Accessory dwelling units (ADUs) have become a desired commodity in the State of California, creating opportunities for small owners to expand existing apartment properties or create multiple units on a single-family home site, increasing income potential.

Single-family and small-unit investors interested in these low-cost properties, also known as cottages or granny flats, are at the favor of new state laws under the California Department of Housing and Development. Updated legislation has loosened its ADU development regulations, entitlement and permitting process to encourage more housing supply in the state, which is currently suffering from a dearth of housing and an affordability crisis.

New Regulations Open the Door for ADU Development

These units were once difficult to build, particularly for small investors that are not familiar with the extensive regulatory development hurdles in California. However, the new lax regulatory environment around ADUs has created market-feasible potential to build an estimated 1.5 million new housing units, according to a recent study by the Lewis Center of Regional Policy Studies at the University of California at Los Angeles.

The most recent regulation changes by the California Department of Housing and Development include the updated ADU law effective January 1, 2020 that clarified and updated various provisions to promote the development of ADUs. Included in the legislation is the permission to build ADUs simultaneously with a single-family dwelling, incorporation of ADU development in all zoning districts allowing single-family and multifamily uses, modified utility fees such as special districts and water corporations, limited exemptions or reductions in impact fees, and reduced parking requirements.

Another notable legislative change to ADUs passed on January 1, 2019, allowing homeowners who created ADUs without the required building permits to have the opportunity to bring the unit into compliance. Upon inspection of the unit, local officials can apply the building standards that were in effect at the time of construction. It is supported by the bill SB 1226, which added Section 17958.12 to the California Health and Safety Code Opens in New Window and permits the application of the required building codes, so homeowners receive the issuance of the building permit for the residential unit.

In 2019, ADUs also saw three key bills instrumental to exponentially increasing the development of the units in California. Bill AB 68 outlined minimum design standards for ADUs regarding their size and space, shortened the application review period for the unit type, prevented local municipalities from enacting stringent design or parking requirements, and expanded ADU construction options. Bill AB 881 prohibited local jurisdictions that required an owner to occupy any new housing built on their land parcel to allow more owners to build ADUs for renting for supplemental income or providing living space to a family member. Bill AB 670 halted influential homeowners’ associations from restricting ADU development in subdivisions.

The Benefits of Adding an ADU to Your Property

ADUs are a highly sought affordable home-type to construct in California. They do not require land payments, mega new infrastructure, structured parking or elevators, while providing a source of income for homeowners and investors. Usually built with cost-effective wood frame construction, they’re less costly than units in new multifamily infill buildings.

A report on ADUs by the Terner Center of Housing Innovation at the University of California at Berkeley cited that the average cost of construction for an ADU hovered around $156,000, while the average cost of affordable housing statewide is $332,000 per unit. In major metros, the cost to build affordable apartment units is even higher. In San Francisco, for example, the average cost per unit is $591,000, and in Los Angeles, it is $372,000. In addition to low construction costs, ADUs are also quick to build. Of the ADU owners surveyed, 83% reported that an ADU took 18 months or less to construct from design to completion.

ADUs, also referred to as secondary units, are attractive to a varied pool of potential tenants, another benefit for landlords. They are a fit for couples, small families, friends, millennials and seniors.For extended families living close to one another, ADU homeowners have the flexibility to split independent living areas with their family members while maintaining privacy and autonomy.

The Challenges of ADU Development

Despite California legislative support of building ADUs, there are roadblocks for property owners aiming to secure financing to construct them. ADU financing is not a match for traditional loan products. Some lenders have been unwilling to lend on the property type deeming it risky. Limited financing tools that have emerged are cash-out refinancing, a home equity loan or line of credit (HELOC) or renovation financing.

Fannie Mae, Freddie Mac and the U.S. Department of Housing & Urban Development (HUD) have reserved this financing to only part of the equity that an owner has on their home, not enough to pencil out substantial costs. Private lenders have been conservative as well, reserving loan products for very high-net-worth borrowers or borrowers with spotless credit scores.

Another limitation is the financial products available for ADUs do not account for the current value of a property and prevent homeowners from borrowing against the anticipated rental income an ADU will generate.

Despite hurdles to capital access for ADU developments, private firms on the West Coast have begun specializing in ADU lending or construction like Dweller, United Dwelling and Rent the Backyard. California policymakers are actively calling for government-sponsored financing programs for ADUs as affordable housing becomes harder to find and to meet the needs of homeowners aiming to make a splash in the ADU market.

As ADUs gain popularity and momentum with the passing of new regulations, ADU construction in California will continue to surge. California jurisdictions went from issuing 5,911 permits in 2018 to 15,571 in 2019, according to the Terner Center of Housing Innovation. ADU completions more than tripled from 1,984 to 6,668 during this period.

ADUs have proved low-impact and sustainable buildings, requiring fewer resources than an average single-family home. With their smaller size means they keep utility and management costs low. Single-family and small unit investors are sure to continue to flock to the investment type.