In Episode 2 of our Accessory Dwelling Units (ADUs) series, we’re helping investors understand what kind of returns ADUs can generate. We ran a deal analysis on a property that includes a main house and ADU in the Cory-Merrill neighborhood of Denver. Because ADUs can be flexible, we ran three different scenarios to show the different options investors have for a property like this.
- Listen to the podcast “#331: ADU #2: ADU in Cory-Merrill, Does it Cash Flow?” on the Denver Real Estate Investing Podcast
- Watch the YouTube video (at the bottom).
- Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the podcast or video.
Investment Property Details
The main house is a two bed/one bath home with a basement. The basement has the potential for another bedroom down the line. The ADU is a detached studio apartment over the garage.
Appealing Features of the Property
The property is located near the Wash Park neighborhood border. This is a desirable area and a hotspot for ADUs. The main house was recently renovated, while the ADU has a unique layout. The kitchen is on the first floor and opens to the garage, while the upstairs has a studio-style living and bedroom area with a bathroom.
Property Financing Details
Houses with ADUs tend to have a higher price tag, but you can still make the numbers work. While investors have the option to buy a property and build an ADU, the most common scenario we see is buying one that already exists.
Scenario 1: Living in the Property and Renting the ADU as a Short-Term Rental
In this scenario, the house costs $720K and we are assuming a 10% down payment. At this price point, the buyer is getting a jumbo loan. It’s common for these types of properties to be above the conforming loan limits.
We’re assuming that there aren’t any repair costs because the property is turnkey, but we are accounting for the initial furnishing and setup of the studio for about $5K.
To understand how this property would perform as a short-term rental, we ran an AirDNA report. It came back with $135 for a nightly rate and 80% occupancy. That means $3420 for monthly gross income.
Property Operating Expenses
Since the ADU is on the property, we’re assuming the investor will self-manage. For this type of product, it’s possible to find a hybrid property manager who will take client calls, so you could budget in a PM for a lower percentage than the usual 10%.
There is a lot of debate for reserves when it comes to short-term rentals. Some say that having so many different eyeballs on the property means a lower maintenance cost because preventative maintenance will be performed.
Note that reserves don’t include cleaning supplies or replenishable materials. That cost is calculated separately at $600 a year.
First Year Returns
This scenario brings a negative cashflow of $4K a year. While this doesn’t look great initially, keep in mind that in this scenario, the investor is living on the property. That means they are only spending about $350 a month to live in the home while building equity.
This is a nice setup because the ADU isn’t a shared space, which means that the investor gets significant help reducing their mortgage payment while maintaining privacy.
For ADUs, it’s important to remember that the price of the property will be higher, but it’s more important to account for all of the details. Are the location and quality of finishes good? Look at all of the factors, such as debt paydown and depreciation. Sometimes, it’s possible for investors to cashflow more on an $800K property vs one for $600K depending on various circumstances.
These spreadsheets aren’t built for all of the nuances, so be sure to talk to a financial advisor when making a decision.
Scenario #2: Renting the Main House to a Long-Term Renter with a Short-Term Renter in the ADU
In this scenario, we’re assuming a NOMADer is buying the property and planning to move out after 13 months. Once they move out, they want the property to keep generating income and help with cashflow.
Investors need to make sure they are following all zoning and rental laws, but there are a lot of different options. For instance, a long-term renter can be put in the main house while a short-term renter will go in the ADU. In Denver, the long-term renter would need to hold the short-term rental license.
Now, we’re getting income from two units instead of one. We put the rent for the main house as $2200 because it’s not uncommon to give the long-term renter a little upside from the Airbnb income. There’s wiggle room here to make sure this is a good situation for everyone and all obligations are fulfilled.
Monthly Operating Expenses
We are keeping the monthly reserves the same because we’re doubling the rental income. It’s not exact, but it’s a good estimate.
Because we have renters in both units, we increased utilities slightly. If the investor makes an arrangement with the tenant to include utilities, the renter will likely be less conscious of using resources.
First Year Returns
Now, we jump to $20K in cashflow, 20% cash on cash return, and a 7.2% cap rate. With a great property in a desirable part of town, these numbers show the value of having an ADU.
Scenario #3: Add a Property Manager
If the investor wants to make their income to be more passive, they can hire a property manager for both units. In this case, we estimate around 15% because they are 2 different types of units.
First Year Returns
In this case, the cashflow drops to about $10K a year, or just under $1K a month. This is a great option for investors who don’t want to do any management but still have a decent cashflow.
These scenarios show some of the possibilities of setting up an ADU, but there are a lot of different options. Depending on how Airbnb laws evolve, it could even be possible to rent out both units to short-term renters!
The great thing about ADUs is the flexibility they bring. Depending on the investor’s needs and where they are in life, there are great options for renting out an ADU.
Connect with Us
If you want to invest in your own property with an ADU, reach out to us. We’d be happy to present you with different scenarios and help form a strategy that’s right for you.
Be sure to check out our ADU Directory to learn more about the ADU rules in your area.