ADU rental income and payback: a sober look

Many people build an ADU because they want rent to cover the cost. That can work. It works better when the numbers come from real rents and real costs, not a builder's brochure.

What ADUs actually rent for

The California owner survey is the best public source we have. It found a median ADU rent of $2,000 a month, ranging from $1,925 on the Central Coast to $2,200 in the San Francisco Bay Area. The median was $3.68 per square foot. These rents were reported in a survey published in April 2021, so your local market today may be higher or lower.

The same survey found that 51 percent of new ADUs were rented for income, 16 percent housed a relative for free, and only 8 percent were short-term rentals. Many owners also charged less than market. Factor in that you may want to rent to someone you know.

A simple way to run your own numbers

Here is a worked example using the survey medians. It is an illustration, not a forecast for your property.

• Construction cost: $150,000, the survey's statewide median
• Rent: $2,000 a month, or $24,000 a year
• Gross yield: $24,000 divided by $150,000 is 16 percent
• Simple payback before expenses: about 6.25 years

That gross number is the most optimistic version. Real returns are lower once you subtract:

• Vacancy between tenants
• Repairs and maintenance
• Higher property tax on the new unit (see our insurance and property tax guide)
• Insurance, which often rises when you rent the unit
• Utilities, if they are not separately metered
• Interest, if you borrowed

Run the example again with your own quotes. Use the full installed cost, including site work and fees. The San Diego pilot found soft costs and contingency of roughly 20 to 30 percent of the total, so do not leave those out.

What a lender will count

If you plan to refinance later, lenders will not count all the rent. Fannie Mae uses 75 percent of gross rent from an existing ADU, caps ADU income at 30 percent of your qualifying income, and allows it only on purchases and limited cash-out refinances. That 75 percent figure is also a useful rule of thumb for your own planning.

Short-term rentals: check before you count on them

Short-term rental income can look much higher on paper, but many cities restrict it for ADUs.

• Portland, Oregon waives system development charges for new ADUs, but only if the owner records a covenant that no structure on the property will be used as a short-term rental for 10 years. Breaking the covenant costs 150 percent of current charges.
• Austin, Texas says an ADU built after October 1, 2015 may not be used as a short-term rental for more than 30 days in a calendar year.
• California state law says JADUs cannot be short-term rentals and, if rented, must be rented for longer than 30 days. ADUs built under the state's streamlined path must also be rented for terms longer than 30 days, and cities may require 30-day minimums on others, according to the state handbook. Check your local ordinance.

Value, not just rent

Rent is only half of the return. An ADU adds a second home to the property, which can show up when you sell or refinance. We have not found a reliable public number for how much value an ADU adds in a typical market, so we will not quote one. Ask a local appraiser how recent sales with permitted ADUs compared with similar homes without one.

Ways owners improve the numbers

• Build at or under 750 square feet in California to avoid impact fees.
• Convert existing space. In the survey, conversions had the lowest median cost, $90,000 to $100,000.
• Use a permit-ready or preapproved plan to cut design time and fees.
• Meter utilities separately if the cost is reasonable, so tenants pay their own.

Before you call a builder: answer six questions to pick a type, rough out a budget, and save builders to My Stack as you go.