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 6 of 9] Denver ADUs as Investments” on the Denver Real Estate Investing Podcast
- Watch the YouTube video at the bottom of the page.
- Read the blog post.
Once an ADU is built there are many ways it can be utilized as an investment to build long term wealth. Every individual has a different preference for the way in which they like to get their return on investment and much of the variance has to do with how they plan on deploying the flexibility of the unit. Homeowners who have family visit for extended periods of time like to keep the unit available for this type of circumstance. While other homeowners have no limitations on the availability of the unit and can rent it any night of the year.
Long Term Rental
Much like a traditional rental property, ADUs can have a tenant in place and they can be used to help create long term wealth. Housing is in high demand in the Denver market and the rents created by a long term tenant in an ADU have the potential to cover the costs of an existing mortgage. Utilizing an asset in a manner to cover living expenses can give a homeowner an opportunity to increase their savings rate, supplement retirement savings, or create a source of income for travel and leisure.
Market rent in metropolitan Denver averages about $1,462 per month for a one-bedroom apartment. Once a homeowner secures a 12-month lease the ADU will be generating $17,544 in gross annual revenue. Assuming the ADU cost $250,000, the payback period is only 14.25 years. This assumes no growth in rent over time. If the ADU is financed on a fixed interest rate the rent will continue to increase while the payback on the loan will remain fixed and the cash flow on the unit will continue to improve.
Long Term Rental Benefits
The biggest advantage that long term rentals have over a short term is the amount of work that is required to manage the property. Once a tenant is in place the owner of the ADU only needs to ensure that the unit has no maintenance issues and that the rent is continually paid on time. Having an investment unit in your backyard also makes for an extremely unique situation that is beneficial for both the owner and the tenant of the ADU. The owner gets better tenant compliance due to the proximity of the unit and the tenant gets a more direct manner of contact to deal with any potential issues. This can stop small problems from becoming expensive ones due to the immediacy in which they can be addressed and remedied.
Short Term Rental
Short term rentals have the advantage of being able to command a rental premium compared to long term rentals. The downside to them is that do require additional work. Rather than just getting a tenant in place the owner of the ADU is responsible for much more. Things like bed and bathroom linens, overall cleanliness, furniture damage, keeping a kitchen inventory, and checking in and out guests to name a few.
Another point to consider about short term rentals is their legality in your municipality. Some areas have an outright ban while others will only allow it if the main house is your primary residence. Assuming that you are able to rent your ADU out on a short term basis consistently, the payoff for the unit does drop down closer to 10 years. It is important to note that if you end up hiring staff or contractors to help with the management it will cut into your revenue which will extend the payoff period. Thoughtful deliberation and calculations should be done when deciding which avenue you decide to pursue.
Short Term Rental Considerations
Unlike a long term rental a short term rental means that you will have a rotating door of people entering your property. You should make sure that you and anyone else living in the main property is OK with strangers constantly coming in and out of your property. Keeping your neighbors up to date with your plans is a good way to avoid any unnecessary headaches or delays in your project. Asking for their input for exterior siding that faces their property and avoiding privacy infringement on their property is the minimum that a homeowner should do.
The ADU should be consciously designed to avoid any potential issues with tenants, long term or short term. Window location merits careful attention. They should not look directly into the main house or neighbors home. Equally as important is privacy looking into the ADU. The entrance to the ADU should be accessible without having to enter through the main home. An alley entrance for short term guests and secondary entrance near the main house is a great way to balance the unit for family and overnight guests. Consider ways to add additional value to your ADU as well. You could provide bikes or other leisure activities that are unique to your area, access to a rentable car, or well-developed landscape to help increase the value.
In some instances, neither of these are the reason that an ADU was built. As housing prices continue to rise and parents are living longer some families are using these units to create a multi-generational living environment. It allows for privacy in close proximity or could also be used to house an in-home nurse for an older family member who lives in the main house. Many ADU owners have transformed their spaces into home offices, gyms, galleries, workshops or personal entertaining space. The number of ways that they can be utilized is remarkable.