Adding an ADU to a Multifamily Property

An Accessory Dwelling Unit (ADU) is an additional structure designed for permanent housing built on a property that already has a primary home or dwelling. They are often referred to as guest houses, casitas, granny flats, or backyard cottages. These secondary units have their own separate entrance as well as a kitchen, bathroom, and living space. ADUs can be built on single-family or multifamily lots. ADUs have gained significant popularity in California due to changing laws allowing property owners to streamline the process of constructing ADUs.

Multifamily owners looking into adding ADUs to their property must be up to date on ADU regulations, how these units affect their property’s overall value, the average costs of building them, and how their property taxes will shift after making the addition. Deciding to make this type of investment has several benefits, but in order to reap the full benefits of an ADU, multifamily property owners must have a comprehensive understanding of the entire process.

California ADU Regulations

California stands out among a limited number of states where constructing an ADU is becoming more feasible, courtesy of recent modifications to state laws that have simplified the process of obtaining a building permit. Furthermore, the state has enacted legislation that puts a halt to cities implementing regulations that overly hinder the construction of ADUs.

Due to the implementation of this new legislation, the construction of ADUs throughout California has experienced a significant increase. As of the previous year, approximately one out of every seven homes granted permits in California were for ADUs. In 2022, accessory dwelling unit production increased by 60.6 percent, with the state adding 20,638 ADUs in one year.

Here are a few key points regarding the recent ADU laws that came into effect in January 2023, according to EZPlans:

• Revised Assembly Bill 2221:

Under the revised Assembly Bill 2221, it is now mandatory for all entities responsible for evaluating ADU plans, such as planning departments and utility companies, to respond within 60 days of the plan’s submission. This modification will result in a notable reduction in the duration of application review and processing.

The bill also changed the height restrictions for ADU buildings. Under any circumstances, a height of 16 feet or below is permitted. Next, if the proposed ADU is within a half-mile of public transit or if the property already has a two-story multifamily dwelling, an 18-foot-tall building is allowed. Additionally, suppose the ADU is attached to the primary dwelling; in that case, its height can reach up to 25 feet, depending on the underlying zoning code of the property, with the lowest applicable height regulation being the determining factor.

• Redefined Setbacks:

In 2022, minimum setbacks of four feet from the side and rear lot lines were required for new construction ADU of any size, both attached and detached. As of 2023, if the size of a proposed ADU is below 800 square feet, the front setback requirement will no longer serve as an obstacle to the construction of the ADU.

• Senate Bill 897:

According to California Building Officials, Senate Bill 897 introduces fresh guidelines building departments must consider when granting permits for ADUs. Initially, it mandates local agencies to simultaneously review and issue a demolition permit for both the proposed ADU and any existing detached garage. Additionally, the bill prohibits local agencies from refusing ADU permits based on nonconforming zoning conditions, building code violations, or unpermitted structures that do not pose risks to public health and safety.

ADUs and Property Taxes

Property taxes are determined by the assessed value of the property rather than its current market value in the state of California. As a result, the property’s assessed value is likely to closely reflect its value at the time of purchase.

However, concerns arise among multifamily property owners when considering the construction of an ADU, fearing that it will lead to a significant increase in property taxes. Fortunately, building an ADU does not require a reassessment of the primary property’s value. Instead, the county tax assessor conducts a “blended assessment” by estimating the value of the ADU, usually based on its construction cost. This value is then added to the current assessed value of the property.

Importantly, the assessment for the primary property remains unchanged, meaning that the property taxes will only increase based on the additional value created by the ADU.

Upon completion of an ADU project, the property taxes will only increase proportionately to the added value of the ADU. The taxes paid for the primary property will remain unaffected by the ADU construction, allowing multifamily owners to enjoy the benefits of their ADU without a significant tax burden.

Adding Value with an ADU

Although constructing an ADU will lead to a slight increase in property taxes, the magnitude of the tax hike is relatively insignificant compared to the substantial value that an ADU can add to any multifamily property. In the Los Angeles region, adding an ADU can increase the property value by around $500-600 per square foot, according to Revival Homes.

