Today, we’re looking at the Return on Investment (ROI) of an Accessory Dwelling Unit (ADU) in Denver. As part of our recent series on ADUs, we talked a lot about how to finance and build one, but what does it look like once it’s complete?
Chris and I reviewed a property located in the Sloan’s Lake neighborhood of Denver with a recently completed ADU. The owners spent about $300K to build this high-end, 1 bedroom/1 bathroom structure in their backyard. They’re renting it out as a short-term rental on Airbnb.
- Listen to the podcast “#353: Do the Numbers Make Sense to Build an ADU in Denver?” 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.
Property Financing Details
For example purposes, we’re assuming the ADU was financed through a refinance of the owner’s primary home. As we’ve discussed, financing ADUs can be tricky, and this option is commonly used. We’re focusing more on the operational costs and cashflow than we are on financing.
We ran the numbers using the Rental Property Spreadsheet.
Even though the ADU is brand-new, we estimated $5K in repair costs to furnish it as a short-term rental.
The $3900 in monthly rental income is what the owners are actually getting from this property. The property goes for $150 a night 30 days a month.
We ran the vacancy rate at 20% to be conservative, but anywhere in Denver is going to be under that number.
Property Operating Expenses
A big difference between long term and short term rentals is the cost for property management. A PM for a long term rental generally charges about 10%, while the average for short term rentals is 25%. This number may seem jaw dropping, but these services include everything: bookings, cleaning, coordinating repairs, etc.
We were able to run reserves and maintenance at 3% because it’s a new build and having all of those eyes on the property keeps it better maintained. Our interview with Bryan Looney on short-term rental property management goes into this in more detail. In short: guests and cleaners tend to notice smaller issues on a property before they become bigger problems.
Since we’re assuming this is a refinance, we wrapped taxes and insurance into the main house. Electricity is separately metered, but water and sewer are connected to the main house.
Because this is a short term rental, we’re budgeting for replenishables that are used by guests, such as shampoo, soaps, toilet paper, and snacks.
First Year Returns
These numbers are based on what a refinance of the main property would look like. They would look similar if the owners did a construction loan or a cash out refinance. The great thing about ADUs is that there is a lot of flexibility in how to finance them.
First Year Returns with No Property Management Fee
Since the owners live on-site, we also ran the numbers if they chose to management the property themselves. This is a popular option because it requires a fair bit of work to get set up but can run like a well-oiled machine once the processes are in place. Once we remove the PM, the numbers get even better: the cap rate jumps to almost 10%. That’s a number we usually only see in room by room rentals, and it makes building an ADU even more attractive.
Does It Make Sense to Build an ADU?
A lot of people want to know if it’s worth it to build an ADU. Having the option to use the ADU as a short term rental is great since they are in such high demand in Denver. We’re all scared of the steep cost to build ADUs, but it can make sense once you figure out the financing. The appreciation in the Denver area in the past 18 months is astounding, and many homeowners are sitting on a lot of equity that can be used for this purpose.
While some investors may want to put that equity into a higher performing asset, it comes back to what an individual’s goals. If you’re already in your forever home, putting an ADU in your backyard can be a smart move. The great thing about ADUs is their flexibility—they gives homeowners the option to use them as a short term rental for income, and be used for a variety of other purposes, too.
An ADU is a lifestyle investment. Many people buy mountain homes to use and then rent them out in the mean time, and an on-site ADU is no different. It’s a great option for out of town guests, a place for family members to move into, or nannies or other helpers to stay.
Connect with Us
To learn more about ADUs, check out our recent series:
#1: ADU Overview and Zoning Regulations for the Denver Metro Area
#2: ADU in Cory-Merrill, Does it Cash Flow?
#3: How the Hell Do I Finance My ADU?
#4: What It Takes to Build an ADU with Phil Daughton
ADU Directory for Denver, Colorado
As always, reach out to us with any questions about ADUs, but be sure to check with your locality for specific rules and guidelines.