Backyard Studio vs Granny Flat – Which Is the Better Investment?

If you're looking at your backyard and seeing untapped potential, you're not alone.

Across Australia, homeowners are transforming unused spaces into valuable assets that boost both their property value and income potential. The big question is: should you build a backyard studio or invest in a granny flat?

The choice between these two options can significantly impact your financial returns, rental income potential, and long-term property value.

Let's break down everything you need to know to make the smartest investment decision for your situation.

What are the key differences?

Before diving into the investment potential, it's crucial to understand what sets these two options apart.

What Makes a Granny Flat Special

A granny flat can have a maximum living space of 60 m², while a studio is limited to 36 m². More importantly, granny flats are self-contained dwellings with full amenities. This means they include a bedroom, kitchen, bathroom, laundry facilities, and their own entrance. They're designed for independent living and can legally house tenants.

The beauty of a granny flat lies in its versatility. You can rent it out for substantial income, house elderly family members, provide accommodation for adult children, or even move in yourself while renting out your main home.

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Backyard Studios: The Flexible Alternative?

Backyard studios, on the other hand, are typically non-habitable structures. While they can be incredibly useful as home offices, art studios, or entertainment spaces, generally speaking, as a studio is a non-inhabitable dwelling, it can not be rented out.

However, some councils may allow you to rent out your studio to someone who works from home, as long as they are not running a business.

This limitation significantly impacts their investment potential compared to granny flats.

The Investment Case for Granny Flats

When it comes to pure investment returns, granny flats emerge as the clear winner. The numbers speak for themselves.

Impressive Rental Yields

Granny flats offer rental yields often exceeding 7%, they provide a faster return on investment than standard rental properties. Plus, recent government incentives and tax benefits make them even more appealing. In some cases, granny flats offer rental yields as high as 12%.

To put this in perspective, as a general rule, rent percentages of 4 - 5% and above are currently considered to be good yields in Australia. This means granny flats are delivering well above what's considered a solid return.

Strong Rental Income Potential

The rental income from granny flats can be substantial. In high-demand areas, a granny flat can generate between $200 – $600 per week in rental income. NSW property owners smile to the bank with weekly rentals of $570-$1,300.

Significant Property Value Increases

Perhaps most impressively, a granny flat can boost property value by up to 30%, making your home more attractive to buyers. CoreLogic found that the rental yield on a property with a granny flat was 27% higher than on a property without one.

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Investment Considerations for Studios

While studios have their place, their investment potential is more limited. They work well for personal use – perhaps as a home office that adds value to your work-from-home setup, or as an entertainment space that enhances your lifestyle.

However, a backyard cabin can be a good investment, as it can be used for several different things, including art studios, cooking rooms, or pool houses. The key limitation is that most councils don't allow traditional rental arrangements for non-habitable studios.

Some studios can generate income through platforms like Airbnb for occasional guests, but this isn't the same as the consistent rental income a granny flat provides.

Financial Investment Analysis

Let's crunch the numbers to see the real financial picture.

Build Costs

On average, a complete two-bed granny flat tends to cost between $170,000 and $200,000. This price should include site costs, designs, approvals, build price, standard inclusions, and full turnkey ready-to-move-in.

Studios typically cost significantly less, with backyard cabins advertised anywhere from $19,500 for a build-it-yourself one-bedroom cabin, to $94,500 for a one-bedroom built to the turnkey stage.

Return on Investment

While studios cost less upfront, granny flats deliver superior returns. Watch your investment grow with 10-20% annual rental returns from granny flats. The tax benefits? Simply brilliant. First-year depreciation averages $10,000, blossoming into $45,000 in deductions over five years.

Financing Options

Here's the golden ticket – borrow up to 95% of your completed granny flat's value, spread over 30 years. Better yet, keep those initial costs manageable with interest-only payments during construction.

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Market Demand and Future Trends

The Australian housing market is creating perfect conditions for granny flat investments.

Housing Supply Crisis

Australia faces a critical undersupply of 106,300 dwellings over the next five years. This shortage means strong demand for alternative accommodation solutions like granny flats.

Changing Demographics

With rental prices hitting record highs and housing affordability at an all-time low, more people are searching for cost-effective living options. Granny flats offer a solution by providing self-contained, affordable housing in established neighbourhoods.