Multifamily property owners can also make up for the increase in property taxes by renting out the ADU, which can significantly increase the current cash flow at the property, effectively paying for itself. Rents vary depending on the neighborhood/size of the ADU, but in many cases, the income from the ADU exceeds the income of a similar-sized unit.

It is crucial to consider that the exact value enhancement of an ADU depends on the specific location within the area.

How Much Does Building an ADU Cost?

The cost of building an ADU can vary significantly based on a number of factors. The main one is whether it is a newly constructed unit or if you are converting an already existing space at your property. The size, location, fixtures, and finishes also can add to your costs.

According to Revival Homes, a rough estimate suggests an ADU costs approximately $250 to $300 per square foot if constructed in a converted space, such as a garage or a rec room. For a brand new construction ADU, costs can be anywhere from $350 to $450+ per square foot range.

ADUs and Rent Control

In many cases, California state and local rent-control measures do not apply to the ADUs themselves. However, it is important to understand how it can reclassify the existing units.

Constructing an ADU changes the classification of a single-family property to a multifamily one because both structures exist on the same lot and cannot be sold separately. This transition from a single-family property to a multifamily one brings about the application of a new state law that protects tenants and certain ordinances in specific cities, which would not typically apply to single family homes.

The existence of multiple state, county, and city laws has resulted in a complex and confusing combination of rent control and tenant protection regulations for ADUs.

The following are the primary factors determining whether rent controls will apply to a property after constructing an ADU:

• In 2019, California passed Assembly Bill 1482, a tenant protection and rent control bill. This rule includes all parts of the state that do not have local rent stabilization legislation, such as Pasadena, Long Beach, Lancaster, and Torrance. The state’s rent caps apply only to properties constructed after the municipal rules have expired. Under AB 1482, landlords can annually increase rents by five percent plus the inflation rate in their metro area, up to a maximum of 10 percent. However, this limit only applies to structures that are at least 15 years old and will expire in 2030.

• State law does not prevent more stringent rent increase limits set by local ordinances. The properties covered by rent control can vary from city to city. State law also prohibits local governments from implementing rent control on units built after Feb. 1, 1995, unless they replaced older units under rent control. Depending on the city, local rent increase limits usually apply to considerably older rental properties.

• The classification of the ADU as attached or detached can affect its inclusion under rent stabilization ordinances. In Los Angeles, a detached ADU is exempt from the local rent stabilization ordinance, while an attached ADU falls under the ordinance if the main house was constructed before October 1978. However, new ADUs must comply with other tenant protections and eviction restrictions as per the Costa-Hawkins Act.

Benefits of Investing in an ADU

It has never been easier to get an ADU approved or built. With the lack of available housing nationwide, adding an ADU offers several benefits for any owner. Some of those benefits include:

• Increase Overall Property Value:

An ADU increases the property’s square footage and functionality, making it more appealing to prospective buyers or investors.

• A Source of Additional Rental Income:

Adding an ADU is not just limited to multifamily investors. Homeowners with extra space can also take advantage of adding a rental unit to their primary residence to provide an additional source of income.

• Portfolio Diversification:

Adding an ADU to a multifamily property diversifies the owner’s rental income sources and enables you to expand your portfolio by incorporating an extra unit. If one of the apartments is vacant, the income from the ADU can assist in offsetting the loss and offer a more constant cash flow. Remember, only new construction ADUs are exempt; converting an existing structure would give it the same rent control rules as the main structure.

• Fast-Tracked Permitting Process:

This benefits owners seeking to increase their property’s value, generate rental income, or provide additional living space for family members or tenants. The fast-tracked permitting process contributes to the overall promotion and expansion of ADUs, encouraging affordable housing options and addressing the growing demand for housing in many communities.

Being aware of the opportunities available when it comes to ADUs will help you to increase your bottom line, differentiate your property in the market, and add value when it comes time to sell. For more information regarding ADUs, please connect with a Matthews™ agent to help decide if this investment is worthwhile for your property.