How much is that accessory dwelling worth? How do we really put a value on it? It’s not always easy to figure that out in real estate, so I wanted to share some of the issues I tend to think through as an appraiser when there is an accessory unit on a property. Anything you’d add? I’d love to hear your take.
Things to consider when valuing a property with an accessory dwelling:
1) Comps: How much are other homes with accessory units selling for? This is a fundamental question to ask. Since data is often limited we might have to look through years of neighborhood sales (or competitive neighborhoods) to try to find something that has sold with an accessory dwelling unit (ADU). Even if the sales are older or a bit different in size we can at the least come up with a percentage or price adjustment to try to get a sense of what the market has been willing to pay. Ideally we’d find three model match sales in the past 90 days, but that’s probably not going to happen. Remember, we might not use the really old sales as comps, but we can still use some of the older data to get a sense for how the market has behaved regarding accessory units.
2) ADU Minimum: At a minimum an accessory unit needs to have a bathroom, sleeping area, and kitchen. This means an outbuilding without a bathroom really isn’t an accessory unit. And that Man Cave / She Shed isn’t an accessory dwelling because it’s basically a game room meant for hanging out instead of living.
3) 2nd Unit or Not: Are we dealing with a second unit or an accessory unit? It might sound like I’m splitting hairs to ask this question, but there is actually a difference between a full-fledged second unit and something that would be classified as an “accessory” unit (or “Granny flat”, “Mother-in-Law” unit, or “Guest Quarters”). I wrote a post here to describe the difference. In short, whether something is a full second unit or merely an accessory dwelling could potentially change the way we approach valuing the unit and which comps we choose.
4) Just a House: How much would the property sell for if it just had a house without an accessory unit? This doesn’t help us put a value on the accessory unit, but in a sense it helps us start gauging value for the neighborhood. This at least gives us a place to begin.
5) Combining Square Footage: Often times an accessory unit’s square footage gets lumped into the main square footage of the house. This happens in MLS and sometimes it happens in Tax Records. So we might read a home is 2000 sq ft when in reality the main home is only 1400 sq ft and the accessory unit is 600 sq ft. In this example we don’t really have a 2000 sq ft house but rather a 1400 sq ft house with an accessory unit. The question becomes, could the subject property sell on par with homes that are 2000 sq ft? Maybe. Maybe not. This is where we have to do research. I will say quite a few properties are priced based on a lumped square footage and then they end up sitting instead of selling. This is not always the case, but it reminds us to be careful about assuming a home with an accessory unit is always going to have the same value as a larger home.
6) Permits: Was the accessory unit permitted? If you are hoping to see more significant value recognized for an accessory dwelling, having permits is a key factor. My friend Gary Kristensen in Portland wrote a post on ADUs and he says, “Provide the appraiser and your lender with documentation that your ADU was legally permitted. Also, list information about rental income, expenses, and detail construction costs (if your unit was recently constructed).” Good advice, Gary.
7) Rent: Can the accessory unit be legally rented? What is the market rent? This is where we might use the Income Approach to come up with a value (another blog post). Imagine an accessory dwelling has a market rent of $1000 per month. Now imagine an appraiser says the extra unit is worth $10,000. Does that seem reasonable? Doesn’t it seem low right away since the unit would be 100% paid for after 10 months? Or imagine a unit rents for $300 but it’s being given $150,000 in value. Doesn’t that seem excessive based on the low rent? Thus sometimes when we know market rent we can begin to sniff out whether a value adjustment is even approaching reasonable.
8) Square Footage Adjustment: If I’m adjusting $50 per sq ft for extra square footage in my report, would it be reasonable to see that same adjustment for the 600 sq ft accessory dwelling? This is only a question I ask myself. There isn’t a constant where the market will pay the same amount for square footage for the main dwelling and something else (converted basement, converted garage, accessory unit). Part of it depends on quality too. If the extra unit has a quality clearly below the main house, it’s probably not reasonable to see buyers pay the same amount for square footage outside the house. Though if the quality is the same, we might be looking at an adjustment that is similar or the same to that which is given to the house. Again, there is no rule here. This is only a question I ask myself in the background when approaching an accessory unit. I would never automatically give an adjustment like this. Remember, square footage adjustments are NOT based on the entire value of the property divided by the square footage.
9) Cost vs. Value: We all know the cost of something doesn’t necessarily translate to the value, but cost can help us gauge quality. There might be a difference in value for an accessory unit that cost $125,000 compared to $15,000, right? This is basic logic, but let’s not overlook the importance of it.
I hope that was helpful.
Questions: Anything you’d add? Did I miss something? If you work in real estate, how do you come up with the value of an accessory unit? I’d love to hear your take.
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Hey Ryan,
Excellent help on valuing ADUs, Thank you!
