A guesthouse is, to many of us, the ultimate dream-home wish list item: Instead of being jammed into a tiny bedroom, visitors get a whole house. That’s good for everyone—having a separate space can actually make your in-laws’ lengthy visits enjoyable (or at least tolerable). Plus, there’s the potential cash flow from renting it out.
But guesthouses (also known as “accessory dwelling units,” or ADUs) aren’t all money and in-law magic. Purchasing a property with an ADU can be a legal and financial nightmare if you’re not prepared.
“A guesthouse can be a great investment, but it can also be a foolish one if the homeowner does not understand all the pros and cons upfront,” says Ron Humes, a contractor and real estate agent.
Before falling in love with a home—and its cute guesthouse in the backyard—make sure you understand all the potential pitfalls. Here’s what to review.
1. Understand your tenancy options
A guesthouse probably seems like a built-in cash cow: You rent it out, you get money. Simple, right? But should you rent to short- or long-term tenants? And what about Airbnb? Each of these options has different financial implications—get yourself familiar before listing your house for rent.
“While renting [out] the guesthouse on a short-term basis, like Airbnb, may yield more money, it’s smart to compare the rates to the more traditional long-term tenants,” says real estate agent Beatrice de Jong.
The vacation rental game has complicated rules. (Here are more details about renting out your space on Airbnb.) You’ll need cleaners, furniture, photographers, and more—and that money adds up.
“Long-term tenants typically want to take care of their home,” de Jong says. “Ultimately, it is a more passive income.”
So while long-term rentals have their own onerous requirements, it might be simpler than dealing with a vacation rental.
2. Ensure the guesthouse is properly permitted
What a nice guesthouse you’ve got there! It would be a shame if you had to tear it down.
Before buying, make sure the builder pulled permits; an un-permitted structure could even prevent the sale from going through. Your insurance company might consider it a risk, or the appraiser won’t use the square footage to calculate value, and suddenly you’re back house hunting.
3. Understand your mortgage financing
Found the guesthouse of your dreams? Make sure your mortgage program permits purchasing a property with multiple residences.
“Conventional, FHA, VA, and private financing platforms often have different requirements, and may or may not allow the loan recipient to use their property for the desired purpose,” Humes says.
For instance, FHA loans will allow you to rent out your guesthouse—but you have to live in the other unit. And your lender might take potential rental income into account when determining how much you can borrow. Or, it might run its mortgage approval calculations assuming you won’t have any renters, leaving you with a higher payment.
4. Brush up on the rental market
Don’t do a quick search on Craigslist, find a similar space renting for $2,000, and assume that’s what you’ll earn each month. If you’re determined to be a landlord, make sure you fully understand the market.
Yes, you should start by looking at rental websites to see what other similar units are renting for in the area. But you’ll also want to get an idea of demand, says Oklahoma real estate agent Crys Keith. Are rentals sitting on the market for weeks or months? Or are they snapped up in seconds?
And don’t make the mistake of relying on rental income. Your guesthouse might sit empty for months on end, so ensure your savings can cushion the blow.
5. Get comfortable with communal living
When’s the last time you shared space? If you haven’t lived with a roommate since college, spend time considering your comfort zone. Will you be all right with renters lounging in the backyard when you want to stretch out in the hammock? What if they want to throw a party?
“Will you share a driveway?” Keith asks. “Will they be walking through your backyard to get to their door?”
If the thought makes your skin shiver, “there are many creative ways to build privacy to help everyone feel more comfortable,” she says.
Consider tall bushes, privacy fences, or gorgeous greenery to delineate your space from their space.
6. Examine the legal issues
OK, so the construction was properly permitted. But is the ADU allowed?
“Many counties and cities across the country are relaxing their regulations,” says Jeremy Browne, a Realtor located in the Washington, DC, area. But your jurisdiction might be a step behind the game. Check your county or city for restrictions.
“The last situation you want to be in is inheriting something that you can’t use, and it ends up being a problem,” Browne says.
7. Split your utilities (or don’t)
Depending on which company handles your utilities, you might be able to set up your guesthouse separately. That way, tenants can handle their own gas, electricity, internet, and trash.
If your utility company won’t subdivide bills for a single address, determine how much your bills will run to before you buy—and whether you’ll charge renters for utilities or shoulder the full financial burden.
Remember: You can’t assume the current homeowner’s usage accurately reflects your potential costs, since you don’t know if the homeowner is renting out the guesthouse or it’s sitting vacant.