According to Prudential Financial, planning for retirement should be focused around 4 key pillars: Individual savings, 401(k) plans, Social Security, and Lifestyle choices made in our sunset years. In markets like the SF Bay Area, where home prices have risen consistently, many homeowners have also tended to use the equity in their home as a piggy bank and have drawn from it via refinancing and cash-outs when interest rates are dropping. However, when interest rates are on the upswing (or flattening out), that strategy doesn’t work.
Which is where ADUs come in.
Photo Courtesy: San Jose Mercury News
ADUs Fill A Very Unique Niche
ADUs or Granny units allow homeowners to remain in their homes, not have to worry about mortgage refinancing, and still be able to generate an incremental revenue stream. Different cities have different rules governing ADUs, and until July 27, 2018, ADUs were highly restricted in San Jose. To alleviate the housing crisis and incentivize homeowners to stay in the area for retirement, the City of San Jose has considerably loosened the rules governing the planning, permitting, and construction of these structures last year.
Some of the key changes are highlighted here:
- Minimum lot size to qualify is now only 3,000 sq ft (formerly it was 5,445 sq ft)
- Bigger-sized ADUs are now allowed depending upon the lot size for the main house. Unit sizes range from 600 sq ft to 900 sq ft.
- Depending upon the location of the ADU (e.g. over an existing garage) and lot size, 2-bedroom, and 2-story ADUs are also permitted.
- The rules governing parking, setbacks, and design have all been considerably eased as well.
Cost of Building an ADU
While the exact costs of building an ADU will depend upon your lot size, the size of the permissible ADU, and the kind of goodies you choose to put in the ADU itself (e.g. concrete floor versus French white oak), here are some estimated costs to help you make a more informed decision.
Estimate for a 700sq foot detached ADU in Willow Glen (MLS area 10), San Jose
Return on Investment (ROI) for an ADU
In the Willow Glen area of San Jose, you can command a $2,000 rent per month for a nicely built 1-2 room ADU. Whether you do this as an ongoing rental or through some sort of an AirBnB type vacation rental website, you can potentially generate between $20k-$30k of income every year. Over the span of an individual’s retirement (assume 20 years for now), that can generate a significant amount of cash flow as is shown in the chart below.
Of course, as time goes by, rental prices will likely increase, which will have an even more beneficial impact on the cash flow generated. Our estimated calculations indicate that an investment of roughly $200k made in building an ADU could pay itself back within 6-10 years, depending upon the rental rates that can be charged. Pls note that there will be additional costs that may be incurred in ongoing maintenance, tenant management, additional property taxes, etc that have not been taken into account here for this blog. Hence, these calculations are intended to be for general guidance only.
Return on Investment for a sample ADU that cost $200K to build
So, Should I Invest in an ADU?
In my opinion, the answer is absolute YES. There are very few investments that will generate the kind of cash flow such ADUs will, and the payback period of 6-10 years is quite compelling as well. Potentially, you could also consider living in the ADU yourself and renting out the main family home in your golden years, which will generate even greater returns and significantly increase financial stability.
Either way, this is an opportunity you ought to think about seriously and to talk to your tax professional about. This certainly has the potential to be the 5thpillar in your overall financial planning.
Pls contact me at [email protected]
and I will be happy to help you understand why San Jose (in general) and Willow Glen (in particular) remain a great places to invest.