Backyard Box Blog
May 11, 2010
Backyard Cottage ROI
Posted by Sloan, 3:15 pm
OK, lets do the math here to see the mechanics of this as an investment. You are thinking about a backyard cottage, now that the city has legalized that in its single family zones, which affects roughly 100,000 Seattle homes. Considering that it might cost somewhere in the ballpark of $100,000 to build a backyard cottage in Seattle (and to keep the math simple we’ll use round numbers like this), it has to make some financial sense unless you’re loaded and that’s just spending cash. Even if you’re loaded, you’ll still probably want to know how this works as an investment.
One way to look at it is using a traditional investment property valuation method such as Cap Rate to determine value. I won’t get too deep into this so as not to bore anyone but the result is: assuming a 6% cap, rental income of $1000/month, $600/yr in expenses yields a value of $190,000. If you don’t like the 6% cap, plug in other numbers – 8% yields roughly $140K. At $800/month rental income the value is ~ $150K. That’s the cap rate valuation method.
Another method is simple payback. Say it costs $100,000. Say you rent it for $1200 a month (it is a completely separate house afterall) and net $13,000/year, you will own it free and clear in year 8 and every month thereafter is $1200 more dollars in your pocket. If you happen to live in a great neighborhood maybe the rent is $1400 or $1600 so the payback is faster. If the rent is less, the payback takes longer. Essentially it’s a leverage of your land value (location, location, location).
Another possible factor is if you can have a family member stay in the backyard cottage instead of having to pay for assisted living facilities which are easily into the $3000 and $4000 a month range. If a backyard cottage would provide that family member the ability to live independently but still have someone nearby to help, the payback goes from 8 years to two or three.
A final way to look at it might be the bank financing perspective. Lenders typically amortize real estate over 30 years, so in our $100,000 case, if you were to take out a home equity line of credit in that amount, at 6% interest, your payment would be about $600 a month. With rents at $1000 a month, you either cash flow the investment immediately, or pay it off more quickly.
