Accessory Dwelling Unit - ADU
What is ADU?
Accessory Dwelling Unit, ADU, also known as Granny Flats, in-law unit, is a legal and regulatory term for a secondary house or apartment that shares the building lot of a larger, primary home.
ADU can be new construction, garage conversion, or conversation parts of the living space in the house.
Due to the lack of affordable housing in California, new legislation was made, And today virtually all single-family homeowner has the right to create an ADU and generate themself.
In California, ADU cannot sell separately (unlike Texas), however, they can be rented separately from the main house.
So what is JADU?
Junior Accessory Dwelling Units (JADUs) are small living units (up to 500 square feet) created out of space within an existing single-family home or an attached garage.
JADU is a legal and regulatory term unique to the state of California and can be built as an accessory unit in addition to an ADU. The Diffrence between JADU to ADU
ADU & JADU Laws and Guidelines
ADU can be new construction, garage conversion, or conversation parts of the living space in the house and must function as a self-sufficient unit. This means that it must have its own kitchen, a full bathroom, a separate electric meter and a separate sewer line.
ADU laws on single-family property
As January 2020 the state of California allows virtually all single-family owners to build an ADU on their properties regardless of city or HOA (homeowner association) regulations. In fact, the state of California passed a series of laws that provide the absolute minimum benchmark that every city must meet. Again, those benchmarks are the absolute minimum, however, each city can choose to write more lenient guidelines. For this discussion we will call that ADU state exempt ADU.
To be more specific, we will need to separate between the new construction ADU and Converting the existing structure ADU.
What is the size limit for ADU?
As far as size goes the state benchmark says that new construction state exempt ADU the maximum size must be not less than 850 sqft or 1000 sqft for more than 1 bedroom ADU (2 and above), and for cities that didn’t establish their own ADU guidelines the maximum size will not be larger than 1200 sqft, that means that homeowner can choose to build smaller than 850 sqft (or 1000 sqft for 2bds), the planning department of the city must approve any project below 850 sqft as long as it meet all other requirements.
Example #1: 1600 Sqft house with 400 sqft garage
Same house as example #1 plus new construction ADU of up to 850 sqft for one bedroom or studio, and 1000 sqft for 2 bedrooms or more
What is the size limit for converting an existing structure to ADU?
when it comes to existing structure ADU it is a totally different story. You can convert any permanent, permitted structure such as a barn, shad, garage or part of the existing structure or main house without the size limit that is imposed on new construction. Furthermore, if you would like to expand the existing structure even more, you can add up to 150 sqft without being subject to the size limit of the new construction. That means that if you currently have a 3,000 sqft barn you can convert the bard to a 3,150 sqft ADU and the city can tell you nothing about it.
Example #2: 1600 Sqft house with 3000 sqft barn
Same house as example #2, only that the 3000 sqft barn converted fully to ADU
Same house as example #2, only that the 3000 sqft barn converted fully to ADU plus 150 sqft were added to the bard as new construction
Percentage of the primary residence? True or false?
One misconception that people have is that there is a minimum percentage requirement from the total size of the house. Although it might be true that each city can enforce a percentage of the total property, that only applies for units larger than the minimum benchmark of 850 sqft (or 1000 sqft for more than 1bds). That means that technically if you own a 700 sqft house and you have an adequate size back yard to meet the required setbacks. (Scroll down for more information) you can build up to 1000 sqft (for more than 1 bds ADU) even if the city allowed only 50% ADU from the original structure. Amazing, isn’t it?
Example #3: 800 Sqft house with 200 sqft garage
Same as example #3 plus new construction ADU of up to 850 sqft for 1-bd or studio, and 1000 sqft for 2 bedrooms or more. as you can see the ADU is larger than the main house
With that said, if you want to build more than 1000 sqft ADU you will be subject to the city limitation even on existing structure conversion.
Go back to the 3,000 sqft barn example. In this case the city had 50% limit of original structure. To convert the entire barn, the main house must be larger than 6,000 sqft. If the city imposes 25% limit, to convert the entire barn the main house must be 12,000 sqft.
For a city with percentage requirement the owner could convert only from the main house size or up to 1000 sqft whichever is higher
For a city with a percentage requirement, the owner must have at least 6000 sqft house to convert the entire barn to ADU
Heights and setbacks
What is the maximum height allowed when building new construction ADU?
As far as height goes, state-exempt ADUs can be up to 16 ft tall from the curb.
however, some cities and counties (Santa Barbara for example) allow you to build up to 30 ft high or the height of the primary house. whichever is less.
