I often get asked about the valuation of an ADU. The appraisal considers various factors that affect the property's worth, such as its location, size, condition, amenities, and market demand. One critical aspect of the appraisal is the value of any additional dwelling units (ADUs) that may be present on the property. In this post I will discuss how an ADU is valued in a real estate appraisal. It is important to note that an ADU is not added to the main dwelling square footage and is not counted as living area on the appraisal report. It is considered separately as an amenity of the subject (much like one would value any other major separate amenity like a pool).
What is an ADU?
An ADU is a self-contained living unit on a property that is separate from the main house. ADUs can be either attached or detached from the primary residence and can be in the form of a guesthouse, in-law suite, garage conversion, or a separate structure altogether. ADUs are becoming increasingly popular in many areas due to their ability to add affordable housing options and increased rental income for property owners. In many areas, ADUs were not typically allowed by zoning but in recent years, most municipalities have made it easy to get a permit to add one.
How is the Value of an ADU Determined?
The value of an ADU in a real estate appraisal is determined based on several factors, such as the size, age, and condition of the unit, its features and amenities, and the local real estate market. Appraisers will typically use one of three methods to value an ADU: the cost approach, the sales comparison approach, or the income approach. Keep in mind that in a mortgage finance transaction, it is almost always a requirement by the lender to use the sales comparison approach and even if a large radius is used or an older sale is used, it is absolutely required to have some basis of value based on the market reaction to that ADU (requiring at lest one ADU comparable sale in the report).
Cost Approach
The cost approach involves estimating the cost to replace the ADU with a new one of similar size and quality. This method considers the construction materials and labor costs, as well as the depreciation of the ADU due to age, wear and tear, and other factors.
Sales Comparison Approach
The sales comparison approach involves comparing the ADU to other similar properties that have recently sold in the area. Appraisers will look at factors such as the size, age, condition, and amenities of the ADU and compare them to other similar properties that have sold in the area. The appraiser will make adjustments based on any differences between the ADU and the comparable properties to arrive at a fair market value. A simplified hypothetical example of this method is; if you had two comparable sales that were overall similar. House 1 has an ADU and sold for $800,000. House 2 does not have an ADU and sold for $725,000. The ADU would then be given an adjustment (value) of $75,000 in the appraisal report.
Income Approach
The income approach is typically used when the property owner intends to rent out the ADU for income purposes. This method involves estimating the potential rental income that the ADU could generate and then using a capitalization rate to determine the present value of that income stream.
Factors that Affect the Value of an ADU
Several factors can affect the value of an ADU in a real estate appraisal, including the size and layout of the unit, the quality of construction and materials used, the age and condition of the ADU, and the features and amenities of the unit. Additionally, the local real estate market can also have a significant impact on the value of an ADU. In areas with high demand for rental properties, ADUs can be an asset that can significantly increase the value of a property.
Conclusion
Overall, the value of an ADU in a real estate appraisal is determined based on several factors, including the size, age, condition, and features of the unit, as well as the local real estate market. Appraisers will use one of three methods to value an ADU, including the cost approach, sales comparison approach, or income approach. If you're considering adding an ADU to your property, it's essential to consider how it may impact the overall value of your property and to consult with a professional appraiser to determine the best course of action.