Unlike most other forms of development, ADUs must be financed by an existing property owner. There are currently no mechanisms that would allow a developer, for example, to build ADUs in someone’s backyard and then sell or rent them for profit as they would not own the land the ADU was built on. This leads to the question, can the “average homeowner” afford to build an ADU? One of the biggest barriers is getting financing, and there are two primary thresholds a homeowner needs to reach.
First is whether they have sufficient equity or cash on hand to build an ADU. A property owner will need to refinance their existing property to pay the $150,000+ construction cost of the ADU. An important point is that most financial institutions will only allow up to 80% of a property value to be financed without additional risk. So, a $500,000 home only has $400,000 of equity that can be normally tapped into.
The recent housing appreciation that has helped to create the affordability crisis in Canada does assist in creating potential equity, but market price that someone would pay and appraised price that a bank will assess your property at are different. Homeowners with more than 5 years or more of mortgage payments are in a much better position to have sufficient equity while newer homeowners are much less likely to have earned sufficient equity. Across our existing processed cities, we estimate approximately $138,000 in average equity is available – this amount is generally less than our surveyed construction costs across Canada.
Assuming there is enough equity or other cash/financing options to access, the second threshold is whether or not the household can bear the carrying cost of repayment. For this, we utilized median after-tax household income. This can be supplemented by planned rental income, with most financial institutions allowing you to assume 80% of the annual rental amount towards your income threshold. This income amount is held up against a 42% debt servicing level. The level determines what income would be required for annual debt amounts (both mortgage and non-mortgage) to not exceed 42% of total income. If this threshold is not met, property owners would potentially be considered a high risk customer which could impact approval or interest payments. Based on our modeling, we see the debt servicing level exceeding the income by approximately $15,000 across Canada.
This modeling is highly sensitive to interest rates and other debt levels but does give insights to the financial barriers that may be needed to encourage ADU development. Our Resource Centre highlights some financial incentives that are available from municipalities to support the development of ADUs.
Fundamentally, the question of whether or not an ADU is affordable to build is a personal one. If a property owner is willing to charge higher rents approaching or above market rates to generate additional income, they can ensure a favourable debt-servicing level, albeit at the cost of possibly making the unit unaffordable to most renters. Generally speaking, an average homeowner probably can easily afford to build a new ADU on a whim. However, for others, time, planning, and potentially saving (or paying off other debt) may be needed before they can undertake this process.
The full report on homeowner financial modeling and data can be found on our Data Exports page.
