Accessory Dwelling Units
New Life & New Challenges in an American Tradition
By Carole VanSickle Ellis
If you have read the Little House on the Prairie books by American pioneer girl Laura Ingalls Wilder, then you may remember the book in which the family lives in a dugout underneath a hillside next to a creek while they build a farmhouse in which to live permanently. Wilder describes this time spent “on the banks of Plum Creek” (also the name of the fourth book in the Little House series) as a largely idyllic time in her childhood, but living underground in a home where a cow could put a hoof through the roof at any time could not have been entirely pleasant.
However, it gave the Ingalls the home base they needed while they built a larger, more permanent home and, in the process, Laura participated in the long-practiced model of leveraging accessory dwelling units (ADUs) in order to improve housing affordability and access.
“ADUs are an American tradition,” observed AARP “Livable Communities” authors in 2019 as part of an initiative to familiarize the Gen X and junior Boomer populations with the concept of possibly living in a “granny unit” once they hit retirement age. “[For centuries], people with wealth and acreage regularly populated their lands with secondary mansions and ancillary buildings independent of the main estate,” the report said.
Today, ADUs are, once again, an indicator that a property owner is working on building wealth for the future, often by renting out the smaller property or even subdividing it off and selling it. However, these small housing units have become much more than just an outward sign of affluence and prosperity. Today’s ADUs and their associated local legislation can indicate the presence of huge potential returns for real estate investors or, conversely, enormous potential headaches for investors and their neighbors alike.
Opportunities & Challenges
“The ADU space provides both opportunities and challenges,” said Michelle R. Rodriguez, a partner with the California branch of legal firm Wright, Finlay & Zak who specializes in Compliance, Licensing, and Regulatory issues. Rodriguez is a licensed attorney, a licensed real estate broker, and a member of the board of directors for the California Mortgage Association.
She continued, “For investors, when you are considering buying a property, you need to be aware of all the possibilities around ADUs. How many units are there? How many units could there be? How will the deal pencil out? Knowing what the rules are gives you a leg up and differentiates you from the hundreds of other people and entities in the space.”
California, where Rodriguez is based, has one of the most proactive state policies on these little dwellings, which many researchers believe are the key to solving the affordable housing crisis without losing the attractive elements of single-family residential communities. In California, a property may have as many as three ADUs on the property, and those units may be built and sold as condominiums instead of remaining with the “parent” property.
New construction must go through an approval process and may be taxed at a state or municipal level, may have as many as three bedrooms (but no more than 1,200 square feet and less in some circumstances), and may have a height of 18 feet, or 25 feet if they are attached to a larger structure.
The goal of these “relaxed” regulations, Rodriguez said, is to ameliorate the affordable housing problem in the Golden State. “There are certainly communities out there that either do not want ADUs or want to greatly restrict the number and type of ADUs they permit, and often these are the communities where there is a great need for affordable housing,” Rodriguez explained.
“The state of California has stepped in with its new legislation in an effort to force municipalities to allow ADUs to a certain extent, such as setting a minimum allowable number of units on a property (3).”
This means, at least in theory, that communities will not be able to prohibit property owners from building three ADUs on their properties assuming other building and inspection codes are met; some cities in California have elected to raise that number to five.
“Offering a mix of housing types and sizes will always be a boon to affordable housing,” observed Karen Patten, principal of Atlanta, Georgia-based YIMBY (Yes In My Backyard) Consultants. “Here, ADUs are still very much in an experimental stage,” she continued, “so the impact is still to be determined.”
In Georgia, some cities, such as Atlanta, and counties (roughly 10% of the 159 counties in the state) permit some closely regulated ADU construction. However, even in a municipal area, communities may have restrictions on who can inhabit an ADU (renter vs. non-paying or related resident) and how many ADUs may be constructed in a given area. At the state level, ADUs may be attached or detached and are permitted to take up no more than just under one-third of the backyard of the house, the only place ADU construction is permitted. Furthermore, the owners of the property must occupy either the main residence or the ADU.
“I think they are more accepted in metro-area historic communities where you see a mix of single-family, small multifamily, and commercial together and well-integrated,” Patten said. “I think it works best there [and] they are less likely to face ‘NIMBYs’ [Not In My Backyard].”
“So many people are against adding units; you always will have the NIMBYs,” agreed Kristin Weekley, a Boston-based agent and investor who owns one ADU and several other small multifamily properties in the Boston area. Weekley said that for many people in the Boston area, owning a property with a legally rentable ADU can be a gamechanger as the cost of living skyrockets.
“Having the rental income is huge for a lot of homeowners,” she said. “I have had clients who, if they had been able to legally convert part of their property to an ADU, could have stayed in their property instead of selling it.”
Weekley noted in many areas of the northeast, taxes and income make single-family homeownership infeasible for owners on a fixed income even if a home is paid off. “[ADU] income would be huge for these people because average one-bedrooms can rent for $2,000 a month or more, and in the suburbs, it can go as high as $3,000,” she said.
Supporting the Trend Toward Multigenerational Living in High-Cost Areas
Weekley said many households in her market are opting for multigenerational living arrangements in order to remain in attractive locations. She believes this trend could be supported even more with changes to ADU policies. “It would be a big advantage for older adults who want to remain in their homes,” she said.
