Understanding and appraising properties with accessory dwelling units

Martin John Brown and Taylor Watkins, September 2011.

Contact the authors at http://martinjohnbrown.net & http://watkinsandassociates.net.

EXECUTIVE SUMMARY
Few forms of housing have caused as much excitement among planners and social advocates, and as much consternation among appraisers and real estate professionals, as accessory dwelling units (ADUs) also known as granny flats, backyard cottages, carriage houses, and numerous other labels. ADUs are small, independent dwellings on the grounds of a single family home. They have promise for meeting social and environmental needs, flexibly housing families and providing legitimate rental units. However, appraisals and lending on properties with ADUs are complicated by misunderstanding of these dwellings, and varying policies among institutions. A house with an ADU offers a seeming contradiction to many parties in the lending process: a two-unit, income-producing property with single family zoning. Though permitted by local government, the guidelines of national loan repurchasers suggest such properties are illegal, and that the ADU may (and perhaps should) represent only incidental contributory value. Though the ability to produce rent is a crucial characteristic of a legitimate ADU, it rarely plays a part in appraisals. Valuations are usually based on the sales comparison approach to value, with irregular results due to lack of comparables and other factors.

Appraised values based on income vs. sale prices, for 14 Portland properties featuring ADUs. Each property is represented by a bar with three metrics of value.

An income-based approach to value is possible, and given its fundamental basis in market rents, might be more stable and rational than the sales comparison approach, which echoes and may reinforce boom and bust cycles. We created an income approach to valuing properties with ADUs, and applied it to 14 properties with permitted ADUs in Portland, Oregon, comparing the appraised values to actual sales prices for those properties. The income-based approach yielded valuations which were significantly higher than actual sales prices, by 7.2% or 9.8% on average, depending on the exact formula used. Viewed by income, ADUs contributed a substantial proportion of each propertys appraised value, a mean of 25% or 34%, depending on the formula. Appraised values were only slightly less variable than sales prices; the difference in variability was not significant. These results have several implications. Currently, owners in Portland might generate more value by holding and renting properties featuring ADUs than selling them. ADU advocates might lobby for loan programs recognizing the reality of legal ADUs, and oppose owner occupancy requirements in new ADU developments, to interest income investors in developing them. Appraisers requiring an alternative or counterpoint to the sales comparison approach for properties featuring ADUs could gain insight with the income approach. Developing credible and consistent valuations should help this promising form of microdevelopment reach its full potential. # # # This work was supported by The Appraisers Research Foundation. The full details are available in a technical paper currently submitted for publication. For more details or reprint permissions, please contact the authors.