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Real Estate

The business case for accessory dwelling units

The added values of ADUs

Mighty Buildings - Mighty Studio 350 sq ft
One of Mighty Buildings 3D-printed ADUs. Photo credit: Mighty Buildings

Aging parents. College students returning to the fold. Millennials seeking affordable housing in high-priced markets. People with disabilities who can live on their own but need a little family support. All of these populations comprise the target market for accessory dwelling units (ADUs), commonly referred to as granny flats, in-law suites, casitas or guest houses – self-contained living units that usually have their own bedrooms, kitchen and bathroom, but are situated on a lot with a separate home. ADUs come in many different forms.

They can be detached, such as a small cottage or guest house on the same parcel as a single-family home. They can be attached, such as an addition on a primary structure. They can be created from the conversion of existing space, such as a garage. Or they can be what California terms a “Junior Accessory Dwelling Unit,” which results from the conversion of space contained entirely within an existing or proposed single-family residence.

No matter what the form, ADUs are a way to provide affordable housing options in a neighborhood – even a historical neighborhood – without changing the character or causing a substantial increase in housing density. That’s the good news. But there’s a flip side to ADUs.

“The bad news is that sometimes, some analysts in the industry portray ADUs as the solution to the lack of housing,” said Robert Dietz, chief economist and senior vice president for economics and housing policy for the National Association of Home Builders. “It’s not a long-term solution because an ADU is often not going to be the right kind of housing for a young adult who eventually is going to marry and have kids. It’s not a substitute for entry-level, new-construction single-family housing that was particularly important and in high demand during 2020 as people wanted lower-density neighborhoods and more space for home offices. ADUs don’t add that kind of housing. But as an immediate-term solution to the lack of affordable rental housing, ADUs absolutely have a role to play.”

What are the benefits of ADUs?

ADUs offer many benefits and are often seen as a win/win/win for the parties involved – property owners, tenants and builders. The California Department of Housing and Community Development recently summed up the benefits of ADUs as follows:

  • Affordability: An affordable way to construct a home in pricey housing markets because ADUs don’t require the purchase of land (if added by the owner of an existing home), major new infrastructure or parking.
  • Income: ADUs can provide a passive income stream for a homeowner.
  • Cost-effective: ADUs are built with wood-frame construction, which is less expensive than building multifamily on infill lots.
  • Social: ADUs provide a way for extended families to be close while maintaining privacy.
  • Space: ADUs often provide as much living space as apartments or condominiums.
  • Flexibility: They are suitable for many types of residents and allow older adults to age in place.

These benefits are driving the market for properties with existing ADUs, homes with sufficient space to add an ADU and for infill lots where builders can erect new structures. “The markets where ADUs are the most attractive are those where it’s hardest to build entry-level housing,” said Dietz. “It’s markets like California, where the regulatory burdens associated with new construction make it difficult to bring building lots into the system.”

Seattle, another market with high housing prices, is also popular for ADUs. “We are seeing a surge of accessory dwelling units,” said Robin Sheridan, a real estate broker with Compass Washington. “The audience for whom these units are attractive has exploded since last spring when people began working from home. I’m seeing people building detached home offices, but also many clients who are building smaller homes on-site for their downsizing parents.”

The data

In July 2020, Freddie Mac released a national study on ADUs. It reported that the growth of ADUs in the United States has been dramatic, particularly in high-cost areas seeing significant population growth. Freddie’s analysis, the first of its kind on a large scale, is based on 1.4 million single-family properties with ADUs, which were identified after an analysis of 600 million MLS transactions dating back to the late 1990s. “This analysis is both unique and large in scale, giving us insight into the growing movement of accessory dwelling units,” said Sam Khater, Freddie Mac’s chief economist.

Highlights of the study include:

  • ADU sales are up: 70,000 properties with ADUs were sold in 2019 (4.2% of total homes sold on the MLS), compared to 8,000 properties with ADUs (1.1%) sold in 2000.
  • ADU rentals are up: 8,000 ADUs were leased in 2019, up from less than 1,000 in 2000.
  • ADU listings are up: Between 2009 and 2018, the number of ADUs listed for the first time (including for-sale and for-rent units) grew by an average of 8.6% year-over-year.
  • Demand for ADUs is up: Demand is highest in the fastest-growing regions of the country, including California, Florida, Texas and Georgia. The fastest-growing metros are Portland, Dallas, Seattle, Los Angeles and Miami, each with double-digit growth since 2015

This dramatic growth of ADUs, based on growing demand, creates opportunity for many real estate industry professionals.

Carving out a niche in the ADU market

Real estate agent Xio Sandoval realized several years ago the opportunity that ADUs present. As an agent with Century 21 Realty Masters in Montebello, Calif., she knew that due to California’s high housing-market prices, her clients could benefit by purchasing a home with an ADU.

“I’m working with buyers looking for already constructed ADU units because they want the income stream,” she said. Sandoval, who said 70% of her business involves ADUs, has a client who is a builder active in this space. He remodels existing single-family homes and adds a new ADU unit on the property. After she finds a purchaser for the home, Sandoval will help that buyer lease the ADU, usually at a rent of about $1,300, $2,200 or $2,900 for a one-, two- or three-bedroom unit, respectively.

She will market the rental ADU, screen potential tenants, arrange for the lease and get the tenant in place, all at no cost to her buyer. Since she started providing this service, the number of closings she’s doing has doubled. Real estate agents should “follow the trends,” Sandoval said. “Don’t be scared to offer rental services – you’re making a difference to these tenants.”

