The U.S. is facing a severe housing shortage of millions of homes and it’s not hyperbole to call California ground zero for the problem. The Golden State’s housing crisis is the “most serious economic, social and political issue” at this time, particularly for families in the lower income brackets, according to the nonprofit newsroom CalMatters.
The shortfall stems, at least in part, from rising rents and outdated zoning laws. California’s state government has set a goal of paving the way for builders to construct 2.5 million new homes in the next eight years to meet this chronic shortage.
One of the ways that the state hopes to accomplish this task is through the construction of accessory dwelling units (ADUs) in California’s housing market. These units are secondary homes on a property that can be used for family and friends or rented out for secondary income. ADUs accounted for 20% of all new home construction in California in 2023, twice as many as in 2020, according to Yahoo Finance.
California lawmakers also are making it easier to build ADUs in California. One bill passed removes the need for homeowners to live on-site, giving property owners more flexibility in renting out ADUs. Another allows ADUs to be sold separately from the primary home, opening new opportunities for investors.
Other bills would speed up the permitting process, requiring local agencies to approve or deny ADU applications within 60 days. Pre-approved ADU designs, set for 2025, are expected to further simplify construction, fueling greater growth statewide.
Unique opportunity
Even with ADU development gaining traction, financing these projects remains a hurdle. With traditional lenders unfamiliar with ADU structures and cautious due to the unconventional nature of these loans, many homeowners turn to private lenders. Banks and other conventional lenders may not know how to classify ADUs.
This creates an opportunity for private lenders to offer both initial construction loans and refinancing. The initial loans are often structured as bridge loans, allowing homeowners to get the project done and refinance later with conventional sources. That presents an opportunity for originators and private lenders alike. They can originate two loans: a bridge loan and then a refinance after the project is completed.
Proper documentation becomes key in securing favorable refinancing later, avoiding potential roadblocks during the loan process. Ensuring the loan documentation includes accurate zoning approvals and detailed property descriptions is essential to avoid complications. Clear documentation of the ADU’s purpose and structure is important to ensure lenders and borrowers are aligned, particularly during refinancing when stricter underwriting standards may apply.
Mortgage originators have a unique opportunity to tap into the ADU market. In particular, originators focusing on older neighborhoods — especially those developed in the 1960s and 1970s, which tend to have bigger lots and smaller homes — could be well-positioned. However, some neighborhoods, such as those around beaches, are too densely packed for ADUs. Use data and technology to identify prime markets for ADU growth.
Originators should also create a strategic plan that includes building relationships with contractors, real estate professionals and homeowners. There are more than likely people building ADUs in your area. Market to them, show what you can offer and how you can support their projects.
Immediate solution
As California’s housing market continues to face a severe shortfall, ADUs offer an immediate, practical solution. In addition to increasing the housing supply, ADUs can help lower rental inflation by providing smaller, affordable units in established neighborhoods.
Not everyone welcomes ADUs into their community, however. While the housing is needed, homeowners in established neighborhoods have concerns about traffic and safety. This will take some push and pull. While property owners should have their rights respected, there’s a need to find other places to put people.
Homeowners associations’ objections, zoning laws and setbacks are no longer the obstacles they once were in California. The Golden State’s legislative changes have streamlined the ADU approval process, making it easier for homeowners to move forward with their housing projects.
The housing shortage will be even more pressing in the coming decade as millennials and Generation Z both age into professional careers and seek to purchase homes. The most stubborn part of inflation today is the price of rent, and that’s because there’s simply not enough housing.
Homeowners stand to benefit both from the immediate rental income and the long-term appreciation of their properties. While ADUs are starting in California, it’s likely to spread to other parts of the country. It’ll be a popular loan product for originators, helping people find housing, realize wealth and make money in the process.
In areas with high housing demand, such as major cities, this dual benefit of easing housing shortages and increasing property value makes ADUs a particularly attractive investment. Homeowners in these regions stand to benefit both from the immediate rental income and the long-term appreciation of their properties. ADUs are an investment that serves both the homeowner and the community’s broader needs.
National shift
California has led the way in using ADUs to address the housing shortage, but expect this trend to expand into other states, particularly in high-growth metropolitan areas. States like Texas and Florida, where sprawl is an issue, are likely to adopt ADU-friendly policies to address housing demand.
“California has led the way in using ADUs to address the housing shortage, but expect this trend to expand into other states, particularly in high-growth metropolitan areas.”
The COVID-19 pandemic has increased demand for flexible living arrangements, including ADUs. Since COVID, more people want to work closer to home, reducing traffic, smog, and commute times. This shift toward sustainable living, combined with California’s legislative actions, is positioning ADUs as a central housing solution.
There is also a growing need for vertical development in urban areas as land becomes scarcer. Going vertical seems like the only way forward in the long term. High-rise residential buildings have become more common in places like Orange County. While ADUs offer an immediate solution, higher-density housing will be the next logical step in densely populated areas.
A national shift fueled by federal pressure on states to ease zoning restrictions to address the housing crisis could be in the offing. Along with Florida and Texas, states facing significant housing shortages —such as Washington, Colorado and New York — are likely to adopt similar policies and encourage ADU growth. It’s starting in California, but will likely spread.