Can you build two stories ADU?
The short answer is no.
due to the minimum height requirement of 7ft per floor plus the gap between the floors of 12-14 inches and the space for the roof.
However the full answer is probably yes. because the law says that the new construction ADU cannot be taller then 16 ft highet from the curb, and it does not limit to the floor count.
So technically if you dig 2-4 feet underground you'll create enough space for the two stories ADU.
What is setback?
a setback is a minimum distance in which a building or other structure must be set back from a street or road, a river or other stream, a shore or flood plain, or any other place which is deemed to need protection. In ADU terminology setback means the distance between the ADU and the property line.
WHat is the minimum setback requirement for ADU?
Now any new construction ADU must be built with no less than 4 ft rear and a side yard setback.
However, if you convert an existing permitted structure (such as a detached garage or part of the house) you don’t need to follow the setbacks requirement.
Example: here the garage was converted to ADU, and therefore don't need to comply with the setback requirement. However the new construction on the second floor must comply to the 4ft setback requirement
You can build an ADU regardless of the building zone. The only zone that is important is the fire zone
My Zone has Changed to industial or commercial, can I still build ADU?
Yes, it is possible to build ADU in any zone, as long as the house itself is a single or multi-family residence. Regadless of the change in zone
Can I build ADU in a fire zone?
You can convert the garage or any part of the house to ADU regardless of fire zone.
You can also build a new construction ADU in a moderate fire zone, high fire zone, and very high fire zone.
You will not be able to build new constctuin ADU if the property located in a VERY high fire zone AND on steep slope.
To check if your house is in a very high fire zone please check the Fire Hazard Severity Zone map from the state fire marshell website Click Here
Do I need to make parking spot to the ADU?
There is a parking requirement for the new ADU and JADU of one space per bedroom, this parking space can be but not limited to cover space, uncover space, tandem space (parking one behind another) or a mechanical lift.
although there is no parking requirement if the property is located within half a mile from a public transportation station.
Do I need to create new parking if I convert the garage to ADU?
In the case of garage conversion, the number of spaces that were removed due to the conversion needs to be replaced in addition to the new spaces that the ADU and the JADU require.However, there is NO parking replacement requirement if the property is located within half a mile from a public transportation station (bus station or train station or metro station).
So what is JADU?
Junior Accessory Dwelling Units (JADUs) are small living units (up to 500 square feet) created out of space within an existing single-family home or an attached garage.
JADU is a legal and regulatory term unique to the state of California and can be built as an accessory unit in addition to an ADU.
Although JADU and ADU sound similar, the two couldn't be more different.
What is the difference between ADU to JADU?
JADU must be contained in the existing structure of the main house, which means it can be or a converted living space such as a playroom, bedroom etc. Or a converted, unlivable space that confides within the main house, such as an attached garage (conversion of detached garage must be an ADU), conversion of the basement or attic space.
Example #1: 1600 Sqft house with 400 sqft garage
You can can choose to convert more then the garage alone to JADU. You can convert up to 500 sqft from the structure to JADU
Lastly, JADU does only need a kitchen, and can share the bathroom with the main house, needs only an electrical sub panel box and not a new meter, and can connect to the main sewer line of the house. All of those will reduce the costs involved in constructing the unit.
JADU can only exist in owner occupied residence, that means that once you, the owner leaves the house to live in a different one the JADU will cease to exist until or you will return or sell the property to a new owner that will live in the house. That is obviously a downside since rental property investors will not be able to use those units as a third unit in the house and potentially lose tens or even hundreds of thousands of dollars during the lifetime of the property.
There is a way to rent all the units: JADU, ADU and the main residence, without breaking the law. It's called land trust. You can create a land trust and transfer the property to the land trust. The state did give exemptions for the next 5 years in the process, allowing investors to use this method to rent all units. The main issue in using a land trust is that the lander might recall the loan and you might need to pay off the mortgage in full. Therefore, before doing anything else, we recommend contacting the bank that holds the mortgage.
Can I covert detached Garage to JADU?
No, in case of any detached structre or new construction you can only convert it to ADU and not JADU.
Example #4 house with detached garage
You can still convert part of the main house to JADU, however the garage must be ADU
Can you add the 150 sqft to JADU as well?
No JADU do not qualify to the 150 sqft addition that allowed with ADU
What is better ADU or JADU?
