Are you considering renting your ADU to a tenant but not sure if it’s a good idea? Or maybe you just aren’t sure where to start. Well, an ADU can be a great source of rental income and a very profitable investment in the long run — if it’s managed properly. The potential earnings and benefits you could experience from an ADU rental could help supplement your mortgage payments, retirement savings, or vacation fund. Sounds pretty good, huh?
Even if we’ve already sold you on taking the next step, there’s a lot you need to know before getting started. So if you’re asking yourself can I rent out my ADU? — you’ve come to the right place.
Let’s dive into all the considerations and tips to help you prepare your ADU for rent.
ADU Rental Considerations
State Laws and Regulations
Every city is going to have its own ADU zoning restrictions, HOA regulations, and building laws, so if we’re honest, renting your ADU won’t necessarily be easy.
Let’s take Los Angeles and San Francisco, for example. In LA, whether or not your ADU is attached to your home is an important distinction. A detached ADU will be exempt from the local rent stabilization ordinance. And, if your ADU is attached to a house that was built before October 1978, both your house and the ADU will fall under the city’s ordinance. These laws don’t apply to your friend living in San Francisco, but they will have their own set of regulations to follow.
Your state’s zoning laws will also play a role since they regulate how property owners may use their land. One example is that if a certain plot of land is zoned for residential use, the land owner will likely not be able to use the ADU as an office or a commercial warehouse.
There may be further restrictions in regard to building an ADU or multifamily property in a residential zone. Legal experts say building an ADU converts a single-family property into a multifamily one because the two structures share the same lot. This shift from single to multi will be what brings in new ordinances that don’t apply to single-family homes.
Even further, many cities that have legalized ADUs actually did so to boost the supply of affordable housing. They may frown upon homeowners trying to use their units for short-term rentals. But if renting is permitted, you may need to obtain a business license. Before listing your ADU on Vrbo or Airbnb, check on this by contacting your city’s planning department.
Finding Good Tenants
There are several different ways you can find potential tenants for your ADU rental. These are just a few:
- Hiring a property management company
- Placing ads in your local newspaper or rental websites
- Relying on word of mouth from friends and relatives
No matter what method you choose, you’ll need to come up with your own reliable system for screening potential tenants. Here are a couple of items you should be sure to ask for:
- A copy of their credit report (don’t worry, if you don’t know how to analyze credit reports on your own, you can hire a credit reporting agency)
- Three of their most recent pay stubs
- References from previous landlords
- Their current employer’s phone number to confirm employment.
On the flip side, to attract good tenants that want to stay in your ADU rental long-term, you have to make your ADU desirable. If you’d like to rent out your ADU, consider that when designing it. Think about important features like location, privacy, and amenities like a kitchenette, washer/dryer, etc.
And once you make a decision and your tenants are all moved in, don’t neglect your landlord duties! If you take the time to establish a good relationship with your tenants, they’ll not only be likely to stay longer, but your ADU will also be a lot easier to manage.
What to Include in Your Rental Agreement
Getting that strong tenant and landlord relationship off on the right foot starts with clearly understanding your written rental agreements. Don’t leave any room for problematic interpretation down the road. Make sure to include the following details:
- The date by which rent must be paid each month
- The type of pets allowed and how many
- Which utility costs are included in the rent
- If smoking is allowed on the property
- If the tenant has a parking space on the property (and if the price of parking is included in the rent)
- If the tenant has access to shared spaces like the yard
- Any other lifestyle requests (i.e., quiet time hours)
If you and your tenant share the property, you will want to be as detailed as possible, or you may really regret it.
How Much Can You Rent Your ADU Out For?
Like with any other property, the average price of rent will depend on the size, type, and location of your ADU. Take a look at websites like Craigslist, Zillow, and Trulia to see how other ADU units for rent in your area are priced while focusing on the ones most similar to your unit’s size and type.
Typically, detached ADUs allow you to charge more since they offer the most privacy, which is a big selling point for many renters. But if you invest in amenities like a washer and dryer or allow the tenant to have pets, you can usually charge a little extra.
5 Potential Recurring Expenses for Landlords
Now that you have a better idea of what you can charge for your ADU rental, it’s important to understand what you’ll be spending on it as well. There are a number of recurring expenses you can expect that will have to be factored into your total earnings.
1. Insurance premiums: When you use your ADU for rent, you’ll need to extend your current property insurance policy to provide dwelling extension coverage, or you can opt for a separate rental dwelling insurance policy. Typically, these options could add another $600 to $1000 a year to your mortgage.
2. Utilities: If your primary residence is on the older side, you’ll want to ensure your electrical panels can handle the operation of multiple refrigerators, washing machines, air conditioners, etc. If not, you’ll have to upgrade these.
3. Landscaping costs: If you built an ADU in your backyard, it might require significant modifications to your property’s landscaping. If this requires regular maintenance, you can expect an additional $50 a month for these services.
4. Other maintenance costs: There will likely be other maintenance costs associated with a rental property that you didn’t have as well, such as trash collection, water supply, and septic. These fall around $150 to $180 per month.
5. Vacancy expenses: There may also be times when you cannot find a suitable tenant by the time the previous one moves out. Even without someone occupying the space, you’ll still want to pay regular upkeep costs to maintain the condition of your ADU. This will only be added to the rent money lost for every month your ADU is vacant.
Does an ADU Affect Your Property Tax?
The answer to this is another “it depends” scenario. If you are building a detached ADU or an addition to your existing home, it may also increase its usable square footage. In this case, yes, you can expect your property taxes to increase as well.
The good news is that many state and city laws now set a limit on how much an ADU can add to your property tax bill. For example, in California, property tax increases are limited to 1% of the value of the ADU. In other words, if you build an ADU valued at $65,000, your tax bill increase will max out at $650 annually.
But since you are using your ADU as a rental, you may owe taxes on the rental income you receive from it. All of these taxes would be in addition to the property tax you already pay on your primary home.
How Much Can You Profit?
So, let’s dive into what you really came here to find out: how much will you profit from your ADU rental? To calculate how much you can ultimately profit by renting out your ADU, you need to go back to those recurring expenses involved in maintaining your ADU and deduct those costs from your total rental income.
To better understand what those numbers may look like right now, you have to consider the current housing market and rental vacancy rates (or the percentage of units in your area that are currently vacant). We recommend contacting a local real estate agent or reputable property management company that will be well-versed in the rental vacancy rates in your area and provide clarity on the state of the market now and over the next couple of months.
As a rule of thumb, if this rate is below 7%, you can assume the market is healthy. Anything above 7% may be more difficult to find tenants willing to pay your asking price. The more informed you are, the more confident you can be in your decision.
Now that you have all this newfound knowledge, the choice is yours. If you’re interested in moving forward and need to finance an ADU, speak with a RenoFi representative today to help you take the next steps.