Older ADUs. The first step I’ve learned is the permit of especially older ADUs where no permit was issued, say 50 years ago. Around LSU, there were many homes built with larger garage apartments or ADUs, which are not in currently in a legal status. Current A-1 zoning doesn’t allow for rebuilding these units in the case of disaster unless than lot is over 10,000sf and now no more than 500sf in size. If lot is less than 10,000sf and can’t be rebuilt, Lenders such as Chase aren’t allowing Appraisers here to apply extra value for these units since they can’t legally be rebuilt. Also, what if you have a 1,000sf ADU and can rebuild it to 500sf? An Appraiser really has to know the regs, zoning and laws pertaining to these and if and when they can be rebuilt. You don’t want to be that Appraiser that applies $20,000 extra value for an ADU that can’t be rebuilt in the case of disaster. And, it doesn’t matter if the ADUs or apartment brings in an extra $1,000/month in rent money either. Always verify.
Fantastic comment. Thank you Bill. And there certainly was a big disaster in your market recently. This underscores how important permits are. Yes, the market may be willing to pay something even if there aren’t permits, but there is some real liability when valuing something that cannot be rebuilt. Wise words.
Great questions to ask when valuing this type of home. I had a situation recently with a home that had an ADU. This particular home used a septic tank system for sewer. The septic size and field lines are based on the number of occupants of the home, which is estimated by looking at the number of bedrooms. The ADU was added after the septic tank was installed so there were some questions as to whether the county health department would approve the set up. In the end I had to make the appraisal subject to an inspection to determine if the septic tank and field lines were adequate for the home and ADU.
Wow Tom, that is quite the example and the answer could certainly complicate the appraisal too. After all, what is the extra unit worth if the septic tank is not adequate? I suppose our first question would be how much a new septic tank is going to cost. Thank you for sharing. Great job thinking through this issue and catching it for your client.
Ryan, thank you for the honorable mention and link. I really like the simple approach you took on this topic that could have several books written on it. You boiled it down to the most important stuff. It is important that lenders or homeowners ordering appraisals on homes with accessory units look for appraisers who have experience in valuing them (maybe ask for a sample report) and/or have taken classes specific to valuation of accessory units. In the past, many appraisers who were accustomed to lender type appraisals might be tempted to be conservative on the value of the accessory unit as to not raise flags with underwriters and quality checkers. That is when you would see the unrealistic adjustments, like you spoke about, of $15,000 for a new accessory unit that rents for $1,200 and cost $150,000 to build. The good news in our area is that accessory units are a fad right now and are popping up everywhere. This makes it easier for appraisers to support conclusions and not feel the need to be conservative in absence of support.
Thanks Gary. I appreciate your comment. It must be great to have more data at your disposal. I read an article recently in Working RE magazine that used Portland as an example of granny flats being undervalued. The study found accessory dwellings contributed very significantly to the value. The study cited figures like 23-48% of the total property value was the ADU. http://www.workingre.com/working-re-fall-2016/
I recently completed an assignment where there was a legal non-conforming second dwelling unit (garage conversion completed prior to 1981). The city planner told me that the second dwelling (studio with a kith & bath 360 SF) was legal but if involuntarily destroyed it may not be rebuilt and the property would then need to comply with R-1 zoning. My best comp was another property with R-1 zoning and with a legal non-conforming second dwelling. The market data did not show a discount for not being able to be rebuilt if destroyed. Pricing was similar to second dwellings with multi-family zoning. Being able to pair legal non-conforming with legal conforming two unit sales was key in valuing the studio unit.
Great job Tom. You sound like a lucky man to find another legal nonconforming situation. Nice to see there was no discount too.
Does this information apply to the new fad with “tiny houses”?
Hi Terri. Thanks for asking. It really comes down to what a tiny house is considered in the eyes of a city/county. So far I haven’t seen much with tiny homes in the Sacramento area – not in suburban areas at least. I know some tiny homes on reality TV shows would actually be considered personal property rather than real estate because they’re not attached to the ground (you can drive them away). In cases like that a tiny home would not be considered an accessory dwelling by any stretch. But otherwise I can foresee a tiny home being categorized as such as long as it fit within the definition of what the city/county deems an accessory unit. I would defer to whatever local code says and pay close attention to whether the tiny home had a bathroom, kitchen, and bedroom and was actually attached to the site or not.
