Small but Mighty; How ADU’s Are Opening the Door to New Opportunities

What is an ADU?

An Accessory Dwelling Unit (ADU) is a secondary housing unit that comes in many forms. It could be a detached home in the backyard, a separate living space in the basement, an above garage residence, an attached addition etc. Depending on the local zoning laws where it’s located, the ADU may be required to have its own kitchen with a sink, a bathroom, sleeping area and separate entrance. All ADUs must be located on the same lot as a primary residence and be smaller in size and appearance.

Why the increase in popularity?

Known as casitas, granny flats, tiny homes, a guest house, mother-in-law suites, and more, ADUs have gained popularity as a flexible housing solution. For cities with a housing crisis, ADUs offer relief in the form of additional rental units. For homeowners who add an ADU to their existing property, they reap such benefits as increasing their home’s value, gaining square footage, and creating an opportunity to generate income.

ADUs offer:

A solution to low housing inventory: Nationwide, there is a lack of affordable housing. State and local communities are finding ADUs can be a relatively inexpensive way to create more housing units, free up low-income housing, and increase density in single-family areas. And this can be achieved without significantly changing the character of the existing neighborhoods or needing to build new infrastructure such as water, sewer, and roads. Also, because they increase property values, ADUs can bring in additional property tax revenues.

Over the last couple of years especially, zoning laws across the nation have been amended to make it easier for the addition of an ADU. One of the first states to address ADUs directly was California. In 1982, the state banned local governments from outlawing ADU development outright. Since then, the state has continued to pass legislation regarding ADU development to become the most ADU-friendly state in the nation.

Because of this, the number of ADUs in California has surged. Between 2019 and 2022, ADU construction grew from 5,852 units to 17,460 new units – a growth of nearly 200%! As of 2023, one in every five construction permits granted in California were for ADUs.

But California isn’t the only state easing restrictions. ADUs now represent a sizeable share of the housing stock in Seattle, WA; Portland, OR; Los Angeles, CA; and Austin, TX. Here are some of the recent rulings throughout the country:

• In Oregon, new legislation prevents localities to adopt ADU-obstructive laws. In cities with at least 10,000 residents, property owners are no longer required to live in the primary housing unit, and in Portland, detached ADUs are allowed on duplexes.
• In July 2023, HB 1337 took effect in Washington. Some key changes with this bill included a lift on parking mandates, an end to owner-occupancy requirements, and allowance for two ADUs per lot – one attached and one detached.
• Connecticut passed a bill in 2021 which made ADUs legal by right anywhere single-family homes are permitted.
• Maine’s new ADU law went into full effect in January 2024. The law allows for two ADUs on any residential property, including those with a multi-family unit, and can be sized accumulatively equal to that of the primary dwelling.

More bang for your buck: For homeowners, the addition of an ADU means being able to stay put in a home or neighborhood you love (and maybe at an interest rate you don’t want to lose) while also meeting your family’s changing needs.

Some of the benefits to homeowners include:

• Increased square footage – ADUs can serve as multifunctional spaces, and provide a dedicated office space, gym, or hobby room.
• Multi-generational living – ADUs can be designed with aging-in-place features to give an aging parent or grandparent a place to live that is safe and close to family.
• A place for young adults just starting out – There is a growing trend of parents adding an ADU to rent to their grown children who can’t yet afford to buy a home of their own. Young families struggling with the cost of rent and daycare may find this a more affordable option.
• Added value – According to a study by the National Association of Realtors (NAR), adding an ADU can increase your home’s value by as much as 35%, particularly in areas where housing demand exceeds supply.

Income opportunity: Another reason ADUs have been rising in popularity is the opportunity for homeowners to generate rental income from their current property.

Who doesn’t need extra income? Not only are homeowners adding a new revenue stream, but they can offer an affordable housing option to another family.

How are ADUs financed?

With the increase in popularity and more favorable legislation, financing ADUs has become easier than ever.

State and local programs:

To increase ADU production, some states are offering incentives and financial assistance. According to Localhousingsolutions.org, in Berkeley, CA, a newly constructed ADU will not be counted as a new residential unit when calculating water and sewer fees. In Oregon, ADU additions are considered property improvements rather than an additional housing unit to limit tax increases. In Boston, homeowners can access an interest-free loan up to $50,000 to add an ADU, and in Multnomah County, OR, a pilot program covered the construction costs if the homeowner agreed to provide housing for five years to a tenant transitioning out of homelessness. Several states are planning a similar pilot program.

Mortgage options:

In general, most mortgage programs allow for the purchase of a home with an existing ADU. One potential exception could be USDA’s Rural Development loan. ADUs are allowed with this loan program as long as the unit is consistent with the USDA single-family housing definition (as in multi-generational living) and not designated to create rental income.

Otherwise, there are many financing options available. ADUs not only maximize a property’s potential but depending on the loan program, borrowers may be able to use actual or potential rent to qualify for the loan and can offset a portion of their monthly mortgage cost.

In fact, last year, the Federal Housing Administration changed its policy regarding ADU’s. In a historic move, the FHA started allowing rental income from Accessory Dwelling Units to be considered as a valid source of income when qualifying for an FHA-backed mortgage. This change, which comes after years of advocacy and research, marked a pivotal moment for aspiring homeowners across the nation.

The costs of building an ADU is typically much less than those of new single-family or multifamily units and can be relatively quick to construct. Some loan options for those looking to add an ADU include:

Cash-Out Refi – With just one monthly mortgage payment to manage, you can refinance your current home loan into a new one and receive a lump sum of cash at closing. That money can be used to cover the cost of building your ADU without taking out a second loan.

Home Equity Loan – Homeowners who took advantage of the historically low interest rates a few years ago may not want to give up that rate by moving to a new home. With a Home Equity loan, borrowers can increase square footage and keep their current mortgage and interest rate. In this scenario, a new loan is obtained on just the equity and given in a lump sum of cash that can be used to fund the ADU.

Home Equity Line of Credit (HELOC) – This program gives some flexibility. Tap into your equity as you need it during the ADU build, rather than getting all the cash upfront in a lump sum. You can borrow and payback in increments, paying interest only on the amount you draw.

Renovation loan – This is a great option for homeowner’s who want to add value, space, or income opportunity to their existing home or for potential borrowers who would like to purchase a property and add an ADU at the same time. FHA’s 203(k) and the Conventional HomeStyle loan allow you to combine the mortgage and renovation costs into one monthly mortgage payment.

As a Renovation Loan Specialist, MiMutual Mortgage closes a high number of these types of loans and has a dedicated Renovation Lending department to follow through with borrowers from application to after closing. (To learn more about the Renovation loan process, check out our segment on  “Designing Spaces” airing on Lifetime Network. WATCH NOW)

The Future of Housing?

As cities and small towns across America try to find solutions to affordable housing, removing barriers to ADUs may be the most practical way to increase both the number of housing units and the diversity of housing types available. ADUs will undoubtedly play a crucial role in meeting the demands of modern living.

Whether you’re a homeowner considering building an ADU or a buyer exploring your options, unlocking the potential of ADUs could be the catalyst that propels you toward your homeownership goals. If you would like to know more about the benefits and pathway to owning a property with an ADU, contact MiMutual Mortgage today!