Does building a granny flat make investment sense?
It’s now easier to build a granny flat, with some councils allowing these structures to be built on the back of suburban homes and many builders are promoting this concept as a good investment.
Recently a client asked whether he should buy a property and build a granny flat to increase his cash flow.
Obviously they're popular.
According to reports, the number of granny flats being approved and built in New South Wales is at an all time high.
With nearly 5000 granny flats being built a year, that’s an increase of more than 260% between 2009 and 2014.
Nearly double the 2,867 built in 2013 and three times more than the 1,500 which were built in 2010.
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.
But does their increasing popularity make them a good investment?
I could have given our client a simple answer:
Granny Flats are investments in inferior locations, chosen by poorly informed investors which add little value and attract bad tenants.
Instead I gave him the pros and cons:
The 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
- Increasing the value of your property – 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
- Spreading 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
- Suits 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.
The Risks when building a Granny Flat
1. 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.
2. Not all councils allow granny flats
While it’s easier to get council approval to build a granny flat nowadays, make sure you cross all you 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.
3. In general those councils that allow granny flats are not in high capital growth areas
Often you’ll have to use this strategy in outer and lower socio economic areas – locations that you’ll find tend to deliver below average capital growth.
4. The cost of constructing the granny flat doesn’t always add sufficient value to the property
Often you’ll spend $100- $120,000 on the granny flat but the banks will only increase the value of your property by $70-$80,000.
In other words you’re overcapitalising.
5. You’ll reduce your resale and rental market potential
This is because the end product has a small market with minimal demand from owner-occupiers and tenants.
Most owner-occupiers are not keen to have a granny flat in their backyard, preferring all the accommodation under the main roof.
Your property will mainly appeal to investors.
And most tenants don't want another tenant in their back yard or the noise and nuisance of an adjoining property.
6. 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.
7. You won’t be able to subdivide your property into two titles.
While you may increase your rent and turn your property investment from negatively geared to giving some positive cash flow, for mine if you’ve got $100,000 or so to spend on a granny flat you could generate a much better return by putting it towards an “investment grade” property.