WE BUILT A GARAGE WITH PLAYROOM ABOVE IN 1996 MY NEIGHBOR IS A MEAN PERSON AND CALLED COUNTY ORDINANCE ON US. WE ADDED A SHOWER SO MY MOTHER-IN -LAW COULD LIVE THEREAFTER RE DEATH MY NEPHEW MOVED IN TO HELP MY DISABLED HUSBAND AND MY DISABLED SELF HELP US. WE WERE TOLD AS LONG AS A FAMILY MEMBER LIED THERE AND NO RENT WAS CHARGE WE COULD DO SO BUT AFTER ALL THESE YEARS LATER GWINNETT COUNTY IN LILBURN GA. SAYS ONLY ONE HOME PER LOT. WE NEED MY NEPHEWS HELP CAN WE ATTACH IT TO THE MAIN HOUSE WITH A BREESEWAY OR SOMETHING CHEEP?I READ ONE MAN PUT A 30 FT. BOARD BUT OURS IS OVER 100 FT. APART. PLEASE ANY HELP IS NEEDED TO HELP US.
Hi Rick. I’m sorry to hear about your situation. I think the most important thing here is finding out what the county / city in your area considers as one house. The thing is an accessory unit is not considered a house in my area, which is why it is called “accessory”. This is why someone can have both a house and an accessory dwelling unit (ADU) and it is still considered just one house (but with an ADU). Find out in your area if a house plus an accessory is allowed. Regarding a board, that wouldn’t cut it from an appraisal standpoint as living area needs to be fully accessible from the main unit, but if that works for some reason in the eyes of the county, that’s great for you (though 100′ is a really long distance). In short, finding out what you can do from the county’s perspective is the best best. You might also consider if there is something you need to modify about the unit in order to keep it. I realize removing a bathroom or kitchenette would alter the room, but exploring those options may be relevant. I hope things work out.
We are currently selling our home in the LA county area, where ADUs are allowed now. We converted a large garage that already had a large “pool” bathroom built. The total square footage of the new ADU is 660.
Our house is in escrow but is stuck do to the appraisal. The appraisal was done over a week ago but the appraiser gave zero value to the Adu. He actually called it an ADUs in the pictures of the bathroom, bedroom, living room and kitchen but calls it a non living quarter in his appraisal. Yes it has been fully permitted and we also supplied the appraiser with the certificate of Occupancy. Our agent had to put together a rebuttal. And it’s been a week with zero response.
They valued our home at 400.00 a square foot but that still puts us well under the offer price.
Its hard to believe that there is zero value to 660 square feet that we paid to have built out and we also know the buyer already has a renter.
Another issue …the appraisal also had the square feet of our actual home that was built over 50 years ago wrong!!! His measurements are off by about 100 sqft
Hi Christina. I’m sorry to hear about this situation. It sounds stressful and very frustrating. It’s hard for me to speak definitely here since I’m not acquainted with your property or market. Here’s a couple thoughts though:
1) The most important thing here is value. What is the house worth? It really is important that this is permitted, and the appraiser needs to find a way to support a value conclusion here. So if the appraiser says it’s worth nothing, then that should be supported in the market. Show me some properties with ADU units that sold for no more than homes without ADUs and I’ll believe there is no value. Otherwise if appraisers don’t use some sales (or data) with ADUs, then we haven’t really supported the value we say exists (or lacktherof). If your unit can be legally rented, that could be a real plus for value. Of course it sounds like there is no garage now, so if there is added value for the ADU, there is also maybe diminished value for not having a garage. Ultimately the appraiser is going to have to find data. If your Realtor or loan officer asked the appraiser to reconsider the value, I really hope solid data was provided (including some sort of substantiation of value for the ADU). Keep in mind too if your property was compared originally with very large homes (your house plus the size of the ADU), then it’s possible the best comps weren’t used to price the home. Just saying to be fair we have to consider that.
2) I pay attention to price per sq ft, but I’m more interested in seeing with other similar properties have sold for. Why? Because price per sq ft can vary significantly depending on the size of the house, location, upgrades, etc… In fact, I’m thinking of a neighborhood in Sacramento where price per sq ft varies between 300 to 600. That’s a huge spread. Thus at some point we need to step back and find similar properties.
3) It’s hard to say why the square footage is different. To play devil’s advocate, are you sure it was correct in public records? It’s not always correct in my area.
Again, sorry to hear about this. Keep me posted if you have any questions. I do get your frustration and I would honestly feel just the same. And personally on my next house I would love to buy an ADU that doesn’t cost me anything…. (I share your concern).
Best wishes.
Hi Ryan, I just stumbled across your ADU appraisal column when searching how to evaluate building an ADU on my coastal property in CA. Thanks for posting your thoughts. I’ve concluded that using a DCF model assuming no residual value is best for my situation: my house is > 60 years old, my neighborhood is gentrifying, and thus my land would be essentially 100% of an appraised value if I sold (the house would definitely be scraped). I do not believe the ADU would add any appraised/perceived value to a prospective buyer (perhaps it would have negative value since it would need to be demo’d). Therefore I am looking at investment/building costs vs. net rental income over the next 10-20 years (my wife and I expect to continue living in our house that long). As you know a key to a DCF model is the appropriate discount rate – and this is where I’d like your thoughts: since the ADU will be attached to our primary residence and we will be actively managing it I’m thinking a discount rate of 4-5% is appropriate. However, I believe that investment real estate discount rates used are typically 7-12%. Do you have any thoughts or experience in this area? thanks!