In the past, what Weekley is describing might have been called a “granny flat,” and, typically, such a unit would not have been zoned or sold separately from the larger housing unit. However, as Baby Boomers age into retirement and find they are not interested in moving into assisted or active-living facilities, much less the once-traditional nursing homes, more and more homeowners have constructed ADUs in hopes of aging in place in the smaller residence while the younger generation inhabits the larger one.
This decision has also been fed by the Boomer tendency to finance college educations for children and grandchildren, which has led to more Boomers retiring with far less home equity than they might have otherwise.
“Older Americans often draw down their home equity to improve their retirement security, pay off high-interest debts, invest in home improvements, and make intergenerational investments like paying for their children’s education,” observed Elemental Green contributor Catherine Poslusny in a report on aging in place. She continued, “As equity diminishes, it makes less sense to sell off this vital asset.”
Poslusny also pointed out new-construction ADUs can be designed with an older homeowner in mind, making them far more accessible than an older residence, and tend to be extremely energy-efficient. “There is also the option for a senior to have a family member or caregiver live on the property without sacrificing either’s privacy or personal space,” she said, citing companionship, stronger family ties, assistance with young children, and improved finances and potential mutual benefits of such an arrangement.
A Tangled Web for ADU Investors
Clearly, ADUs offer enormous benefits to property owners, but they are not universally loved even by those who own them. Investors considering investing in a property with an existing ADU should carefully investigate whether the unit was built in accord with all existing regulations and confirm that any disqualifying elements have been addressed, can be realistically addressed, or have been grandfathered in. This includes issues with proximity to other houses, street parking, water and gas lines, and even independent lot access.
For example, in California, ADUs must have specific permits that state the structure has been permitted for 800 square feet, but then additional bedrooms can alter this minimum permitted square footage. These requirements must mesh with the absolute maximum square footage of 1,200 square feet and the requirement that the ADU not be larger than half of the primary residence’s square footage (if attached). If that is not confusing enough for an investor, California also permits both attached and unattached ADUs and JADUs (junior ADUs), and these structures come with their own unique limitations and requirements.
Interestingly, attached JADUs no longer must have fire sprinklers or a bathroom, although the latter requirement states failure to install a bathroom is only permitted if the bathroom in the primary residence is available. All of this must be layered over renters’ rights laws and owner-occupant requirements in the event that an investor plans to rent out one or both properties, and then the owner of the property must factor in how having one or more ADUs or JADUs on the site will affect their insurance requirements.
“Even if the property owner is not thinking about insurance, you can be sure the lender is interested in knowing it will be adequately insured,” said Rodriguez. “For example, if a homeowner built two ADUs but failed to disclose to the insurer that they have two rental units on the property, that is going to be an issue.”
She pointed out that in some places, a property owner may move into an entirely different category of insurance (i.e., from single-family to multifamily or condominium) by adding the maximum allowable number of units to their property.
Failure to confirm all permits and zoning requirements were followed to the letter can have dire consequences, warned Weekley.
“If you buy a house that has an ADU that is only permitted as a rental as long as the owner occupies the primary residence and then do not live there or get the new usage permitted, then you could face penalties or even have to rip the ADU out,” she said. “If something was designed to function as an in-law apartment and you try to rent it out as a second investment property, you must be sure to get separate permissions before you do so.”
The same goes for ADUs permitted for residential rentals before they can be converted to Airbnb units. In most states, even if an in-law apartment is permitted or a residential rental is a possibility, shifting to an Airbnb can require extensive permitting and regulatory approval. “Some places require you to have your short-term rental units inspected every certain number of years,” Weekley said. “Others prohibit them completely.”
To further muddy the waters, some states, including California, permit the individual sale of ADUs independently from the primary property. This is not a simple process or well-established one.
“In essence, you are either making a tiny little subdivision out of the one lot by splitting it into two or three lots or you are making a condo community,” Rodriguez said. “That is not easy or cheap, and municipalities are still wrapping their heads around how to do it and how to regulate it.”
She also noted some communities are noticing issues with traffic, parking, water, and sewage infrastructure, something that could continue in states like California that have passed state-level laws permitting ADU construction on private properties.
“The important thing to know is that at least in California, legislators are open to relaxing ADU laws to increase housing stock,” Rodriguez said. “That means there is definitely opportunity here, but also that this inclination will affect your market both positively and negatively depending on what is changed. It is important for businesses, lenders, investors, borrowers, homeowners, and potential residents to learn about this issue and make their voices heard. Real estate professionals especially should learn the rules so they can help clients figure them out and make those rules work to their advantage. That will create opportunities for everyone involved.
SIDEBAR
By the Numbers
35% — In 2023, properties with ADUs located in large cities were typically priced 35% higher than those without them (Porch)
5 Million —Number of ADUs expected to be built by 2029 (HUD)
30% — Percentage of ADU inventory located in California as of 2023
12% — Percentage of ADU inventory located in Florida as of 2023
10 — Percentage of ADU inventory located in Texas as of 2023
5% — Percentage of ADU inventory located in Georgia as of 2023
20% — Percentage of all building permits issued in California in 2022 that were for ADU construction (NAR)
61% — Percentage of ADU housing constructed with the primary motivation of multigenerational housing (HousingWire)
73% — Number of homeowners who cited accessibility as “an important consideration” when building an ADU (HousingWire)
32% — Percentage of Americans who do not have an ADU but expressed interest in owning one in the future (Freddie Mac)
