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Better Financing Options For ADUs — But …

They’re affordable but they are still not inexpensive

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Lew Sichelman
ADU Financing

The first accessory dwelling unit (ADU) New Avenue designed was a scant 280 square feet. The occupants were a young family with a newborn, but they made it work.

Fast forward a dozen years and the Berkeley, Calif., design-build firm is now putting up backyard houses as large as 1,200 square feet with up to three bedrooms. In some cases, says founder Kevin Casey, the new units live larger than the older homes that sit in front of them.

“Today’s ADUs work for entire families with work-from-home careers, kids, parents and extended family visitors. They’re real homes for 21st-century people living 21st-century lives,” says Casey.

Over the past 12 years, ADUs, sometimes known as granny flats or in-law suites, also moved beyond a niche market into the mainstream. According to one report, less than 2% of the active for-sale listings in 2000 had an accessory unit. But by 2019, that figure had grown to almost 7%.

They’re “a burning hot topic,” Shannon Faries of Land Gorilla, a technology firm which focuses on helping lenders manage their construction loans, told me. “They’re on everyone’s tongue. And it’s all related to the housing crisis. There’s not enough houses, and there’s not going to be enough in our lifetimes.”

Now, though, perhaps the two most important mortgage market players have given ADUs a proverbial shot in the arm, just as proponents say these mini-houses could go a long way to solving the shortfall of some 4-5 million dwelling units.

Most recently, Freddie Mac has joined cross-town rival Fannie Mae in saying it, too, will boost its investments in mortgages on houses owned by people who want to build an accessory dwelling on their properties or in loans on houses that already have an ADU.

Housing advocates have long argued that accessory dwelling units are necessary to ease the housing shortage. Some people see them as opportunity to generate rental income, while others use them to keep their elders or their newly graduated children nearby.

They also are a part of the Biden Administration’s plan to boost affordable housing, which argues that improved financing options, in combination with state and local zoning reforms, could lead to the creation of more than a million new ADUs over the next five years.

Compared to a typical house, ADUs are affordable. But they still aren’t inexpensive, not by a long shot. According to Maxable, which offers help in planning, hiring and managing an ADU project, a “legal” unit with a kitchen and bathroom typically starts at $80,000 and shoots up from there. “For a stand-alone accessory dwelling unit, expect the cost to start at $150,000.” (Casey’s New Avenue has built more than 100 ADUs, mostly in Northern California, at prices ranging from $130,000 to $750,000.)

– Shannon Faries, Land Gorilla

And that’s just for construction costs. Add the cost of permitting and impact fees and you’re starting to run into some real money.

Despite the cost obstacle, a number of jurisdictions have loosened their rules to permit the construction of accessory units, with more and more doing the same every month. California has been in the forefront of the movement, but states like Arizona, Florida and Texas, where interest has been the keenest, also are working on eliminating zoning roadblocks.

In 2017, California required all cities and counties to allow ADUs as long as the property owner secured a building permit. Two years later, it eliminated occupancy requirements; made it easier to add not one but two ADUs as long as they contain at least 800 square feet of floor space and created a tiered permit structure based on the size of the unit and its location.

Many communities throughout the country also have been relaxing their restrictions against ADUs, and some states have been encouraging their local jurisdictions to allow them. According to AARP, the cities of Atlanta, Austin, Denver, Houston, Philadelphia, Phoenix and Seattle now allow accessory units. Oregon requires cities and counties of a certain size to allow them in single-family neighborhoods, New Hampshire says they must be allowed in nearly every single-family neighborhood.

But financing has lagged. “Financing has been one of the top barriers to production,” Wells Fargo’s Amy Anderson said at a UC Berkeley conference this summer. “A critical aspect of ADU financing … is how to change those federal agency programs that can really play a central role in unleashing more private lending.”

Currently, most people who build an ADU either pay cash, tap into their home’s equity or take out a construction loan that converts to permanent financing when the project is finished. All are expensive options.

