How accessory dwelling units could relieve the inventory squeeze

An answer to the housing supply crunch could be in your own backyard.

With a rush of consumers ramping up for the spring homebuying season, many will find the cupboards bare while others will face heavy competition for the few listings available. The number of for-sale homes hit an all-time low of 497,909 in February, falling 40% year-over-year, according to a report from Redfin. This drove a 15% annual spike in the median sales price.

The Biden administration made clear its intentions to boost accessibility to a greater supply of homes and better affordability, since skyrocketing prices disproportionately impact first-time homebuyers and lower income folks. As traditional single-family home construction becomes increasingly expensive, another avenue needs to be opened to help satisfy demand.

Enter accessory dwelling units: secondary residences built on a primary home’s property. Also referred to as in-law apartments, carriage houses or granny flats, use of these units as separate residences is gaining traction around the country. But a number of hurdles must be overcome before they can make a substantial impact on overall inventory.

It’s “basically impossible” to get an exact count on how many ADUs currently exist in the national marketplace because many localities don't track how many ADUs they permitted, said Emily Hamilton, senior research fellow and director of the Urbanity Project at George Mason University’s Mercatus Center.

However, in an analysis from 2020, Freddie Mac identified an approximate total of 1.4 million properties with an ADU. The latest Census Bureau data estimates there are 79.3 million single-family detached homes in the country.

Conservatively, if one out of every 12 homes added an ADU, 6.6 million units of housing stock would be added to the national inventory. Of course, some would be used as rental spaces. But if they’re used for family members — especially those aging out of homeownership — it would open up the homes they occupied previously.

The challenge lies in making that happen. The lack of a broad loan type specifically geared toward ADUs puts up one roadblock for interested borrowers. Currently, homeowners have to decide between a cash-out refinance, a construction loan or a home equity line of credit.

However, all of those miss a critical component of the home’s future value. The ideal financing would lend on after repair market value of the home and — if the intent is to rent it out — count the estimated rental income towards the borrower’s, according to Laurie Goodman, Urban Institute vice president and co-director of its Housing Finance Policy Center.

“If you look at Fannie, Freddie, FHA and VA and USDA, about 70% of the financing market is government,” Goodman said in an interview. “Government entities have to step up and lead the way because products are created and standardized based on market conditions and major clients.”

Rising demand could make a push for the loan type to be generated, making it easier to finance ADUs at scale.

In addition to federal lending, the other hurdle comes at the state and local level. Getting around the intricacies of zoning regulations — not to mention NIMBYs — adds difficulties for ADU construction, according to NerdWallet’s home and mortgage expert Holden Lewis.

“Many places have maximum square footage restrictions for every lot and most homes are built up to that threshold so it has to be conceived when the house is built,” Lewis said. “The Biden administration wants to target this to modernize housing regulations as a stick and a carrot of reformed zoning and giving grants to local governments.”

While the federal government is limited in how much it can affect land-use policy directly, it can try to encourage localities to extend ADU permits and planning. And because so many homeowners would want to benefit from their increased flexibility, ADUs are often the most politically feasible way to reform land-use regulations to allow for more housing built, according to Hamilton. If policymakers want to address the supply and affordability problem, altering the ordinances would get the ball rolling.

“Owner occupancy and parking requirements are common ADU killers,” Hamilton said. “Some places require a subjective review to ensure the ADU fits the neighborhood character, which adds delay, uncertainty and expense for homeowners, likely turning them off from pursuing an ADU altogether.”

In-law apartments made the largest strides in markets with a combination of strained supply, affordability issues and a housing stock suited to accommodate the additional units. Over the last few years, California and Oregon made ADUs permissible as a matter of right, and individual metros like Minneapolis, Arlington, Va., and Durham, N.C., stand out as well.

"Affordable housing is sought after more than ever, especially with rents skyrocketing,” said Dan Holtz, CEO of Sovereign Lending Group. "California is definitely a big market for these types of units and they’re gaining more popularity in expensive areas.”

Based in Costa Mesa in Southern California, Holtz and SLG expect an uptick in ADUs and more lending to be done for them as interest rates remain low.

Some momentum can be seen in sprawling, car-centric suburban-type cities like Atlanta, Austin, Texas, Denver and across the sunbelt. Aiding this progression are prefabricated ADU manufacturers who are popping up in the cities with the most demand. Going this route cuts construction time, eliminates most regulatory steps and provides homeowners with a set cost, knowing exactly what the finished project entails and looks like.

“That's probably the easiest and usually cheapest way to add an ADU,” Hamilton said. “There's just a lot less uncertainty to the process for a homeowner who might not have any expertise in home building or interior remodeling.”