MW Homeowners are using this hack to cut their mortgage payments in half - and chip away at the housing shortage
By Aarthi Swaminathan
Homeowners in housing-starved areas like California have turned to a lower-friction way of adding supply
California homeowners are embracing tiny homes in their backyards - a movement that has offered a blueprint for cities across the U.S. that are grappling with a housing shortage.
High-school math teacher Kelly Abbott lives in Oakland, Calif., one of the most expensive parts of the country. When she first bought her single-family home in the Bay Area for less than $385,000 in 2012, she thought she had scored a good deal.
Little did she know that her good deal would eventually turn into her golden ticket.
The Bay Area, where Oakland is located, has some of the country's most restrictive single-family-zoning laws, which historians say have helped fuel enduring racial housing segregation across the U.S. Eighty-five percent of residential land in the Bay Area is single-family-only zoned, meaning denser forms of development such as apartments cannot be built there, according to a 2020 study by the University of California, Berkeley.
As a result, affordable homes in the region are rare. The average home in Oakland was valued at $741,000 at the end of October, according to an estimate by the real-estate platform Zillow (Z) $(ZG)$.
Seven years into living in her home, Abbott got an idea. She had heard that more people were building accessory dwelling units - an independent housing unit situated on an existing single-family lot - in their backyards. An online search led her to a company that built ADUs.
She was intrigued. As a full-time single mom, she wanted to keep her options as open as possible. Could she make the house bigger by adding an attached ADU to her primary home? Perhaps she could build a detached ADU in the backyard that she could rent out, or move into the ADU and rent the main house.
She called a mortgage-loan officer she'd worked with before, who revealed that her home value had gone up to $850,000 - meaning she could refinance her current mortgage to a higher value, given the equity she built up in her home, and use it to build an ADU. Abbott refinanced, raising her mortgage balance from $350,000 to $600,000 with an interest rate around 3.6%. She used about $215,000 for the construction of the ADU.
The effort paid off: Abbott's home value has nearly tripled in a little over a decade, she estimated, with the main home plus the ADU valued at over $1 million. The rental income from her ADU now covers about 60% of her mortgage payments, and she's on track to pay off her mortgage sooner than she was before the refinance.
And even with the ADU on her property, she still has enough yard space.
The move by Abbott and thousands of other homeowners across the U.S. to create additional housing units on their single-family lots presents one small piece of the solution to the country's ongoing housing-affordability crisis, advocates say.
Home prices and mortgage rates are too high for many Americans to afford. A typical family would need to make about $106,000 to afford a home worth $343,000 without stretching their financial limits, according to an analysis by Zillow in February. The company assumed a mortgage rate of 6.6% for its analysis.
Today's rates and home prices are even higher: The 30-year mortgage rate was over 7% as of Thursday, and the median price of an existing home in September was about $404,500.
California leads in ADU construction
In California, one of the most expensive states in the country, ADUs have become a common tool for getting around highly restrictive zoning laws that make it difficult to build multifamily homes.
In California, one in every five permit applications to build new construction in 2023 were for an ADU, according to data from the California Department of Housing and Community Development. Los Angeles led the state in terms of the number of ADU units permitted to be built that year.
That enthusiasm for building more housing without changing local zoning laws has spilled over to other cities and states, as well. New Jersey cities and towns such as Jersey City, Maplewood and Montclair, as well as states such as New York and Vermont, have ramped up efforts to entice homeowners to build an ADU on their property.
The cost to build an ADU can vary between $40,000 and $360,000, according to the home-improvement platform Angi $(ANGI)$ - depending on whether it's an attached or detached unit, whether the homeowner is converting a garage into an ADU, and other factors.
The New York program, announced last year, offered low- to no-interest capital loans and construction financing for 15 eligible homeowners to build or convert ADUs on their property. About nine homeowners were identified, New York City's Department of Housing Preservation and Development told MarketWatch, with four getting started with the process and five still pending income-eligibility confirmation.