Jett Miller, a loan officer with Cherry Creek Mortgage in Las Vegas, hasn’t been bombarded with requests to finance ADUs. But he suspects there’s far more activity than he knows about because he’s doing a lot of business in cash-out refinancings and home equity lines of credit. In those cases, borrowers are not required to reveal how they intend to use the proceeds, and most don’t, Miller told me. “We don’t get into conversations about intended use.”

Now Fannie and Freddie have stepped up with more financing options. The two government-sponsored enterprises are key mortgage market players who together put their stamp on roughly half of all home loans.

They don’t make loans directly to borrowers. Rather, they purchase loans on the secondary market from main street lenders, package them into securities and sell them to investors worldwide. In so doing, the GSEs keep money flowing into the mortgage market by allowing the direct lenders, the ones you and I deal with, to replenish their supply of funds.

Fannie and Freddie still won’t purchase loans used to finance an ADU. But they will buy loans on primary residences that include accessory units, either in the house itself — a basement apartment, for example, an attic in-law suite, or a granny suite over the garage — or somewhere on the property.

Under Freddie’s recent “ADU Expansion,” for example, accessory units are not just limited to single-family homes. Now, two and three-unit properties are eligible as long as they have just one ADU. Also, any rental income can be used to qualify for funding, whereas it used to be limited to borrowers who have a disability and the income came from a live-in aide. At the same time, though, rental income cannot exceed 30 percent of the borrower’s total “stable monthly income.”

Despite these and other improvements, though, some believe Fannie and Freddie have fallen short of the ADU trend. “Freddie, in my view, God bless them, it’s awesome, but it’s a baby step,” Meredith Stowers, branch business development manager at CrossCountry Mortgage in Brecksville, Ohio, said at the Berkeley conference.

More specifically, Faries of Land Gorilla says a rule that the square footage of the ADU cannot exceed that of the primary residence is outdated. “It’s not in line with the current trend” toward larger accessary units, he says, explaining that many property owners want to move into the accessory unit and rent out their main residence. “I suspect (Fannie and Freddie) will catch up because most consumers want larger units,” Fairies told me. But right now, he added, they’re “not in line with the current movement.”

Faries also laments the “conservative approach” Freddie Mac is taking concerning who the borrower uses as his contractor. He understands the need to protect both the lender and the borrower from hooking up with a fly-by-night builder, or even one who just has a lousy track record of not showing up for weeks or not being on time. But he says the rigorous vetting requirements are “one of the biggest drawbacks.”

Another issue, of course, is the need to refinance, especially for owners who currently hold low-rate mortgages and are loathe to give them up. In that regard, the Land Gorilla executive thinks ADUs should be underwritten as a second livable unit with its own separate mortgage, whether the unit is a separate, detached dwelling or an area over the garage or in the basement.

“I’m sure there’s going to be a lot of changes coming,” he told me. “But we’ve got to stop thinking of these as accessory dwellings and starting thinking about them as another livable dwelling unit where grandma is going to live.”

Meanwhile, while some are waiting for the mortgage business to catch up, others are waiting for state and local jurisdictions to come aboard. In 2000, Washington was the first state to ban localities within its borders from outlawing ADUs, according to AARP. Since then, perhaps a half-dozen other states have done the same. But others are dragging their feet.

Massachusetts, for instance, failed to pass a measure this summer that would have allowed ADUs “by right” statewide without prohibitions, restrictions or cumbersome permitting requirements that are on the books in some cities and towns. The measure would have precluded local governments from preventing accessory units up to 950 square feet on a lot of more than 5,000 square feet.

This article was originally published in the NMP Magazine October 2022 issue.
Lew Sichelman headshot
Lew Sichelman,
National Mortgage Professional Contributing Writer

Lew Sichelman has been covering the housing and mortgage sectors for 52 years. His syndicated column appears in major newspapers throughout the country. He also has been the real estate editor at two major Washington, D.C., dailies and spent 30 years on the staff of National Mortgage News, formerly National Thrift News.

Published on
Oct 03, 2022
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