How to Measure ADU Rental Income Potential

Building an accessory dwelling unit (ADU) to rent out can be a wise move. It lets you earn extra monthly income now while growing in value over time. And recent changes to ADU regulations in California make it easier than ever to build an ADU.

ADU as rental unit: a case study

 

When you build with Villa, the pricing is all-inclusive and the timeline is predictable, so it’s easy for you to assess your payback period. Our ADUs start at $199,000, and there are 10 customizable designs to choose from.

Here’s a case study with calculations that focuses on an investor building two 2-bedroom units in Hayward, California. You can swap in your own numbers to measure the rental income potential of any ADU project.

1. Project cost: $400,000

Total price for 2 two-bedroom units, including permits and installation:

2 units @ $200,000 each = $400,000

2. Projected rental income: $55,200/year

Average rental income for two-bedroom home in Hayward: $2,300/month.

2 units x $2,300/ month = $55,200/year

3. Operating expense: $8,200/year

Property tax: About 1.2% of the cost of the ADU project.
1.2% x $400,000 = $4,800

Property insurance for ADU:

$1,000/year increase in premium for dwelling extension coverage.
Or you might have a separate rental dwelling policy. Estimated cost: $300–$600/year for $100,000– $300,000 worth of coverage

Miscellaneous: Landscaping, carpet cleaning, and other services. Estimate: $200/month

4. Gross revenue multiplier (GRM): 7.25

Initial cost divided by gross income: $400,000 ÷ $55,200 = 7.25 GRM

The average GRM in the Bay Area is 15–20, making the ADU an excellent value.

5. Capitalization rate: 12%

Gross income minus operating expense yields net operating income (NOI): $55,200 – $8,200 = $47,000 NOI

NOI divided by total project expense yields cap rate: $47,000 ÷ $400,000 = 11.8% cap rate

For reference, the median cap rate in the Bay Area is 4.6%.

6. Immediate return: $2,610/month

The monthly cash flow is gross monthly income minus all expenses. This investor made a $100,000 down payment and got a 30-year fixed-rate 3.8% mortgage.

Mortgage: $1,400/month
Rental income: $4,600/month

Vacancy (5%) and operating expense: $600/month
$4,600 – $2,083 = $2,517/month; $30,200/year

7. Cash on Cash (CoC)

$30,200 (annual cash flow) ÷ $100,000 (cash down payment) = 30% CoC

For reference, a minimum of 8–12% is considered a worthwhile CoC.

8. Payback period: 8.5 years

$400,000 (project cost) ÷ $47,000 (NOI) = 8.5 years

Thanks to the expedited building timeline for our prefab homes, which are built offsite and installed on your property in just a few weeks, you can start collecting rental income far faster than if you went with stick-build construction. With the weather, noise, and mess to consider, manufactured housing is a less intrusive and more efficient option than traditional custom homes.

Something else to keep in mind: The new owner-occupancy regulations will be up for review in 2025. Consider building now to have your ADU grandfathered into these regulations for the long haul.

Want to know if one of our ADUs is right for your property? Take this quick assessment and we’ll let you know shortly.

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