4 Reasons for Investors to Add an Accessory Dwelling Unit

Today, it’s imperative to get creative with portfolio additions. Perhaps adding an accessory dwelling unit to the single-family dwellings in your portfolio is the right move for you. An accessory dwelling unit, ADU for short, is a secondary dwelling unit with a kitchen, bathroom, sleeping, and living space on the same tax lot as a primary residential dwelling. The ADU can be detached, above a garage, attached, or within the primary unit. Basement and garage conversions are great examples of bonus spaces that can instead be converted into income-generating ADUs.   Cities all over the country are experiencing a shortage of housing, driving up housing costs for both the rental and ownership markets. Cities rely on property owners and developers to develop the much-needed infill housing. Many cities, especially on the west coast, are reducing barriers to develop ADUs, creating new opportunities for investors that own single family homes and duplexes, to build them.   For investors who prefer the long game, ADUs have an excellent track record of providing reliable income and lifestyle flexibility. Here are four reasons why.  1. Versatility Very few homes have the versatility of an ADU. Unlike primary homes that are typically 3-4 bedrooms, ADUs are typically studio or 1-bedroom units. This is attractive to 1-2 person households who wish to live in residential neighborhoods rather than a commercial apartment complex.  Multigenerational household living is on the rise in both the rental and ownership markets due to housing costs. The need for adaptable 1-story infill housing units that works for different age demographics, has never been more evident.   An ADU can provide for common household needs, such as guest quarters, home office, housing for in-laws or friends in transition, or possibly as a short-term rental. Many small-scale investors start out by adding an ADU to their primary residence and renting it out.  Financially savvier even still, an investor may move into the ADU and rent out the primary residence, potentially covering the full cost of the mortgage for the property. This particular “house hack” is a life-changing financial move for many young property owners, setting them on the course of financial freedom and the wealth production that can come with property ownership.  2. Increased property value Building an ADU is no small task. Design, permitting, and construction costs add up. However, over time, the ADU will pay for itself, some in as little as 3-5 years, depending on the type of ADU that is developed.   ADUs have more advantages than disadvantages once they’re built and performing, especially in urban infill neighborhoods, where walkability to amenities is plentiful, and renters typically pay higher rents. ADUs tend to make the most financial sense to develop on more expensive infill properties where the land values are highest since they are being developed on ‘free dirt’ you already own. Other rental housing development requires land acquisition, and that dirt is typically the most expensive part of housing development.  Consistent rental income, and two livable units are a great combination for buyers, and they are willing to pay higher prices for a home that can meet various lifestyle needs over the course of ownership. Hiring a real estate agent that understands the value of ADUs is crucial, more and more real estate agents are tuning in to the ADU trend and stand ready to help. https://www.aduspecialist.org/registry

3. More affordable than buying a new rental property Building an ADU can be an excellent alternative to purchasing another investment property, particularly in high-priced markets where a deal is hard to find. While a newly built ADU can cost upwards of $300k in some markets, a duplex in the same market might start in the $700k’s and require 20% down to purchase. The rents in the duplex may not be at market rate and legislation may impact the rate in which those rates can be increased. A newly developed unit on a property already in a portfolio can fetch market rate upon completion, a strong case for building new.   Living in the ADU and renting out the primary dwelling offers the opportunity to to receive a higher monthly rent, creating a pathway to paying down mortgage and construction costs at a faster rate. If the jurisdiction allows for both the ADU and the primary dwelling to be rented out, as is the case on the west coast, the return on investment is likely to be high.  4. Making an impact Rental portfolios have social and environmental impacts.  In its Making Room: Housing for a Changing America exhibit, AARP illustrated the type of housing that currently exists compared to the household sizes that are most common in the United States. There is a great disparity between the number of smaller households and the appropriate size homes. Cities desperately need more ‘right-sized’ housing units to serve smaller households, and investors have an opportunity to create housing that is in high demand with a strong tenant base. Building an ADU can also provide jobs and support the local economy. Hiring local architects, designers, builders, and tradespeople supports the local economy with jobs and housing.   Care to make an ecological impact?  Residential buildings comprise 22% of the greenhouse gas emissions in the United States.  An 800 sq ft ADU built to basic code uses less energy than a 2,200 sq ft high performance house, due to the reduced heating and cooling loads. Building small saves occupants money in utility bills, making the dwelling more resilient and reliable. Smaller dwellings, and especially internal conversions, use fewer material resources and can rely on the original dwelling to provide part of or all of the building envelope, one of the most resource intensive aspects of a new build.  

REIT Real Estate Investment Trust Explained

REITs historically have provided investors of all types regular income streams, diversification and long-term capital appreciation.

REITs, or Real Estate Investment Trusts, are companies that own or finance income-producing real estate in a range of property sectors.

These companies have to meet a number of requirements to qualify as REITs.

Most REITs trade on major stock exchanges, and they offer a number of benefits to investors.

A REIT is a company that owns, operates or finances income-producing real estate.

