Financial Analysis of Property with ADU and Rental Income

Introduction
Key Inputs and Assumptions
Revenue and Cash Flow Analysis
Valuation Approaches
- Market-Based Valuation
- Income-Based Valuation
Cost Breakdown
Insights and Recommendations

1. Introduction

This analysis evaluates the financial potential of a property with an existing home and a planned Accessory Dwelling Unit (ADU). The property generates rental income from both units and benefits from increased equity due to repairs and the addition of the ADU. Key metrics include total costs, market-based valuation, income-based valuation, and net equity gain.

2. Key Inputs and Assumptions

Metric	Value ($)
Purchase Price	305,000
Repair Costs	40,000
ADU Construction Costs	125,000
Debt Servicing Costs (6–8 mo)	8,000
Mortgage Financing Costs	6,000
ADU Financing Costs	3,750
Main House Monthly Rent	2,200
ADU Monthly Rent	1,600
Operating Expense Discount	20%
Capitalization Rate (Cap Rate)	5.5%

3. Revenue and Cash Flow Analysis

Rental Income Calculation

Main House Annual Rent: $$ 2,200 \times 12 = 26,400 $$
ADU Annual Rent: $$ 1,600 \times 12 = 19,200 $$
Total Annual Rental Income:
$$ 26,400 + 19,200 = 45,600 $$

Operating Expenses (20%)

$$ 45,600 \times 0.20 = 9,120 $$

Net Operating Income (NOI)

$$ 45,600 - 9,120 = 36,480 $$

4. Valuation Approaches

Market-Based Valuation

After Repair Value (ARV): $420,000
ADU Value Increase: $175,000
Total Market-Based Value:
$$ 420,000 + 175,000 = 595,000 $$

Income-Based Valuation

Using the formula:
$$ \text{Property Value} = \frac{\text{NOI}}{\text{Cap Rate}} $$
$$ \text{Property Value} = \frac{36,480}{0.055} = 663,273 $$

5. Cost Breakdown

Category	Amount ($)
Purchase Price	305,000
Repair Costs	40,000
ADU Construction Costs	125,000
Debt Servicing Costs	8,000
Mortgage Financing Costs	6,000
ADU Financing Costs	3,750
Total Costs	487,750

6. Insights and Recommendations

Key Insights:

Market-Based Valuation:
- The property is valued at $595,000 based on comparable sales and the added value of the ADU.
Income-Based Valuation:
- Using a conservative cap rate of 5.5%, the income-based valuation is $663,273.
Net Equity Potential:
- Total Costs: $487,750
- Income-Based Value: $663,273
- Net Equity Gain: $$663,273 - 487,750 = \mathbf{175,523}$$

Recommendations:

The addition of the ADU significantly increases both market value and rental income potential.
The income-based valuation exceeds market-based estimates by approximately $68,273 due to strong rental cash flow.
This property is an excellent investment opportunity in a high-demand rental market with a clear path to profitability.

Summary Table

Metric	Amount ($)
Total Costs	487,750
Market-Based Property Value	595,000
Income-Based Property Value	663,273
Net Equity Gain	175,523

This analysis highlights the financial benefits of adding an ADU to a property while leveraging rental income to maximize equity growth and long-term value creation.