REAL ESTATE

Is California’s ADU Law the Beginning of a New Era in Housing?


On June 11, the city of San Jose became the first municipality to update its zoning code in accordance with California Assembly Bill 1033, which went into effect at the beginning of the year. The law allows for local ordinances that permit homeowners to sell accessory dwelling units (ADUs) as condominiums, but cities must opt in. 

AB 1033 is one of many state policies aimed at encouraging affordable housing development that have been enacted in California since 2017, many of which focus on increasing ADU production. As the state removed obstacles and closed local loopholes that impeded new construction, ADU production exploded in California, increasing by more than 15,000% between 2016 and 2022, according to research from the California YIMBY Education Fund. Last year, ADUs accounted for about one in five newly created housing units in the state. 

So far, most homeowners are building ADUs to house family members or generate rental income. About 27% of the ADUs completed since 2018 are considered affordable to families earning below 120% of the area median income. 

But, AB 1033, if adopted by more cities, has the potential to impact homeownership rates in California by increasing the supply of affordable starter homes. Currently, the median household income in the state is not enough to meet lender requirements for a mortgage on a bottom-tier home. 

The reform also provides opportunities for investors and existing California homeowners since ADUs are generally cheaper to build than single-family homes and have the potential to be very profitable. Still, there may be challenges to selling an ADU as a condo in California, and it’s unclear whether the strategy will take off now that the state has lifted restrictions. 

An Opportunity for California Property Owners and Prospective Homebuyers

San Jose’s new ordinance, which will take effect July 18, allows local homeowners to sell their ADUs and primary residences separately as condos that share the same property. Previously, the sale of ADUs as condo units was only permitted under limited circumstances. 

While San Jose is the only city that has changed its zoning code since the state lifted restrictions, other cities are likely to follow—the Berkeley City Council has already voted to adopt AB 1033 in 2025. 

A previous law, SB-9, allowed homeowners to split their lots and build additional single-family homes, but the reform had limited impact. Cities were given the freedom to set their own guidelines for SB-9 projects, which were often burdensome, and the process was costly. Legal challenges were also an obstacle in many cities. 

Several previous changes to state law also made it easier to build and rent an ADU, and new financing options allowed homeowners to qualify for a construction loan using the projected rental income. That strategy has become more popular than lot splits, but not all homeowners are interested in becoming landlords. 

AB 1033 provides another avenue for homeowners to cash in on their properties while also allowing for the construction of more affordable homes. For example, retirees could build ADUs and use the money from the sale to support aging in place, while first-time homebuyers comfortable with less square footage could have a better shot at qualifying for a mortgage. Existing homeowners wouldn’t be required to sell their primary residences in order to cash in, potentially removing the lock-in effect of high mortgage rates and increasing housing inventory. 

To legally sell an ADU, property owners would need to establish a homeowners association (HOA) to oversee the maintenance of shared exterior spaces, such as a driveway or a shared roof if the ADU is attached to the primary residence. Owners would also need to notify local utility companies that they plan to convey the two units separately. Property taxes would be assessed on each unit individually, but it’s unclear whether that would lead to a net increase in city revenue.

Property owners seeking a separate conveyance for an ADU must also get consent from their mortgage lender and any other lien holder. That would impact any property owner who does not own their home outright, and the mortgage lending industry’s response could determine the extent of the bill’s impact on housing affordability. 

AB 1033 gives municipalities some flexibility when opting in, so the requirements and review process may vary across cities that choose to amend their zoning codes. 

Obstacles May Interfere with the Goal of AB 1033

Generally, AB 1033 makes it easier for homeowners to obtain ADU construction permits and sell ADUs separately from their primary residence. However, there are still a few hurdles that could prevent homeowners from taking advantage of the reform. 

The most obvious problem is that homeowners with mortgages would need to obtain their lender’s consent. By requiring this step prior to an ADU sale, the law protects homeowners from unwittingly triggering the due-on-sale clause in their home loan agreement.

But it’s not clear whether mortgage lenders would be willing to authorize these transactions. AB 1033 states that homeowners may need to meet additional requirements to get lender consent, which could be as simple as changing the legal description of the property or as infeasible as paying off the mortgage entirely. 

Lenders tend to charge slightly higher interest rates for condos because the unknown variables of the other unit owners and the HOA increase the risk of lending, so it doesn’t seem likely that a lender would be willing to allow a borrower to sell a portion of their property while keeping the rate and terms of their single-family mortgage. That said, property owners who want to build and sell an ADU have options: They can refinance with a loan product such as the CHOICERenovation mortgage or the HomeStyle Renovation mortgage

But access to financing may not override the lock-in effect of today’s high mortgage rates. Borrowers with low rates on their current mortgages would need to weigh the benefits of the investment against the higher interest rate on the new loan. And while adding an ADU to a primary residence as a rental property can significantly increase the value of the original home when sold to the right buyer, selling off a portion of a land parcel and re-categorizing the single-family home as a condo might decrease the value of the original home. The many trade-offs and potential legal issues would most likely require that homeowners get professional advice before attempting the sale. 

With these concerns in mind, AB 1033 may not provide much additional incentive for ADU construction in the cities that opt into the measure. Critics of the legislation also question whether it will increase the supply of affordable housing or impede other, more effective programs. AB 1033 doesn’t contain any affordability requirements for developers, and city housing staff would need to devote time to implementing the new rules, potentially delaying other established housing priorities. 

While it’s clear that relaxed zoning rules in cities like Seattle, which also allow ADUs to be sold as condos, have resulted in an increase in ADU permits, there’s little evidence about their impact on affordable housing. Only a small share of Seattle’s ADUs are on condo parcels, and while those units sell at a lower price, the sample size is small. 

If ADU condos do take off, that could offer investors the chance to enter sought-after California markets at a lower price point. Investors would also have multiple options for getting a return from ADU construction. 

Research shows that ADUs increase a home’s value by an average of 35% in large cities, which could make flipping a potentially successful strategy, though there isn’t yet data on how conveying the two units as separate condos would impact the total value of the property when compared to selling both units in the same deal. Rental restrictions and owner-occupancy requirements vary by municipality in California, and cities that adopt AB 1033 have some flexibility with these requirements when issuing permits. 

But an investor could potentially rent out one or both units, or sell one as a condo and rent the other. It’s good to have options, but choosing the right strategy requires careful analysis of individual factors, such as the lot, the neighborhood, and local laws. 

The Bottom Line

ADU reforms in California, Seattle, and Portland have led to booming ADU construction, and any endeavor that can positively impact the supply of homes at a relatively low cost to local governments could be worthwhile. Dozens of cities have approved ADU reforms in recent years, according to the U.C. Berkeley Zoning Reform Tracker, and the impact of these changes could be meaningful. 

But it’s still unclear whether AB 1033 will meaningfully increase ADU permits in California above and beyond the great results the state has seen from removing barriers to ADU construction and whether cities that opt in will see an increase in affordable housing. A major obstacle could be the discretion of mortgage lenders in “condoizing” a borrower’s property. 

If the legislation does lead to more ADU sales, that could lower the barrier to entry for investors looking to break into high-priced California markets. Those looking to buy a single-family home and add an ADU also have financing options and could potentially profit in multiple ways, with AB 1033 providing additional avenues for investment. 

Ready to succeed in real estate investing? Create a free BiggerPockets account to learn about investment strategies; ask questions and get answers from our community of +2 million members; connect with investor-friendly agents; and so much more.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.



Source link

alabamadigitalnews-com.preview-domain.com