What is an Accessory Dwelling Unit?
Accessory dwelling units (ADUs) are separate units located on or attached to an existing single family residence. The ADU could be in the form of a unit in the backyard, above a garage or in a basement. The ADU is considered part of the same main property and cannot be sold separately. ADUs are commonly built in order to provide rental income for the homeowner or to provide housing for a friend or family member.
Costs and fees for building an ADU can range from $100,000 to $200,000 for a new structure. ADUs typically have 850 square feet of livable space.
The recent passage of California Senate Bill 1069 has increased the interest in ADUs as the bill streamlines the process and drastically reduces fees.
Accessory Dwelling Unit Benefits
- ADUs can provide rental income for property owners.
- ADUs can be built economically.
- ADUs allow homeowners to keep a friend or family member nearby while still maintaining privacy.
- Recent legislation in California promotes the development of ADUs and reduces fees.
Accessory Dwelling Unit Loan Options
2nd Loan Against Property – For many property owners, it makes sense to keep their existing long-term 1st loan in place and request a 2nd loan for ADU financing. The property owner must have sufficient equity in the property so the proposed combined loan to value will remain at an acceptable level (65-70% max). While maintaining an existing 1st loan is often preferred, it is more difficult to fund larger 2nds and the interest rates are higher. A 2nd loan behind a relatively large 1st is more challenging to obtain.
New 1st Loan Against Property – If the property is currently free and clear, a new 1st loan for the amount of the ADU construction costs is the simple solution. If the property has a relatively small 1st, it may make sense to refinance the existing 1st with a new 1st which includes the funds for the ADU as the interest rates for a 1st are lower than for a 2nd.
Borrow Against Another Property – In some situations it may make sense for the borrower to secure an ADU loan against another piece of real estate instead of the property where the accessory dwelling unit will be built.
Accessory Dwelling Unit Loan Exit Strategies
Refinance – Since hard money loans for accessory dwelling units are short-term loans (1-3 years), the property owner will often refinance the ADU construction loan with long-term financing. After the ADU has been completed, the value of the property is likely to be considerably higher. This may allow for the property owner to refinance all existing loans and potentially even pull out some cash to invest elsewhere.
Sell Property – A property owner may wish to add value to their real estate by building an accessory dwelling unit prior to selling. Selling the property would pay off the ADU loan.
Pay Off ADU Loan – In some situations the ADU construction loan amount may be small enough so the the borrower can pay off the loan balance with funds from other sources.