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Accessory dwelling units (ADUs) are all the rage in urban areas, such as Los Angeles, Denver, Washington, D.C., San Francisco and Portland. The demand is expected to climb as the population ages and younger would-be homeowners are priced out of traditional houses. Not surprisingly, an ADU can boost a property’s value, depending on certain factors that appraisers consider.

The Basics

ADUs go by many names, including in-law units, granny flats, second dwelling units and carriage houses. The U.S. Department of Housing and Urban Development (HUD) defines the term as a habitable living unit added to, created within or detached from a single-family dwelling that provides the basic requirements for living, sleeping, eating, cooking and sanitation.

They’re generally understood to be a separate additional living unit, with separate kitchen, sleeping and bathroom facilities. ADUs are “subordinate” in size, location and appearance to the primary unit. Municipalities tend to limit their size to a maximum of 800 to 900 square feet.

ADUs can be categorized as interior, attached or detached. An interior ADU often involves the renovation of a garage, basement or attic into a living unit. Attached ADUs are added to the primary residence, typically to the side or rear of that building or on top of an attached garage. A detached ADU is either freestanding or attached to another structure that’s separate from the primary residence, like a separate garage.

Demographic and economic changes are behind much of ADUs’ growing popularity. Older people and empty nesters can downsize to an ADU to stay in their neighborhoods, renting out their primary units. Younger people may find it easier to afford a mortgage with the income generated from an ADU. And people of all ages can buy into pricier neighborhoods than they otherwise could afford with the help of rental income from ADUs. ADUs also appeal to environmentally conscious individuals because of their smaller “footprints.”

Valuation Factors

Appraisers consider several factors when valuing a property with an ADU, including:

Comparable sales. “Comps” are a common part of the equation when valuing a property, but appraisers might find it difficult to locate recent sales data for similar properties with ADUs. If they have data on only older sales or properties with ADUs that differ in size, appraisers can make appropriate adjustments or at least better understand how the market has treated ADUs in the past.

Cost. Cost isn’t necessarily determinative of value. It can, however, reflect the quality of materials used and similar issues.
Rental income. The rent component has several aspects. For example, does the municipality permit ADUs to lawfully be rented? If so, what’s the unit’s rental history in terms of both occupancy and rents? What’s the market rent? The ADU’s income-producing capacity may also affect the property’s “highest and best use.”

Permits. The appraiser will determine whether the ADU is properly permitted. This is particularly relevant with older ADUs that were constructed before permits were required. It’s possible that local zoning regulations won’t permit rebuilding (or rebuilding to the current size) after a disaster, which would limit the property’s value.

Square footage adjustments. Appraisers generally make square footage adjustments when a comparable was larger or smaller than the subject property. But should an appraiser apply the adjustment to the ADU, too? The answer could turn on the quality of the ADU; it might be appropriate to apply the adjustment if the ADU is of similar quality to the primary residence but not if it’s inferior.

Note, too, that appraisers generally shouldn’t combine the square footage of the two units and value the property as if the primary unit includes the ADU’s space — that is, valuing a 1,600-square foot house with a 600-square foot ADU as a single unit of 2,200 square feet.

Look Before You Leap

Developers and investors who are weighing the role of ADUs in their projects should consider the factors that influence an ADU’s value. Proper planning can help maximize their returns.

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Is it an ADU — or a Two-Unit Property?

Accessory dwelling units (ADUs) sometimes are confused with two-unit properties. As the Fannie Mae Selling Guide explains, whether a property is defined as a one-unit property with an ADU or a two-unit property depends on the property’s characteristics.

A two-unit property is more likely when the unit in question:
• Has separate utilities from the primary unit
• Has a unique mailing address
• Has a separate private entrance
• Has more than two bedrooms
• Is rented
• Has been previously marketed as two-unit, and/or
• Is located in a neighborhood where similar properties are predominantly used as two-unit properties

An ADU is likely if:
• The unit doesn’t have separate utilities (except telephone, television and cable)
• The unit is constructed in a style similar to that of the primary unit, and/or
• Local zoning regulations require the primary unit to be the property owner’s principal residence

Another strong indicator that a unit is an ADU is that the space previously served as an attic, basement or garage for the primary unit.