ROI on ADUs
Should You Invest in Building an ADU in Los Angeles?
You’ve likely heard that California has made it much easier to build an Accessory Dwelling Unit (ADU), also known as a guest house, granny flat, casita, additional unit, or in-law suite, on most residential properties. But is building an ADU a smart investment? Does it truly add value to your home in California? Whether you’re a seasoned investor or a homeowner exploring your first opportunity to generate rental income, the answer depends on several factors. Here are some key considerations to help you evaluate the pros and cons of adding an ADU in Greater Los Angeles.
Is an ADU a Good Investment?
For many homeowners, building an accessory dwelling unit (ADU) can be a great investment. To assess whether an ADU is right for you, it's essential to understand the costs involved in building the size unit you want. Learn more about ADU costs here. Beyond the construction costs, you’ll want to evaluate how much value the ADU will add to your property and the rental income potential, while also considering any tax implications.
For example, if you’re adding an ADU to your primary residence, you can benefit from a significant tax advantage when selling the property. Homeowners can exclude up to $250,000 (or $500,000 for married couples) of capital gains from the sale of their primary residence. This provides a unique tax shelter, unlike a standalone investment property, making an ADU an even more attractive financial choice.
Explore further as we delve into all the factors you should weigh when deciding whether to build an ADU on your property. Learn more about additional benefits of ADUs.
How Much Does an ADU Increase Property Value?
The value an ADU adds will depend on comparable sales in your area. According to a Porch study, homes with ADUs in major cities typically sell for 35% more than homes without them.
Adding an ADU increases your property’s resale value, as appraisers will compare your home to others with ADUs. These homes often sell at a premium due to the added income potential and increased livable square footage. The growing trend of multigenerational living has further boosted demand for properties with ADUs.
While widespread adoption of ADUs is still in its early stages, new appraisal guidelines are making it easier to assess the value of homes with ADUs, leading to more consistent valuations.
A permitted ADU is listed on your title report and enhances your property value by increasing both square footage and income potential. However, unpermitted ADUs or tiny homes won’t be reflected in title reports, so their value is limited to rental income alone.
What Is the Potential Return on Investment (ROI) for an ADU?
From a cash flow perspective, ADUs can deliver impressive returns. For instance, a 1,000-square-foot, 3-bedroom, 2-bathroom ADU that costs $430,000 to build (including design, permits, site work, and construction) could be rented for $4,500+ per month in many areas of LA.
When calculating your ROI, don’t forget to account for maintenance, taxes, and insurance. In the example above, you could net around $45,000 annually. With a 10% unleveraged cash-on-cash return on the total ADU build cost, you could also finance the project. Even at an 8% interest rate, you could net $8,200 annually if you financed all construction costs and only paid for design and permits (about $20,000). This would yield an ROI of 41% on your invested capital.
Refinancing at a lower interest rate in the future could further improve your returns. Plus, this analysis doesn’t even account for the property value appreciation resulting from the ADU, offering further financial gains when you sell.
2 BR / 1 BA (750 sqft)
RENT (monthly)
Vertical Build + Finish Materials
Sitework Cost
Typical Additional Work
Design
Permits/Fees
TOTAL COST
Gross Annual Rent
Maintenance, Vacancy, Insurance (10% gross)
Property Taxes (1% total cost)
NET INCOME
Cash on Cash Return (net income / cost)
FINANCED EXAMPLE
Loan Amount
OUT OF POCKET COST
Total Annual Interest (8% rate)
NET INCOME
ROI (net income / cost)
3 BR / 2 BA (750 sqft)
$3,800
$280,000
$30,000
$35,000
$12,000
$8,000
$365,000
$45,600
$4,560
$3,650
$37,390
10%
$345,000
$20,000
$30,274
$7,116
36%
$4,800
$350,000
$30,000
$50,000
$12,000
$12,000
$454,000
$57,600
$5,760
$4,540
$47,300
10%
$430,000
$24,000
$38,562
$8,738
36%
ROI for An ADU in Los Angeles: Chart
Property Suitability
Assess whether your property is suitable for building an ADU. Look at the available space, terrain, and existing structures on your lot. Check for adequate room to meet setback, parking, and access requirements. Conducting a feasibility study can help identify potential challenges and guide the best placement and size for your ADU.
Design and Functionality
The design of your ADU should balance aesthetics, functionality, and compliance with local regulations. Consider the intended use of the space—whether for rental income, housing family members, or serving as an office or guest house. A thoughtfully designed ADU enhances functionality and comfort, making it more appealing to tenants and potentially boosting its rental value. Explore design inspiration to create the perfect ADU for your needs.
Hiring a Reliable ADU Builder
Selecting an experienced and reliable ADU builder is key to the success of your project. Look for contractors with a proven track record in ADU construction, positive client reviews, and a strong understanding of local codes. A good builder will provide a detailed project timeline, transparent cost estimates, and consistent communication throughout the process.
Impact of Unpermitted ADUs on Property Value
While you might be tempted to cut corners, building an unpermitted ADU can hurt your property’s value. Unpermitted ADUs won’t be reflected in appraisals, which can limit your pool of buyers if you decide to sell. Buyers relying on financing will require the home to appraise at its purchase price, and an unpermitted ADU may not meet this requirement. Conversely, a permitted ADU is included in appraisals, leading to more competitive offers and adding to your property’s overall value during resale or refinancing.
Design and Functionality
The design of your ADU should balance aesthetics, functionality, and compliance with local regulations. Consider the intended use of the space—whether for rental income, housing family members, or serving as an office or guest house. A thoughtfully designed ADU enhances functionality and comfort, making it more appealing to tenants and potentially boosting its rental value. Explore design inspiration to create the perfect ADU for your needs.
Hiring a Reliable ADU Builder
Selecting an experienced and reliable ADU builder is key to the success of your project. Look for contractors with a proven track record in ADU construction, positive client reviews, and a strong understanding of local codes. A good builder will provide a detailed project timeline, transparent cost estimates, and consistent communication throughout the process.
The Risks of Building an Unpermitted ADU
While cutting corners might seem appealing, building an unpermitted ADU can negatively impact your property value. Unpermitted units won’t be included in the official appraisal, which can limit your pool of buyers and complicate financing when selling. Permitted ADUs, on the other hand, contribute to a higher appraised value, leading to more competitive offers and greater equity when refinancing.
What to Consider Before Investing in Building an ADU
Building an ADU is a significant investment that requires thoughtful planning and preparation. Here are some important considerations to help you make informed decisions throughout the process:
Legal and Compliance Considerations
Before embarking on your ADU project, it’s essential to understand local zoning laws, building codes, and permitting requirements in Los Angeles. Each jurisdiction has different regulations regarding the size, height, and location of ADUs. Ensuring compliance with these rules is crucial to avoid legal issues and to ensure that your ADU adds legitimate value to your property.
Financial Planning
Building an ADU requires careful financial planning. You’ll need to calculate the total cost of your project, including design, permitting, construction, and site preparation. Consider your financing options—whether through savings, loans, or ADU-specific financing solutions. Additionally, evaluate the potential return on investment (ROI) by factoring in rental income, tax implications, and the impact on your long-term financial goals.