I would say it depends; it depends if you could do ADU or not. If you can do ADU in addition to JADU I would personally recommend doing both JADU and ADU. However, if you don’t have enough space on the lot for both, building ADU and not JADU is the better way to go
5 Creative layout ideas for ADU and JADU to maximize profit
Example #1 Garage conversion to JADU and 2nd story ADU
Example #3 2nd story ADU for homeowners that don't want to lose their garage
Example #2 two stories ADU
Example #4 two stories ADU plus 500 sqft house conversion to JADU.
Example #5 Garage Conversion to JADU plus house conversion to ADU and addition of 150 sqft to the ADU
So, what are the main reasons that people are doing an ADU and JADU, and why you should do it too?
there are three reasons why people build an ADU.
Capital gains of tens of thousands, thousands of dollars in passive income monthly, and tax benefits. So, let’s dive deeper into each
1st reason – Capital Gains
What do capital gains mean? Capital gains are an increase in value above the invested amount.
For example, if you bought a stock for $100 and the market went up to $110 you've $10 in capital gains once you sell it.
So now let us take a classic 1970 four bed three bath. 2200 sqft livable space and 420 sqft 2 car garage. This house is selling for 1m dollars.
Or $454 per sqft. As you can see the price per sqft includes only livable sqft and a garage is not a part of it.
Now let's say that you built a 800 sqft 2 bed ADU in the back yard and converted the 2 car 420 sqft garage into a one bedroom apartment JADU (we will go over the difference in the next chapter).
Now let's say that hypothetically speaking that because of the 50% increase in property sqft and the fact that those 3 units (Main house, JADU, ADU) will be able to be rented for twice as much as the main house alone, the property value will go up by 40% or $400,000. (We will dive deeper into how to estimate property value increase in the chapter “the top 3 ways to estimate property value”.
Which means that if the construction of the 2 new units will cost $300,000 the owner will have an immediate gain of $100,000 in capital gain and profit. However, if the construction costs $450,000 the owner will have an immediate loss of $50,000.
The 2nd reason – Rental income – living for free and passive income.
So going back to our example of a house with a 1 bedroom 1 bath JADU Garage conversion and a 2 bed 2 bath ADU.
In 2021 the average rent for 1 bedroom in Los Angeles is $1,995 a month, 2 bed 2 baths is rented for $2700, and it is going up every year. Personally, I would not be surprised to see the price of rent double or even triple in 10 years or less.
That means that the two units (JADU, and ADU) can make $4,695 every month while the owners are still living in the main house! If the rental income is higher than the mortgage, the owners will live in this house for free!
And if the owners do not have any mortgage, they will pocket nearly the entire amount or $56,340 as passive income. In comparison, the median household income in the United States is $63,179. It's surprisingly good to make the same amount without leaving the house, right?
3rd reason – Tax benefits
It's different from owning a house to living in, which gives you virtually no tax benefits. Owners that rent their property or part of it can deduct a lot of expenses. For the entire operating expenses, the interest, repairs, maintenance and even the construction of the ADU and JADU are all tax deductible. Generally speaking, those deductions are more than enough to offset the entire income that you generated from renting those units. which means that the $4,695 are tax free, in some cases the deductions are larger than the income and it can even reduce your tax liability outside of those units.
Note that although it’s ideal to build the project if the increase in the property value is significantly higher than the cost of building the units and/or the rental income is lower than the monthly cost of operation. there are times when it is ok to “loss” money in capital gain and even spend more in operation than the income every month. So, if you plan to hold the house for a while or the net rental income is worth it or there is a long-term development in your area and projection for higher demand in rent. Either way, you might be ok with doing the project.
How much does it cost to build an ADU in california?
Prices for ADU can vary greatly from one project to another. New construction ADU will cost much more then a garage conversion to ADU. while New construction on a hillside can almost duoble the cost in ground work and preperation
So how much a new construction ADU cost in CA?
Ground up ADU can range from $150,000- $350,000 depends on many factors.
hillside, 2 stories, hard access, size, expensive finishing materials and more will all greatly infulace the price of an adu
in some cases steep slope hillside can almost double the cost of the project.
And building one story ADU is cheaper then two stories.
What about the cost of garage conversion to ADU?
All thing being equal garage conversion will cost significantly less then new construction.
With a garage convention to ADU you can expect the cost to range between $75,000-$150,000.
here the main contributors to the price difference will the age of the structure, the distance from the water and the power lines, and finishing materials.
While a garage that build on the 80's will e much easier to covert then a house built in the 50's.
