This post is part of the Denver ADU Course. The course explores the ADU building process in Denver.
Three Learning Options:
- Listen to episode “[ADU 5 of 9] Denver ADU Rental Value” on the Denver Real Estate Investing Podcast
- Watch the YouTube video at the bottom of the page.
- Read the blog post.
Now that you’ve completed the process of getting your ADU approved, permitted, financed, and built its time to put together a plan to start earning your return on the investment. There are several different manners in which you can utilize your ADU for income and flexibility. Like any traditional rental property, those which have additional amenities over the competition can command higher rents. In Denver, if you are able to provide a dedicated parking spot or garage space you could expect around an additional $100 per month. This could be even higher in neighborhoods where parking is difficult to come by. Yard space, even if it is limited has proved to be very valuable in Denver as well. Dedicated yard space has the ability to increase rents up to $150, depending on size and landscape, to the monthly rent. There are many pet owners who want the conveniences of a home while having apartment-style living, and they are willing to pay for it. When you are putting together your use plan for your ADU there are 3 main directions to consider.
Long Term Rental
Long term renting provides you with consistent income on a yearly basis with the least amount of time required to manage the unit. In Denver, a 1 bedroom apartment is renting for about $1,462 per month, which is $17,544 on an annualized basis. Location of the ADU will also play a determining factor on how much rent you are able to charge. In addition to standard rentals, there is a market for long term furnished apartments. These are utilized by people doing their own construction, just getting settled in a new city, and for corporate housing.
Short Term Rental
Short term rentals have the advantage of allowing an owner to get a higher ROI compared to long term rentals but they do come with additional time investment. If you are not paying a property manager or a cleaning staff then an owner should expect to allocate 2-4 hours per stay in the unit. There are some special regulations that need to be followed with short term rentals like Air BnB. In Denver, the home is required to be your primary residence in order to rent it on a short term basis along with a lodger and income tax that need to be paid on the revenue generated from the rental.
Competition is growing in the short term rental space which is driving the cost of nightly rates down. Property owners should be aware of the seasonality associated with short term rentals. The winter months tend to have an uptick in vacancy rates while the summer months have a higher likely hood of experiencing full occupancy. As of the start of 2019, there were 5200 properties registered with Air BnB in Denver alone. Again, the location along with amenities are very important to set apart your rental against the rest of the market.
For some ADU owners, neither of these options are exactly what they are looking for. What is so incredible about ADU’s is there ability to solve a variety of housing problems. The units can be scheduled to be unoccupied for when kids are returning home from college or when the family is coming to visit. Some ADU owners have even completed their units and then moved into them as their primary residence. This allowed them to rent out their main houses at a higher monthly rate while still giving them the luxury of living in their neighborhood. This technique allows retired people to downsize, have less home to look after, and create an opportunity for them to travel with the additional income that they are making.
Medium-term rentals can be more difficult to secure but they work great in conjunction with timed visits. Being able to rent out the ADU to one party for several months and then having it available later in the year when you have plans for it is an incredible way to earn income and still provide housing for friends or family. Traveling nurses, corporate rentals, and local renters are all in need of high-quality housing with leases that vary between 3-6 months.
The return on investment for ADU can vary significantly depending on how the unit is utilized. Short term rentals provide you with the highest rates and create a pay off period as quick as 6-7 years. Long term rentals can take between 12-14 years to achieve 100% ROI. A mixture of both of them can create a return that is close to a 10 year payoff period. It’s important to note again that while short term rentals do provide a faster payoff they do come with more work, wear on the property, and costs compared to a long term rental.
It’s important to look at your ADU as an investment and a business to make sure that it is running efficiently to shorten your payoff term. Just like setting long term rental rates, becoming an expert in your market to competitively price a short term rental is extremely important. The auto pricing features on the short term rental sites tend to price the properties fairly low and this could cost you thousands of dollars per year. A hands-on owner should be following up with the cleaners and staying up to date on maintenance and ensuring that the property continues to present itself well. Even a property owner who has hired help should expect to put in close to 10 hours per week to ensure that their short term rental is being managed and priced effectively.