Hi there. Thanks for reaching out. I honestly don’t have solid experience with DCF at this time. I really only do residential right now, and that’s just not something that happens during a typical residential appraisal. I suspect commercial appraiser colleagues would be more acquainted. Sorry I cannot offer much here. You are in a unique position. Technically a buyer might not pay any more if all structures are going to be demolished. Though what is it worth as a rental? If this is a cash cow for you, it could be a huge advantage personally.
Hi Ryan,
Terrific Column, especially for Sacramento in this growing time.
Currently I am in Escrow for an Residential Home w/ ADU and zoned/permitted appropriately. The County has Total Livable Area including the ADU, while the FHA appraisal came back applying a flat $20k to the space or $40/SF leaving the main house well over the comparable market prices in the area ($400/SF) using the main house alone.
Would you have any knowledge for how the ADU is appraised by FHA? So far I have no criteria for range of values, but this is an example of the low appraisal worth when it could rent for $1,000/month. Personally I don’t have a horse in the race beyond paying more out of pocket if seller price holds strong and/or appraisal value less than contracted value holds given that is undergoing review per request of seller. I just want to close the home as if it included ADU square footage I would be looking at $250/SF which is a steal for the neighborhood 2 miles from downtown Sac.
Thanks!
-Steve
Hi Steve. Thanks for reaching out. A couple things:
1) There is no specific way an appraiser has to value an accessory unit. There are no FHA specific standards either that force an appraiser into a box. Ultimately there are three approach to value and an appraiser has to figure out which one(s) to use. In other words, there is more than one way to skin a cat so to speak… When I say three, there is the cost approach, sales comparison approach, and income approach. I don’t have time to unpack each and discuss the pluses and minuses of each at the moment, though I will say I strongly prefer the sales comparison approach here for a number of reasons (this would be finding comps with ADUs).
No matter what the appraiser chooses to do, the value needs to be credible. So as long as the methodology leads to credible results, great. But sometimes what happens is we see a very minor adjustment that doesn’t make sense at all for the market. So when doing the math I think many owners are left puzzled how the adjustment could be that low. In fact, a neighbor just went through this. In his case the unit rents for $1,200 and pays for a very significant portion of his mortgage each month. The appraiser gave a modest $20K adjustment. When thinking about the income, my neighbor earns $14,400 after 12 months. I’m not saying his or yours is too low here, but I sympathize with what you are saying if market rent is that high.
The tricky part about ADUs is there isn’t much data out there. So it’s not easy to value. Bottom line. At the end of the day though it’s so important for the appraiser to find data and support the value he/she says exists. So if that’s $20K, show me comps that support that number. That’s the key. And if there is support, then so be it.
3) It’s important to recognize it’s prudent per ANSI standards for appraisers to not lump the two units together if they are indeed not attached. I just measured a house with this scenario. With the ADU the square footage is closer to 1500 but without it the house is only 1200 sq ft.
I realize Tax Records or even agents in MLS can lump everything together, but think about it this way. If we choose comps that lump everything together we haven’t really answered the question as to what a home with an accessory dwelling is worth. The only thing we’ve showed is what a larger-sized home is worth. In plain terms, if I only look at 1500 sq ft comps, I haven’t really proved what a 1200 sq ft home with an ADU is worth. Maybe it’s the same. But then again maybe it isn’t. Thus ideally we’d like to see similar-sized homes with ADUs. That tells us what the market is willing to pay as opposed to going the easy route of lumping everything together.
4) Be cautious about price per sq ft because there is very likely a huge price per sq ft range in the neighborhood depending on the size of the house. For instance, East Sac has a 300 to 600 psf range right now. Here’s a post I wrote about price per sq ft with a few absurd analogies (I think they’re fun though). I also have a video to explain how price per sq ft works too. I only mention this to hopefully provide some context. What have other similar properties sold for? That’s the real key. https://sacramentoappraisalblog.com/2019/06/04/photoshopping-price-per-sq-ft-in-real-estate/
I hope that helps.
How do you appraiser potential. I own a half-acre lot with a 2500 sq ft house and an 800 sq ft wood shop. Because of the new ADU laws in California, I have plenty of room for a mother-in-law home. Is there a way to value the potential of an ADU.
Hi Jim. Thanks for the question. I know you called me too. Let’s connect on the phone.