And attached garage will be in most cases cheaper to covert then detached garage.
Is garage conversion to JADU cheaper than to ADU?
All things being equal Garage convestion to JADU should be a bit cheaper then to ADU due to the fact that JADU permit do not require to run a new electrical line and can use the main electrical line of the house and only need a sub panel.
The second contributor to the lower cost for JADU compare to ADU is that JADU can use the main water line and the main sewer line of the house.
Therefore save thousands of dollars with the cost of running new lines to the street.
Is it still worth building ADU and JADU in 2021?
To try to answer this question we must understand a concept called opportunity cost.
According to Investopedia:
Opportunity costs represent the potential benefits an individual, investor, or business misses out on when choosing one alternative over another. To read more Click here
In simple terms, opportunity cost is the amount loss or gain from choosing one investment instead of another.
For example, today savings account will generate about 0.5% APY, Annual Percentage Yeild.
So, $100,000 deposited in a saving account that yield 0.5% will return by the end of the year $100,500. After 10 years the same $100,000 will be worth $105,114 due to compound interest.
So the total 10 years return for the savings account is $5,114.
in comparecent the 10 years average annual return of the S&P500 can range between 3.6%-13.2% and will yield a different return depends when the 10 years started.
Historicly speaking an investor that invested $100,000 at the peak of the dot com bubble in the S&P500 in January 2000 and pull his fund 10 years later in 2010 at the low of the great ressetion will only have APY of 3.6%. which mean that after 10 years the investor will have $142,428.
So between 2000 to 2010 the total 10 years return for the investor was $42,428.
in comperenct between the January 2010 to January 2020 the APY was 13.2%
so an invesor that invest the $100,000 in the S&P500 during those 10 years will have $345,512.
The big difference represent another aspect of investing; the risk.
in a difference of of savings account which the APY is gurented, when investing in stocks the returns are not gurentee and carry a certain amount of risk.
For example, from October 2007 to Feberuary 2009 the S&P500 dropped by 53%. therefore an investor that place $100,000 at the peak of 2007 loss more then $53,000 if he pulled his funds a year later to a total balance of only $47,000
another aspect to think about when investing in the stock market is that the profits are taxable and it called capital gain taxes. After holding an investment for more then 12 month the profits are subject to federal long-term capital gains tax. at this moment the long term capital gain tax rate stand on 15% for household making less then $500,000 a year in income and 20% for houses that make more then half a million in income.
in addition any capital gain in the state of California is consider as regular income and therefore tax as such (Forbex - What Are Capital Gains Taxes For The State Of California?)
To check what is your tax braket in California Click here (NerdWallet)
therefore for the average household, the $42,428 gain between 2000-2010 will be subjected to 15% federal capital gain tax and 9.2% in income tax or $6,264 in federal capital gain tax and $3,903 for a total net profit after taxes of only $30,038.
for the 2010-2020 period the pre tax profit was $245,512 however after taking taxes in consideration, the net profit is only $186,098.
with that said don't expect those return, the 13% return that were made from 2010 and 2020 were extremely rare and it required for the investor to belive in the market when everyone else thought that the US economy is about to collapse.
And for that reason, most investors and 401k consider the average return since the S&P500 was established in 1957 when they make their prediction. which stand on 8% annual return.
therefore $100,000 invested today are expected to return about $215,892 in 2031. with net profit after taxes of only $87,846.
Not so bad, but also not great when you had to invest $100,000 for 10 full years.
Another option available is instead of buying stock, you can choose to invest in real estate. Meaning that you can choose buy another property, rent it out, and sell it in 10 years.
In real estate there are 3-5 factors that infulace the profit; Rent collected, profits re-invested in stock, rent increase, increase in property value, and leverage.
net Rent collected
Rent profits is one of the obvious sources of profit to the real estate investor. Rent profit is the rent collected minus all expenses. such as property taxes, insurance, vacancy loss, repairs, replacement reserves (for large repairs such as HVAC replacement, new roof, or any other high ticket repair) management fees and more.
The rental yeaild vary greatly from city to city and from house to house. in short rental yield is the annual percentage return from the total cost of the property.
WIth a state average yield of 6% (homearea)
Therefore a property that cost $100,000 is expected to generate about $500 a month or $6,000 a year.
for simplicity about 30%-50% from the total rent collected will be used to pay any expences.
for example if the monthly rent is $600, and the monthly expenses is about 40% (based on house condition and other factors) your net profit is $360 a month.
