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If you’re looking for a way to create some passive income, look no farther than your own garage. You may be able to convert it into an accessory dwelling unit (ADU) that you can rent out.

That’s what Amy O’Dorisio did. In 2019, the real-estate agent with Coldwell Banker West in San Diego spent $130,000 to convert a detached one-car garage on the property of a two-bedroom investment property to create an additional rental unit. Due to the strong demand for affordable rentals in her market, especially among older adults seeking single-story living, Ms. O’Dorisio, now 40, has an income stream of $2,000 per month from the one-bedroom, one-bath ADU.

“The tenant is a woman in her late 60s, and that’s part of the reason why I decided to do this," said Ms. O’Dorisio. “I knew there was an aging baby-boomer population in San Diego."

Ms. O’Dorisio’s venture was so successful that she’s now planning to build an ADU at another property she owns by adding a second story to an existing garage.

According to a national study released by Freddie Mac last year, ADUs are growing in popularity. Nearly 70,000 properties with ADUs were sold in 2019, the latest year for which statistics are available, representing 4.2% of the total homes sold via the MLS, compared with just 8,000 properties with ADUs, or 1.1%, in 2000. Similarly, 8,000 ADU rentals were leased in 2019, compared with less than 1,000 in 2000. Freddie Mac found that demand for ADUs is highest in regions of the country experiencing rapid growth, such as California, Florida, Texas and Georgia.

Although easy to build, ADUs, including that in-law apartment some people put above their garages, must comply with all local zoning requirements and all necessary permits must be obtained. Failure to do so may create an illegal rental. “In some jurisdictions, the consequences of that may be that the tenant must be evicted," said Ben Metcalf, managing director of the Terner Center for Housing Innovation at the University of California, Berkeley. It may, he said, also prevent the home from being legally sold.

Your insurance needs may change due to the creation of a detached ADU on your property. A normal homeowners policy automatically includes an additional 10% of the dwelling coverage limit for other structures on the property, according to Spencer Houldin, president of Ericson Insurance Services in Washington, Conn. But often if the other structure is rented or used for business, the owner will have to pay additional for coverage of the outbuilding.

Despite the costs, ADUs bring other benefits in addition to rental income.

“It’s an investment," said Elizabeth Gomez, co-owner of Bridge City Contracting, a remodeling firm based in Vancouver, Wash., that builds ADUs. “When you sell a home with an ADU, you have stronger resale value because these homes are in very high demand right now."

There can be roadblocks. An existing garage may not be structurally sound enough to support an ADU. Some zoning ordinances allow only a kitchenette in an ADU, not a complete kitchen with a stove. If your home has a septic system, its capacity might limit your ability to create an ADU, or require you to build a separate septic system for it. Lastly, neighbors might object to your plans due to parking or density concerns.

Here are some things to consider if you’re planning to convert your garage to an ADU.

Check your zoning carefully. State, county and local zoning laws that govern the size and design of ADUs vary widely and they change frequently. Some jurisdictions prohibit short-term rentals, so if you plan to use your converted garage as such, you might be in for a rude awakening.

Hire professionals with ADU experience. If you don’t have the time or patience to learn about ADUs yourself, consult with an architect and contractor, or a design/build firm that has specific experience creating ADUs. “The ADU process is complicated and involves understanding how to work with architects and contractors, navigating city processes and doing leasing and tenanting," said Mr. Metcalf. Those unfamiliar with ADUs can take advantage of resources such as the Casita Coalition, a California-based organization that provides information on permitting, floor plans, construction, financing and more.

Prepare for being a landlord. Consult an attorney or real-estate agent who is familiar with landlord/tenant laws in your area. Remember that ADU landlords may share property with tenants. Consider erecting a fence or other barrier to create private yards for both you and your tenant. “Not everyone likes to share their personal space with a stranger, or even an extended family member," said Xio Sandoval, a real-estate agent with Century 21 Realty Masters in Montebello, Calif., who said 70% of her business involves representing home buyers who plan to add ADUs. “If you know you cannot give up the luxury of having your own space, then it’s not for you. Once it’s done, you can’t undo it."

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