored when it comes to increasing a home’s resale price. They are more valuable as a source of rental income or if you truly need additional living space for a family member.
Bump Out ADUs
These are also called “addition” accessory dwelling units and are added directly onto the existing structure. These can be more cost effective, since they make use of existing plumbing and electricity systems.
Basement Accessory Dwelling Units
Basement apartments have been popular for years for both familial accommodation and a potential source of rental income. They are different from a finished basement, which typically does not include a separate entrance. An ADU must be accessible outside of the primary residence and function as its own living quarters.
Why are ADUs So Popular?
Accessory dwelling units offer an affordable housing solution for both homeowners and renters. They allow homeowners to generate rental income or provide housing for family members without the need for a separate property.
Furthermore, the FHA now allows rental income from ADUs to be included when underwriting a mortgage. This means that potential buyers interested in a property with an ADU may qualify for a federally backed loan, allowing them to purchase the home with less money down.
Increased Property Value
ADUs can increase the value of a property by adding additional living space and potential rental income, making it a lucrative investment. The ROI will depend on the area you live in and the type of ADU. However, a 2021 study by Realtor Magazine found that the addition of an ADU can increase your home’s value by as much as 35 percent.
Flexible Living Arrangements
ADUs provide flexibility in housing arrangements. Homeowners can use them as rental units, guesthouses, home offices, or accommodations for aging parents or adult children. This last purpose made ADUs especially popular during the COVID-19 pandemic, when family members needed a way to care for more vulnerable loved ones.
Accessory dwelling units promote sustainable living by utilizing existing infrastructure and reducing the need for new construction. They also contribute to urban infill and reduce urban sprawl.
Addressing Housing Shortage
In areas facing housing shortages, ADUs provide a practical solution by increasing housing density without altering the existing neighborhood character. In some states, like California, homeowners may even qualify for a grant to build an ADU on their property to close the gap between dire housing shortages and sky-high cost of living.
Bridge Loans for Accessory Dwelling Units
While the benefits of ADUs are clear, financing their purchase can sometimes pose a challenge for homeowners. They are not cheap to build, after all, with the average cost falling somewhere around $180,000. Many people choose to finance an accessory dwelling unit with a home equity loan, which is also known as a second mortgage. But many do not have enough equity to cover the entire cost of their build.
This is where bridge loans come into play. A bridge loan is a short-term loan designed to “bridge” the gap between the purchase of a new property and the sale of an existing one.
Bridge loans are a type of hard money loan that closes much more quickly than a conventional loan. The rates are higher since the lender is taking on more risk, but this cost is often mitigated by the time you save in completing your investment project.
Bridge loans for ADUs are ideal if you intend to sell your home upon its completion. In theory, you could easily repay the bridge loan with the additional funds you secured from a higher sale price (thanks to the ADU).
Bridge loans may also be an option for constructing an ADU while you await long-term financing, such as an FHA or state grant.
Building an ADU in Colorado
Accessory Dwelling Units represent a versatile and sustainable housing solution with numerous benefits for homeowners and communities alike. In Colorado, the professionals at Pinetree Financial Partners lend on all types of construction and acquisition projects anywhere in the state. We love working with entrepreneurs and real estate investors looking to diversify their portfolios. We also understand that, for many projects, time is of the essence. Our bridge loans can help overcome barriers to conventional financing by offering flexible funds in as little as a few business days. Call or go online today to schedule a consultation so you can get started.