The recent ADU movement is not exactly a brand-new idea, Yonah Freemark, a principal research associate at the left-leaning Urban Institute, told MarketWatch. "We've had backyard 'granny flats' for many decades," he noted.
What is new is that cities and states have been actively trying to promote ADU construction, he said, seeing them as a key to unlocking housing supply in cities that face a shortage.
The surge of interest in ADUs is but the latest chapter in U.S. policymakers' search for a solution to a shortage of affordable housing. Demand for homes has exceeded the number of homes available, with a present shortfall of about 1.5 million, according to the Mortgage Bankers Association.
Previous efforts have included converting unused or underused commercial spaces - such as abandoned factories or little-used office buildings - into homes, as well as adjusting current zoning policy to allow for more units and increasing density by building townhomes with two to four units in one building.
Some Southern U.S. cities have made significant headway in adding housing supply. In Austin, Texas, home building has ramped up so aggressively that supply has exceeded demand and home prices have fallen. The median price of a home sold in Austin as of Nov. 10 was 1.3% lower than it was at the same time a year earlier, according to data from the real-estate brokerage Redfin $(RDFN)$.
But challenges remain as these efforts nibble away at the core issue: Americans have a pressing need to buy homes, particularly in the big cities where they work, but there simply aren't enough to go around.
Challenges with building a backyard unit
Zoning reforms vary by city - and in many large cities, where homeowners have much of their wealth tied up in their homes, opposition to the construction of big apartment buildings has been strong.
Though ADUs are more palatable to many homeowners than the construction of new apartment buildings, the paperwork involved with building an ADU is not much simpler. Processes vary widely by town, city and state, Anthony Dedousis, the founder and chief executive of Revival Homes, a Los Angeles-based company that builds and finances ADUs, told MarketWatch.
The timeline to apply for and receive a permit to build alone can take anywhere from one to six months, Dedousis said. "If we are simply converting a garage, I generally tell customers to anticipate a four- to six-month process" regarding permits, he explained. "But if you are building from scratch, I advise people to expect six to nine months."
"So from start to finish, it is a one- to one-and-a-half-year undertaking," Dedousis said.
To sidestep delays and paperwork, some California homeowners have built illegal ADUs without the necessary permits. Between 2016 and 2020, nearly 80% of the ADUs built in San Jose were unpermitted, according to a Stanford University study published in June.
To be sure, the process of applying for and securing permits has been a pain point among all builders, not just homeowners looking to construct an ADU.
Across both blue and red states, the process needs much reform, James Gallagher, the founder and chief executive of GreenLite, a startup focused on making the permitting process more efficient, told MarketWatch. It's clear why local officials need to review construction plans to make sure necessary standards for fire safety and electrical compliance are met, he said - but the process can sometimes be confusing, and approvals can take a long time.
"Whether it's red states reducing regulatory barriers or blue states focusing on affordability and access, the underlying issue of inefficiency remains the same," Gallagher added.
ADUs sold as separate property
California lawmakers have also been introducing new rules to allow for more ADU development. The changes have created more incentives for homeowners to build tiny homes in their backyards.
Among the numerous ADU-related bills that California Gov. Gavin Newsom has signed into law, one enacted in January has changed the calculus for some homeowners by allowing ADUs to be sold separately from the primary dwelling unit. In other words, a homeowner can build a backyard ADU and create a condo that they can sell separately.
The fact that the ADU can both provide rental income and potentially be sold as a separate house made buying a property with an attached ADU all the more compelling, Karina Ramos, a 48-year-old lawyer from Los Angeles, told MarketWatch.
Ramos, a first-time homeowner, bought her home in the West Adams neighborhood of Los Angeles in 2022 for $1.12 million. The home came with a garage that the previous homeowner had been in the process of turning into an ADU, and they handed Ramos the documents so she could start construction. The clincher: The paperwork and permits had already been approved.
"I was renting before I bought, and so I know the market in L.A., and I just figured this is a great advantage to be able to have this as a guest house," Ramos said. "But, more importantly, to help with the mortgage."
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