Government Support

Government policies are also playing a role. Many states have relaxed planning laws, making it easier for homeowners to build a granny flat without the red tape. Plus, new tax incentives mean investors can claim depreciation and running costs, further boosting their bottom line.

Approval and Regulatory Considerations

Understanding the approval process is crucial for both options.

Granny Flat Approvals

The Victorian Government's announcement in December 2023 means Victorians will no longer need a planning permit to build a granny flat under 60 square metres on properties over 300 square metres. Similar streamlined processes are being implemented across other states.

However, you need to adhere to council regulations concerning size, setbacks and renting. It's essential to check your local council requirements before proceeding.

Studio Approvals

Studios often have simpler approval processes, especially if they're non-habitable. Not every cabin will require a permit from your local Council – that is, if it is under a certain size. However, as soon as you have a kitchen or kitchenette then it will usually no longer be regarded as a studio.

Tax Implications and Benefits

The tax treatment of these investments differs significantly.

Granny Flat Tax Benefits

Granny flats offer substantial tax advantages. Formal granny flat arrangements involving elderly relatives or loved ones with disability will qualify for a capital gains tax (CGT) exemption as of July 1, 2021 for family arrangements.

For rental situations, you can claim depreciation, maintenance costs, and other investment property deductions.

Studio Tax Considerations

Studios used for business purposes (like home offices) may qualify for some tax deductions, but they don't offer the same comprehensive investment property benefits as granny flats.

Risk Assessment

Every investment carries risks, and it's important to understand them.

Granny Flat Risks

There will be less demand for a property with a granny flat in the backyard. Your pool of tenants will be restricted for both properties, so you'll have fewer choices in your selection, experience longer vacancy periods.

Some experts argue that 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.

However, these concerns are often outweighed by the benefits in the right circumstances and locations.

Studio Risks

The main risk with studios is limited income potential. They're essentially a lifestyle investment rather than a financial one.

Making Your Decision: Key Factors to Consider

When choosing between a studio and a granny flat, consider these crucial factors:

• Budget: Can you afford the higher upfront cost of a granny flat for potentially much better returns?
• Goals: Are you seeking income generation or lifestyle enhancement?
• Property: Do you have adequate space and the right zoning for a granny flat?
• Location: Not all areas deliver the same rental yield. Suburbs with high rental demand, close to transport, schools, and amenities, will attract more tenants and higher rents.
• Long-term plans: Consider your long-term goals. While you might only require a studio, is this what potential buyers in your area are looking for or is a Granny Flat a better investment in the long term?

The Flexibility Advantage

One often-overlooked benefit of granny flats is their adaptability. Some customers have built a complete granny flat and then used it for extended family recreation as with a gaming or media room, knowing that it's there and available whenever the family's needs have changed. Over the years, granny flats can be occupied by young people trying to save for their own home, then later rented for retirement income.

This flexibility means your investment can evolve with your changing circumstances while maintaining its value.

Expert Recommendations

Before you commit to building a backyard studio, think again about proceeding with a fully self-contained granny flat as an outstanding investment. You might not want to rent it out in the foreseeable future but it's always there and it will always add value to your home.

The consensus among property experts is clear: if you can afford the higher upfront investment, granny flats offer superior long-term returns.

Backyard Studio or Granny Flat: We Can Help

While backyard studios serve their purpose for lifestyle enhancement and specific use cases, granny flats emerge as the superior investment choice for most Australian homeowners.

The combination of strong rental yields, significant property value increases, tax benefits, and future flexibility makes granny flats a compelling investment. With lower maintenance costs and the added bonus of increasing property value, granny flats are proving to be a smart, long-term investment choice for 2025.

However, the "better" choice ultimately depends on your specific circumstances, budget, and goals.

If you're primarily seeking lifestyle enhancement and can't justify the higher investment, a studio might be right for you. But if you're looking for genuine investment returns and long-term value creation, a granny flat is typically the smarter financial choice. Superior Granny Flats can help.

Contact us today for a free consultation.

Our experienced team will help you understand the potential returns for your specific property, navigate council approvals, and create a granny flat that maximises your investment while meeting your family's needs.