Building a granny flat out the back of your property has fast become a popular way to increase your living space or even earn some extra rental income, but does it make good investment sense?
According to reports, the number of granny flats being approved and built in NSW is at an all-time high.
The construction of a house or apartment attached to a house (a “granny flat”) has skyrocketed from 4,729 granny flats in 2016 to 21,342 in 2021.
The rise in popularity of granny flats across Australia can be attributed in part due to state-level legislative changes regarding secondary dwellings which aim to boost housing affordability in capital city areas and each state or territory provides their own legislative requirements, including the land and plot sizes of a secondary dwelling or granny flat.
Sure, granny flats are popular, but are they a good idea from an investment perspective?
In short, no.
Let me explain, but first, let's look at the list of pros and cons so you can see for yourself how the risks outweigh the benefits.
5 benefits of building a Granny Flat
Extra rental income
Putting a granny flat in your backyard or at the back of your investment property can be another source of income.
Depreciation
Renting out a granny flat gives you extra claimables on your depreciation schedule.
It may increase the value of your property
Note that while building a granny flat may increase the value of your property, you’ll probably find that it won’t increase it as much as the cost of construction.
It helps to spread your income risk
If you just have one investment property and it is vacant then you have no money coming in, however, with a granny flat, it is unlikely both properties will be vacant at the same time.
It may suit your family’s needs
Building a granny flat at the back of your home may be suitable accommodation for your teenage children, your granny, or even your mother-in-law.
7 cons of building a Granny Flat
It could cost more than you expect
Just like any renovation or construction project, there are likely to be cost overruns when building your granny flat.
Not all councils allow granny flats
While it’s easier to get council approval to build a granny flat right now, make sure you cross all your i’s and dot all your t’s.
Check things like the size of the block required, access needed, and how close it can be built to a fence.
Granny flats are generally not built, or permitted, in high-capital growth areas
The cost of constructing the granny flat doesn’t always add sufficient value to the property
Often you’ll spend $100,000-$120,000 on the build but the banks will only increase the value of your property by $70,000-$80,000.
In other words, you’re overcapitalising.
You’ll reduce your resale and rental market potential
There will be less demand for a property with a granny flat in the backyard.
You’ll experience longer vacancy periods
Your pool of tenants will be restricted for both properties, so you’ll have less choice in your selection, experience longer vacancy periods and it’s likely you will have to deal with two sets of lower socio-economic tenants instead of one average socio-economic family.
You won’t be able to subdivide your property into two titles
Does a granny flat make good investment sense?
As I said above, no, in almost every case building a granny flat does not make good investment sense.
Investors might be tempted to buy an old house on a decent block and build a granny flat in the backyard to increase their rental yield.
And at face value, it seems like a great idea.
But as you can see by the list of pros and cons, the cost of building a granny flat is usually more than the potential capital gain.
Not only that, even if you do manage to build to your budget, while the income from rent provides cash flow, it doesn’t build wealth.
And wealth building is the ultimate goal of property investment.
Let’s not forget that granny flats are generally investments in inferior locations, chosen by poorly informed investors which add little value and attract bad tenants.
Plus, not to mention the fact that you need to pay tax on a rental income.
Granny flats can actually reduce a property’s value
The goal of property investment is capital growth.
Capital growth and the secret to capital growth is buying an asset that there will be a surplus of demand for when it comes time to sell.
Rental yield does not add value to a residential property.
That means that if you buy an old house on a big block and then build a granny flat which takes over a significant portion of the backyard, it will only reduce the property’s value when it comes time to sell.
As some explain it, you end up adding something onto a property which devalues the overall asset.
And it’ll cost you a fortune to build and run in the meantime, possibly even more than you’d planned or budgeted for.
This is because the end product that you’ve created has a small market with minimal demand from owner-occupiers and tenants.
Homeowners want space and land, especially in the wake of COVID when many Australians reevaluated what they want in a home, they don’t want a property with an additional self-contained property taking up their backyard.
Both owner-occupiers and tenants want their entire property under one roof.
Let's also not forget that granny flats are generally not permitted, or built, in high capital growth areas so if this is the strategy you want to use, you’ll be confined to outer and lower socioeconomic areas which tend to deliver below-average capital growth.
And these aren’t the areas which make good investment sense either.
Investment grade needs to be the focus
Investment-grade property in A-grade locations needs to be the focus for any property investor.
Because by now you know that the location of your property will do around 80% of the heavy lifting of its capital growth.
There are many factors to take into account when looking for your next investment property, but if you do your research to find one which ticks boxes such as good demographics, employment opportunities, walkability, local infrastructure and amenities, and a low crime rate you can be confident you’re making a good investment decision.
Not only that, but once you’ve found a great investment-grade location, you’ve then got to find an investment-grade property within that area.
In my mind, less than 4% of the properties on the market currently are what I call “investment grade.”
Investment-grade properties appeal to a wide range of affluent owner-occupiers, are in the right location, have street appeal as well as a favourable aspect or good views, offer security and secure off-street parking, have the potential to add value, and have a high land-to-asset ratio.
In summary
While you may increase your rent and turn your property investment from negatively geared to creating some positive cash flow, building a granny flat does not make good investment sense.
No matter how much money you can budget to put towards a granny flat, that money would generally give a much better return by putting it towards an investment-grade property instead.
