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Should U Adu?

Sunday, August 2, 2020   /   by Carol Glover

Should U Adu?

Should YOU ADU?

Accessory Dwelling Units (ADU), also known as granny flats or companion units, have been dubbed the solution to California’s housing crisis.  They provide additional housing units to the current short supply and can provide a much-needed income stream especially in these unprecedented economic times.  They can also provide for a separate living place for extended and growing households.  Best of all, they can be constructed right on your property, often encroach into rear and side yard set-backs,[1]  not require replacement parking when converting an existing garage, and many cities are even waiving impact fees associated with new ADUs.  So, what’s the catch? Well, as with all things, there are some possible consequences that should be considered prior to jumping into an ADU.

For example, (1) is an ADU the “highest and best use” for the property, (2) what will the cost be and is it worth it, (3) how do lenders and appraisers look at ADU additions, (4) are ADUs subject to rent control (5), can ADUs be converted back to Single Family Residence (SFR), and (6) can I use my ADU as a short-term vacation rental.   

ADUs provide a much-needed opportunity for first time home buyers to afford housing in some of California’s most expensive cities like Redondo Beach, Manhattan Beach, Los Angeles, Newport Beach, and San Diego.  ADUs allow for the conversion of existing garages and the construction of new structures, either attached or detached, into rental units.  ADUs are also being used to create on site housing for parents to age in place or college aged children to live at home.  There are even companies partnering with homeowners in Los Angeles to convert their two-car garage into an ADU and then manage the rental for them.  Cities have been jumping on board too.  For example, the cities of San Diego and Encinitas even have pre-approved ADU building plans to expedite the process and save the homeowner money with downloadable building plans.  And with 3D printing and prefab or modular units, ADUs are becoming more affordable than ever. 

California, seeing an opportunity to provide much needed affordable housing, has also jumped on board with ADUs.  Last year, Governor Newsom signed five separate ADU related bills which makes ADUs even easier to permit.  For example, cities can no longer require replacement parking for conversion of a garage, there is limited design review so long as they fit within the 16-foot height limit, 4-foot setbacks, and 800 square foot max even those cities with grueling design review processes will be required to approve them, and multiple ADUs must be allowed on lots with multifamily dwellings.  Even HOAs have become somewhat limited in preventing homeowners in their community from constructing ADUs; allowing only reasonable restrictions on new ADUs. 

So, with ADUs becoming easier than ever to permit and rent values skyrocketing, is there any reason not to build an ADU?  A deeper analysis before moving ahead should be undertaken with a professional.    

1.      Is an ADU the “highest and best use” for the property?

Never forget the adage, “Location, Location, Location.” Before you embark on any journey regarding an ADU, you must understand what you have at the starting point.  What is the highest and best use of your property?  What will an ADU add to the value of your property?  The ADU may impair value, depending on where it is located or it may enhance the value either from a market value or a lifestyle perspective.  You have to know where you start and then educate yourself of where you will end up with an ADU.

 2.      What is the cost of constructing an ADU, and is it worth the cost? 

The cost to build an ADU is a big “it depends” based on the size of the unit, local permitting and construction and architecture fees.  You may be able to save with pre-approved plans provided by your local city or a pre-fab unit, but this is not necessarily true.  Before starting make sure that you understand the full cost of construction and also have an estimate of fair rental value if you plan to use the ADU to supplement monthly income.  This will help answer the big question of how long will it take to recover the cost of the build before the additional project starts to cash flow for me.  

3.      How do Lenders and Appraisers look at ADU additions?

Appraisal and Home Values with an ADU. Does an ADU make your property a “two-family property,” a duplex or triplex or is it still a single family.  There is not a blanket answer to this question.  It really depends on the characteristics of each ADU. According to the Fannie Mae guide, “an accessory unit is typically an additional living area independent of the primary dwelling unit, and includes a fully functioning kitchen and bathroom. Some examples may include a living area over a garage and basement units. Whether a property is defined as a one-unit property with an accessory unit or a two-unit property will be based on the characteristics of the property, which may include, but are not limited to, the existence of separate utilities, a unique postal address, and whether the unit is rented. The appraiser is required to provide a description of the accessory unit, and analyze any effect it has on the value or marketability of the subject property.” 

Do Lenders Provide Credit for ADUs? The Lender guidelines suggest that you may not be able to receive credit for the additional income associated with the ADU.  The Lender guideline choices are:  single family with a guest house; single family and an ADU or Duplex.  You can get credit for the income if you have a duplex, but if there are limitations on the characterization or permitting on the ADU in your particular city or county, the income may not count, nor will the additional square footage.

4.      Will constructing an ADU subject my property to rent control?

Maybe. The Tenant Protection Act of 2019 (aka AB 1482) enacted certain rent control provisions on residential properties across California for the next ten years.  Thankfully, the Act has several exemptions including newly built-housing (less than 15 years) and ADUs if the property is owner-occupied.   Civil Code §1946.2(e)(5).  In other words, if the property has an SFR and ADU on the site and neither is owner-occupied, then both units could become subject to rent control if the units are older than 15 years.  This could become a real concern for those looking to take advantage of SB 1226 that allows homeowners to bring their previously unpermitted ADUs into compliance.  Moreover, litigation is likely on the topic of whether an older SFR will be subject to rent control when a newer ADU is added to the property and neither is owner-occupied. 

The Tenant Protection Act has a 10-year sunset date, but many experts do not anticipate the Act disappearing after 10 years.  Moreover, some cities may have more stringent rules that will result in an ADU being subject to rent control even if the SFR property is owner-occupied. 

Based on the fact sensitive nature of the Act and other local provisions, we recommend that you consult with your attorney as to whether renting out an ADU could result in your property being subject to rent control provisions. 

5.      Can a property with an ADU on it be converted back to one single-family residence?

This is somewhat of a novel issue and something that will likely warrant litigation in the future.  It is not really a contested question right now as the current trend is to construct ADUs, not remove them. However, it is something that must be considered before committing to an ADU property.    

If the ADU took advantage of reduced setbacks, parking, and even avoidance of design review in cities with view ordinances; there may be an argument to be made that to convert the property back to just one SFR would require alterations to the ADU to comply with the city’s code for an SFR.  Moreover, to the extent a City relied on the additional unit to achieve its RHNA numbers under the Housing Cycle Update, we might see cities start to adopt policies that prevent the conversion of an ADU back to just one SFR; or require impact fees to do so. Also, to the extent the ADU is subject to rent control, there may be relocation requirements. As time goes on, it is likely that the State and local cities and counties will adopt additional legislation that makes it more difficult to remove ADUs given the State’s housing shortage.  

Given the fact sensitive nature and varied set of local policies and ordinances, we recommend that before purchasing a property with an ADU or constructing an ADU, you consult with your attorney to fully understand the pros and cons of ADUs.

6.      Does an ADU limit the ability to use the property for a short-term vacation rental?

Yes.  Pursuant to AB 68, any rental of an ADU for less than 30 days is seemingly prohibited.  Government Code § 65852.2. Arguably, the ADU could be rented to a long-term tenant and the SFR used as a short-term vacation rental. But see the Fourth point above for a discussion on the triggering of rent-control provisions. 

[1] Government Code 65852.2(d)(vii)

Salzman Real Estate Team ENGEL & VÖLKERS • LA - South Bay
Dave Salzman
1147 Highland Ave
Manhattan Beach, CA 90266
DRE# CalBRE#: 00952732

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