Builders attracted to ADUs as well

Builders and remodelers are also entering the ADU market, attracted to the strong fundamentals. According to NAHB’s first quarter 2019 Remodeling Market Index, one-fifth of remodelers undertook projects that created an ADU within the 12 months prior, with three-quarters reporting that their projects cost at least $50,000– and 28% reporting projects costing at least $150,000. But business models vary.

Some of the nation’s largest builders are responding to the rise of multigenerational households in the United States, one trend creating a need for ADUs. According to a 2016 Pew Research Center analysis, a record 64 million people, or 20% of the U.S. population, lived with multiple generations under one roof. Miami-based Lennar Corp. offers its single-family Next Gen “home within a home” product in 12 states. The model has a separate, self-contained suite that includes a bedroom, bathroom, living room, kitchenette and even a garage.

Other builders have entered the market to build ADUs for both sale and rent. John Hunt, president of Atlanta-based MarketNsight, a housing-industry consultant, said that local zoning rules permit builders to construct a duplex with an ADU on a single-family lot. He said that instead of building a single-family home, which might sell for $500,000, the duplexes would sell in the low $200,000s and the ADU, about 750 square feet, would sell for about $180,000, creating more affordable housing-purchase options for buyers. “That’s mainly on infill lots,” he said. “But there are some plans in Atlanta and other cities for redevelopment, and they’re looking at doing that en masse – putting 215 homes, all in that same configuration of a duplex and one ADU. We’re on the cutting edge of this, but the time is right.”

Jim Cheeks, the owner of Atlanta-based Fortas Homes, is primarily a builder of affordable single-family homes. But, lately, he’s building ADUs to rent with a long-term-hold strategy. Last year, he completed an ADU project on an infill lot he owned in Atlanta, building two four-bedroom, three and a half bath duplex units, each about 2,100 square feet, plus a 750-square-foot ADU unit with two bedrooms and one and a half baths. Instead of the single-family home the lot was zoned for, which he could have sold for over $800,000, Cheeks now rents the three homes – which leased within days.

The rents for the duplexes are market-rate – about $2,800 – while the ADU rents for $1,117, or 60% of the area median income, restricted because Cheeks used financing by a Community Development Financial Institution. “To me, building one large house is not a society good,” he said. “I’m a thoroughly for-profit business, but I am mission-driven. I’m still doing well, but feel like I’m doing good at the same time.” Mighty Buildings, a startup in Oakland, Calif. is even touting its pre-designed ADUs; the company can fully 3D-print a 350-square-foot home in less than 24 hours.

The company claims that it can produce structures with 95% fewer labor hours and twice as fast as conventional construction, with 10-times less waste. While the average traditional stick-build home in California costs $327 per
square foot, the company said, a Mighty Buildings home costs up to 40% less and produces virtually zero waste. Company spokeswoman Helen Chong said the company has successfully delivered five ADU units, with 30 units in the production pipeline. Pricing starts at $183,000.

Zoning still needs to catch up

An increasing number of states and communities are responding to the need for affordable housing by updating existing zoning laws to allow for multiple units in a single-family zone. California legalized ADUs throughout the state in 2017 – “a state law that overrides local zoning to say in almost all circumstances that you can have an ADU,” said Ben Metcalf, managing director of the Terner Center for Housing Innovation at UC Berkeley.

New Hampshire passed an ordinance in 2017 that requires local zoning ordinances to allow ADUs nearly everywhere single-family homes are permitted. Minnesota’s Twin Cities have responded as well, with Minneapolis introducing an ordinance in 2014 that allows all types of ADUs, and St. Paul allowing ADUs on single-family lots throughout the city in 2018.

The Chicago City Council approved an ordinance in December 2020 that allows the creation of ADUs in five areas around the city starting on May 1, 2021. Some of the units will be required to be affordable, and all are expected to increase the supply of housing while maintaining neighborhood character through “gentle” density that will not be visible through significant exterior changes to the principal residence. Laws are changing in other states as well, and Metcalf said that “a flurry of interesting work” is going on in Maryland, Virginia and the District of Columbia.

ADUs not without challenges

Despite all of their benefits, ADUs present some challenges as well. John Lesak, an architect and principal of Page & Turnbull in Los Angeles, has faced several issues when designing ADUs. The first is to stay within the historic character of a neighborhood. The bigger challenge is parking.

“A lot of people don’t want more cars on the street or more traffic,” he said. “People don’t want the cars on the streets because it messes up their beautiful neighborhood, and there’s no place on the parcel to put the cars, so the neighbors start to complain.”

But Hunt, of MarketNsight, thinks the parking objections will disappear over time. “People are most afraid of the parking issues,” he said. “But that’s recent – only in the past 30 years have we decided every house has to have a covered garage. But because of Uber and the pandemic and working from home, parking is becoming less of an issue. And as millennials start buying houses and getting on zoning boards, that will change because they seek
out walkability.” Financing is another challenge for homeowners who plan to build an ADU. Since the ADUs can’t be separately mortgaged, most homeowners finance them by taking out a home equity line of credit on the principal residence – or paying cash.

And, of course, there’s the social challenge. “You have a very intimate relationship with your landlord,” Metcalf said, referring to an ADU resident. “The person who is evicting you is living next door.” That’s why he thinks that there’s future opportunity for someone to manage rental ADUs to provide a buffer between landlord and tenant. “We’re seeing single-family owners who want the revenue but don’t want the hassle,” he said. “I think that’s probably, long-
term, one of the keys to scaling ADUs – figuring out how to take this from day-to-day burden, out of the homeowners’ hands, and professionalizing it.”

This article was pulled from the HousingWire Magazine April issue. To read the the rest of the issue, go here.

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