REITs historically have delivered competitive total returns, based on high, steady dividend income and long-term capital appreciation.

Their comparatively low correlation with other assets also makes them an excellent portfolio diversifier that can help reduce overall portfolio risk and increase returns.

Modeled after mutual funds REITs provide all investors the chance to own valuable real estate, present the opportunity to access dividend-based income and total returns, and help communities grow, thrive and revitalize.

Types of REIT’s

Equity REITs

A company that owns or operates income-producing real estate

Mortgage REITs (MREITs)

Provide financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities and earning income from the interest on these investments.

Public Non Listed REITs

PNLRs are registered with the SEC but do not trade on national stock exchanges.

Private REITs

Offers that are exempt from SEC registration and whose shares do not trade on national stock exchanges.

REITs must pay out at least 90 percent of their taxable income to shareholders and most pay out 100 percent.

REIT owned real estate, located in every state, is an important part of the U.S. economy and local communities.

What interest rate hikes mean for multifamily property investors

As the Fed continues to ramp up interest rates, find out how increases could impact real estate investors.

Inflation—and rising interest rates—are at the center of the American economic conversation. And for good reason. In 2022, the Federal Open Market Committee (FOMC) raised rates by 75 bp four consecutive times between June and November.

In December 2022, the Fed raised rates by 50 basis points, bringing the target federal funds range to 4.25% to 4.50%.

While inflation has slowed in recent months, it remains near 40-year highs. Combined with historically tight labor markets that are driving higher wages, “we’re in uncharted territory,” said Ginger Chambless, Head of Research for Commercial Banking at JPMorgan Chase. “As a result, the Fed is currently tightening monetary policy as rapidly as ever.”

Rate hikes may not impact all financing structures

Interest rate hikes may impact short-term and adjustable rate loans more than long-term, fixed-rate ones.

“The Fed’s actions on short-term rates don’t directly translate to a like effect on fixed rates underlying commercial real estate mortgages. After any Fed rate hike, it’s possible that fixed rates might rise or fall depending on circumstances,” said Mike Kraft, Commercial Real Estate Treasurer for Commercial Banking at JPMorgan Chase.

For investors with fixed-rate loans, you may also want to keep an eye on the Treasury yields, which help determine mortgage rates. The Treasury yield is viewed as a sign of investor sentiment about the economy. Yields are driven by the market and aren’t directly under the Fed’s control. “Treasury yields depend on long-term inflationary expectations, on the market’s assessment as to whether an economic downturn is impending,” Kraft said.

As of December 2022, yields are near the low end of that range. “While they will certainly continue to move about, they are not likely to take off in the immediate future,” he said.

What interest-rate hikes mean for multifamily investors

“As one of the most sensitive sectors in the economy to changes in interest rates, housing activity has weakened significantly in the last few quarters of 2022,” Chambless wrote in her 2023 Outlook. “However, demand for multifamily housing has held up amid tight single-family home supply and affordability challenges, with multifamily housing starts still close to the highs of the cycle.”

The Fed anticipates more increases in early 2023. While multifamily property owners and investors may feel the negative effects of rising interest rates, there may also be some offsets.

Higher interest rates could price would-be homebuyers out of the single-family housing market, causing them to remain renters for longer. Inflation, along with rising costs and construction delays may increase existing properties’ rents. 

Multifamily property owners and investors with fortress balance sheets in particular can benefit from the current economic environment, offering an opportunity to grow their portfolio at a lower cost.

Looking beyond interest rates

For those looking to purchase a multifamily property or refinance their apartment complex, there’s more to look at than interest rates. Consider other factors, including:

Supply, demand and demographic shifts: The housing inventory—especially affordable housing—is low, with demand outpacing supply. Likewise, more people have moved to the center of the country and are seeking workforce housing. Investors may also want to weigh the merit of a shift from suburbs to cities.

Local market: Real estate is a largely local business, so investors may want to take a close look at the specifics of the market before purchasing or refinancing. It’s also important to evaluate each property individually, including its capitalization rate, which generally goes up when interest rates increase.

What’s next for interest rates, inflation and the economy

“While inflation is likely to remain somewhat elevated through the end of 2023, we see signs that a moderation is already underway and that this cooling will become more prominent over time,” Chambless said.

Interest rate fluctuations could correspond. “The Fed’s own projections indicate that the target would top out at 5.25% by the end of 2023,” Kraft said. “Markets have treated this forecast with skepticism, with futures implying a maximum 5.00% target by May. Shortly after that, markets imply a ‘pivot’ by year end—at some point, the Fed could begin easing to accommodate a possible economic downturn. The Fed itself doesn’t project such a pivot, maintaining that it will be necessary to hold rates at a higher level for a while to bring inflation in check.”

Unexpected national and international geopolitical uncertainties may continually arise, resulting in market volatility and interest rate fluctuations.

Source https://www.jpmorgan.com/commercial-banking/insights/rising-interest-rates-effect-on-commercial-real-estate