Insight from the Appraisal Institute on Evaluating ADUs

The growing acceptance and adoption of ADUs has generated an important question: how can appraisers best approach the valuation of properties with these units? Vice President of the Appraisal Institute Sandra Adomatis addresses this question and proposes several solutions in this peer-reviewed white paper. We’ve broken down some of the key takeaways below - for more information, read the paper here.

What Appraisers Need to Know

ADUs aren’t new - and their extensive historical documentation can be important for appraisers to consider. Prior to the implementation of modern zoning in the United States, ADUs were extremely common. They have risen in popularity recently as a way for homeowners to meet community housing needs, create multigenerational households, and provide more rental housing.

One of the most significant hindrances in the ADU evaluation process is the wide variation of key data. Federal Government agencies define “ADU” differently, local zoning records don’t always properly identify ADUs and often multiple listing services (MLSs) aren’t yet applying consistent standards. In order to properly evaluate ADUs, appraisers need to stay ahead of these issues by understanding the changes in local zoning codes, agency definitions, and seek out any education and training that can help them properly assess properties with ADUs. 

It is also essential that appraisers gain an understanding of the ways in which ADUs can impact local housing markets and property values. ADUs can have incredibly positive impacts on property value - rental income being one of the most significant. Even though different markets have different experiences with ADUs, they are climate-friendly, can be designed to fit in with the surrounding architecture and structures, provide flexibility as homeowner needs shift over time, and lessen urban sprawl - all things that can affect property values now and in the future.

Evaluation Approaches

Sales Comparison Approach

In a sales comparison approach to value, the appraiser will use local sale price data to compare the value of similar properties. This method is tricky for properties with ADUs, since the data may not be as easy to find if the property is in an area where ADUs haven’t been adopted, or coded properly in local MLS listings. Depending on what’s out there, appraisers can consider using expired or withdrawn listings as evidence to build a logical case for the property’s value. This is the method most often required as the primary appraisal method by federal agencies, but it can be supported with other methods.

Income Capitalization Approach

Income capitalization is most useful in determining the value of an ADU that the homeowner intends to use as a rental - with some caveats. Appraisers analyze market rents to determine the appropriate rent for the unit, and then develop a gross rent multiplier (GRM) by finding comparable sales and dividing the sale price by the monthly rent. Adomatis cautions appraisers against multiplying a market-extracted GRM by a market-extracted rental rate when evaluating an ADU, however. GRMs include rent that is attributed to the land the property is on, but this number is already factored into the value of the primary dwelling, not the ADU. This means that ADUs tend to get overvalued. The ideal solution would be for the appraiser to base their income capitalization calculation on similar sales when ADUs and primary dwellings are both rented out. 

The GSE’s have taken first steps into recognizing ADU rental income, with Freddie Mac and Fannie Mae now allowing project rental income in the calculation for properties that have existing ADUs. Speculative income for a proposed ADU isn’t yet accepted. However, in qualifying buyers for loans, some portfolio lenders (credit unions, CDFI’s) do consider projected rental income for ADUs that haven’t been built.

Cost Approach

A cost approach can provide important supplementary information to a sales comparison approach to evaluation. Since a cost approach takes into account the sum of the estimate land value plus the depreciated cost of the building and other improvements, it allows appraisers to factor in things like building permit costs, ADU impact fees, cost to comply with ADU-specific building ordinances, and the fact that certain units may cost more to construct. Fannie Mae guidelines do not allow a cost approach as the primary or sole basis for a property valuation.

The ideal ADU valuation will come from an appraiser who understands their local zoning history and code updates, has a strong sense of the keywords to use when searching for data on ADUs, and knows how to construct a valuation using the appropriate methods that makes a logical case for the property’s value. Adomatis believes that appraisers who take the time to learn how to properly evaluate ADUs will be in high demand as the ADU industry grows.