Profit reinvested will derived from the net rent profit after paying all expenses.
that mean that whatever net profit remain will be reinvested back to the S&P500 with the annual average return of 8% as discuss above.
So if a property generate $1,200 a month or $14,400 a year in net profit. this profit will be reinvested annually to S&P500 to grow with an average return of 8%.
Rent increase rate
Rent increase rate take in consideration the increase in the cost of living. in California the average rent increase is about 5% annually from 1980,. In los Angeles in the past decade the rent increased by more then 65% which mean that a house that was rented for $2,000 today. could probably be rented for $2,100 the following year, and $2,205 the year after and so on. Those increases will be reinvested as well to the S&P500.
Increase in property Value (appreciation)
Increase in property value is probably the most aluring reason why people invest in real estate, especially when considering leverage (will discuss below). However investing in real estate just for the increase in property value can be a very risky strategy especially if the expected rent is not enough to cover the mortgage and any other expences.
Look at the 2008 crisis, people bought houses with the conviction that the market will keep climb forever, and most of them bought houses that the rent value is much lower then the mortgage and monthly expenses. therefore when the market turned and housing prices drop by 30%-50% a year between 2007-2009 (GlobalPropertGuide) and people lost their jobs and couldn't pay for the house the bank had to foreclose on the property and force those investors to bankrupt and lose everything.
With that said appreciation is a very strong profit generator in California., last year for example; the year to year increase (APR20-APR21) in property value in los Angeles was 18.7%, Orange county rose by 16.6%, San Diego rose by 15.5% (LA Times), Santa barbara prices rose by 24.6% (Zillow) and in San Francisco and the Bay area, prices rose by 17.8% (Norda)
However the average year to year appreciation in California for the last 40 years stand on 6.7% (Jacobonwealth)
For that appreciation should be the cherry on the top when investing in real estate, and not the only reason. If the fundamental of the investment property doesn't work, meaning if the rent can't cover the mortgage payment and the monthly expenses investing in that property carry high risk, especially when the market is at an all-time high.
As you can see in our example of the S&P500, tax libilety can carry a hafty cost.
When it come to taxes, selling a property in a profit called capital gain and fall in the same tax braket as the long term capital gain taxes as in stocks.
However when renting an investment property, you will need to pay taxes on the net rent collected. Any net income your rental property generates is taxable as ordinary income on your tax return. Generally speaking the federal tax braket is 22% for business owned property and your tax braket for individual owned property (How Is Rental Income Taxed? - RoofStock)
In addition to federal taxes the owner is also liable to California income tax (for California Tax calculator click here - CA.gov)
Becasue the amount of taxes owed is calculated based on the total income minus all costs, one of the way for an investor to keep more money in their pockets is to show higher costs.
Thankfuly the government support real estate investors and provide clear guidelines regarding to what costs can be deducted and what investments can be dippreciated over time.
So beside the obvious expences, that we discussed above (repairs, management, replacement reserves and more)
The Californian homeowner can depriciate the property value (minus the cost of the land based on market value) in a straight line for 27.5 years.
for example before buying a property for $100,000 we found out that the cost of the land is 15% from the property value. therefore $85,000 are divided by 27.5 years giving the owner an annual depriciation of $3,090. This depriciation will be added to the annual cost to offset taxable amount and increase the investor net income.
So as our previous example shows for $100,000 the expected rental income is about 6% or $6,000 from that amount we will reduce the 40% expences or $2,400 and the annual depritiation of $3,090. to a total net rent before taxes of only $510. and for that amount the investor will pay only $112 in taxes to federal based on 22% tax rate, and 47$ to the state based on 9.2% tax rate.
Putting it all together
In order for us to understand what is the actual return for investing in real estate we will need to add up all the profit generators.
So how real estate investing compete against savings and the stock market.
to answer that lets use our average investor. After doing som research the investor decide to invest $100,000 in property and buy it cash outright (click here check your area - homearea).
In the research the owner found that a
what happen when we add leverage to the picture?
Wikipedia defines leverage as any technique involving using debt (borrowed funds) rather than fresh equity (value of owned assets minus liabilities) in the purchase of an asset. Or in other words, buying a house using a mortgage.
Putting it all together
In LA, the standard size for new construction ADU is 800 sqft, and it is the perfect size for 2 beds 2 baths unit. The Average rent for a unit like this is $2,747 a month for a 12-month lease. However, in most areas, this unit will be rented for much more than that.