How Much Can You Earn with an ADU in San Diego?

ADU’s (Accessory Dwelling Units, also known as granny flats or mother-in-law suites) are the hot-button topic in residential construction and remodeling in the San Diego area.

Our clients give a variety of reasons for building ADU’s — from wanting more affordable housing for and closer proximity to family members, to long-term investments or passive income.

Regardless of the reason, one of the questions that consistently arises has to do with the earning potential versus cost of building an ADU.

Since we’ve been very active over the last couple of years designing, permitting, and building ADU’s, we thought we’d share some of what we’ve learned as our clients invest in themselves and in their property.

City of Encinitas a Leader in ADU Efforts for San Diego County

As a model for this article, let’s look at two projects we are working on in Encinitas, California.

The City of Encinitas has been a leader in San Diego County efforts to facilitate building ADU’s. They’ve pre-approved many ADU floor plans and sizes, called PRADU’s (permit-ready ADU’s), as well as reduced or completely eliminated many of the fees previously charged for such projects.

This means big savings right out of the gate.

Homeowners save many thousands of dollars when they elect to build a PRADU — seeing fee reductions and eliminating major design costs for their new ADU’s.

It’s also great to see many other municipalities — including the City of San Diego, City of Carlsbad, City of La Mesa and many others — following suit when it comes to easing the way for building ADU’s.

 

Example A: Pre-Existing Structure

This project involves converting a freestanding, 700-s.f. garage unit into an ADU.

Despite the pre-existing shell, it requires quite a bit of infrastructure work.

We need to get utilities to the structure from the main house, which include electrical, gas, underground drains, and water.

Ultimately, the cost of this project was estimated around $144,000, or around $205 per square foot, which includes cabinetry, flooring, plumbing fixtures, appliances, doors, and windows.

It is a completely built out, independent, freestanding ADU that includes one bedroom, one bath, and a substantial living space, complete with kitchen, laundry area, and central air/heat.

Remember, in California garages are not counted as living space, and the square footage is not included in the value of the home. Since the current value per square foot of this home is $474, that adds a value of $331,000 to the property  — or a net gain of $187,000 — once the existing garage is added to the building record as living space.

Our client on this project is self-financing the construction of this ADU. For purposes of understanding the full picture of the costs-vs-income potential of building an ADU, however, let’s assume they had chosen to finance the build with a home loan or equity line of credit.

Let’s assume a mortgage amount of $150,000, to be repaid over 20 years at 6% (well above current prime lending rates). The monthly payment on a loan of that amount and term would be around $1,075.

We also know property taxes will increase with an ADU addition. Fortunately with these types of builds, the property tax only increases as a result of the new improvements. The entire home is NOT re-assessed.

This is called a blended value, where the original purchase price of the home is combined with the value of the ADU. Since the average property tax rate in San Diego is 1.1%, the tax increase on an ADU costing $144,000 would be $1,584 per year, or $132 per month.

This would make the monthly cost of the ADU during the 20-year loan period $1,207 (loan repayment of $1,075 plus property tax increase of $132).

As of the writing of this article, 15 units were available for rent in Encinitas, ranging from 500 to 750 square feet. The lowest priced one-bedroom, one-bath unit available for rent was a 650-s.f. apartment unit at $1,950 per month. The most expensive was a 626-s.f. apartment unit at $2,600 per month.

Even though our ADU is a freestanding autonomous unit, rather than an attached apartment, we’ll consider a median value for similarly sized rentals in the area, which falls around $2,250 per month.

At that rent amount, a net of $1,043 per month would be left after deducting the $1,207 for financing and property taxes.

 

Example B: Starting From the Ground Up

 

 

This project involves building an Encinitas PRADU.

The unit will be a 499-s.f., freestanding structure with one-bedroom, one-bathroom, built in the backyard of an existing home.

It will be built from the ground up, requiring foundations, framing, roofing, and underground utilities.

It also needs to be completely finished as per City of Encinitas PRADU plans and specifications, including a stucco exterior.

Total costs for this unit were estimated at $173,000, or about $347 per square foot. Since the cost per square foot of this home currently sits at $418, adding 499 square feet of new, independent living space would add about $208,000 of overall property value — or a net gain of about $35,000 — immediately upon completion.

Since this is a ground-up build, let’s give ourselves a 30-year term for the loan on this ADU. At $175,000, to be repaid over 30 years at 6%, that would mean a monthly payment of $1,079.

Property taxes would cost an additional $1,903 per year, or $159 per month, bringing the monthly cost of the unit during the loan period to $1,238 per month (loan repayment of $1,079 plus property taxes of $159.)

Median costs in Encinitas for other similarly sized apartment rental units average around $2,200 per month.

Our ADU will be freestanding and unattached, with a private entrance.

That will leave a net of $962 per month for this unit.

Added Income Over the Long Run

It’s important to note that these numbers are the initial net of the new ADU’s.

While considering that property values in San Diego have increased by approximately 12% in the last 10 years, and rents in California have increased approximately 14% over the same span, it becomes easy to understand that investing in an ADU today could be an excellent income generator for years to come.