Accessory Dwelling Units

Accessory dwelling units – separate dwellings on single-family properties – are gaining popularity and interest, and more states are passing laws allowing them, and easing zoning and permitting regulations.  There is clearly a need for ADUs.  Homeowners are interested in collecting income from the units.  Governments are interested in them as a way to increase the supply of rental housing, and building affordable homes on a large scale is uneconomical without the help of government subsidies.

However, a lack of dedicated financing is preventing us from seeing the scale we would expect from a new solution for homeowners looking to maximize their income.   Most people building ADUs on their property either have the money or have a lot of equity in their homes.  According to a survey by the Terner Center for Housing Innovation, UC Berkeley, only 4% of homeowners in Portland, Seattle, and Vancouver who built ADUs borrowed against the income or expected value of the unit.

Financing is a challenge because:

  1. Fannie and Freddie do not count the rental income from ADU’s towards a loan, so big banks will not offer this financing b/c they can’t sell the loans to Fannie/Freddie,
  2. There is not enough volume to create a secondary market for banks to sell the loans,
  3. Small banks will give these loans but have to hold them on their books,
  4. Companies like Dweller are financing the ADU’s but Dweller itself can’t get a bank loan, so can only fund growth with raised equity. 

Without financing the number of ADUs being built will not scale up. Except for lots in high rent districts, the economics of renting an ADU that costs ~$100,000 in cash is not a great investment without debt to lower the investment amount. 

This is a real problem in California, as according to the McKinsey Global Institute, the state faces a housing shortage that is projected to reach over 3.5 million by 2025, and over 20% of this amount could be created with ADUs.  This is a conservative estimate, as in San Francisco and Los Angeles, 93% of the residential land is dedicated to single-family housing.

There are some emerging ADU financing methods offering hope:

Renovation Mortgages (first position)

  1. Fannie Mae and Freddie Mac offer products that allow homeowners to obtain new or refinanced mortgages based on a property’s value after renovation.
  2. Regional banks offer portfolio renovation loans with greater flexibility in loan-to-value (LTV).

ADU Specific Home Equity Line of Credit (second position)

Consolidated Community Credit Union and CDFIs offer HELOCS based on after completed value

borrowing locally

Local and regional lenders, and credit unions, are more comfortable financing ADUs than larger banks.  Local banks also already understand the local real estate market in general and ADUs.  Banks can also use ADU loans to comply with Community Reinvestment Act (CRA) requirements.

CDFI/Local Partnership Loan Programs

CDFIs and smaller lenders (less than $10BB in assets) have the greatest regulatory flexibility to make loans they intend to keep in their loan portfolios.  This is a promising avenue for ADU financing.

Silicon valley housing trust adu program

This project received a $1.75 million grant from the JP Morgan Chase Foundation.  They are planning to partner with tech companies and Community Reinvestment Act (CRA) motivated banks for financing.

Local Gov’t Grants
Self-Help Federal Credit Union Backyard Homes Project Pilot Program (in Los Angeles)

This is a joint effort of LA-Mas, Genesis LA Economic Growth Corporation, Self-Help Federal Credit Union, and other entities.

ADU VEndor Financing

Some builders that provide ADUs, like Dweller, retain ownership of the ADUs and provide financing, paying a share of the rent each month to the property owners.  The property owner can purchase the ADU at any time, and at the end of the 25-30 year lease owns the ADU.  However Dweller is funding the ADUs itself, and has not yet obtained a bank line of credit.

Look at the pace model

Property Assessed Clean Energy (PACE) financing, which is used to finance energy and water efficiency projects and is repaid with an assessment on property tax, offers a business model that may work for nonbank lenders for ADUs.  For example, Solar Capital Solutions offers ADU loans which are often suggested to homeowners by contractors, similar to PACE.  Unlike PACE, it does not have the status of a tax lien and there is no government agency involved. But the thought is that eventually these loans will be bundled into collateral for bonds, similar to PACE.

We expect to see more creative private, public and nonprofit options emerge over the next few years, but these sources seem to be the best bet right now.

The next question will be, if good financing options become available for ADUs, will ADU installations take off?