George Paquette,
Chief Operating Officer of Valligent
Imagine having an opportunity to not only own a home but to generate additional income through that same property. Sounds enticing, right? With policy revisions announced in mid-October 2023 by the Federal Housing Administration (FHA)1 and the U.S. Department of Housing and Urban Development (HUD) 2, this dream is becoming an achievable reality for many borrowers, especially in regions like California (CA) where Accessory Dwelling Units (ADUs) have become increasingly popular due to zoning allowances.
What Is Changing?
Three notable shifts due to the policy revisions is increased inclusion of ADU rental income, construction and rehabilitation boost, and expansion of eligible improvements. Let us look at each of these individually.
Increased Inclusion of ADU Rental Income: Before the policy revisions, rental income from an existing single unit on a mortgaged property was not considered when determining borrower eligibility. Following policy revisions, underwriting criteria for FHA-guaranteed loans can include 75% of estimated rental income.3 If you have a rentable unit on your property, three-quarters of its potential revenue can be factored into your loan qualification.
Construction and Rehabilitation Boost: Due to the policy revisions, the FHA’s Standard 203(k) Rehabilitation Mortgage Insurance Program now considers 50% of the estimated income from an ADU rental.4 This move facilitates the construction of proposed units, supporting homeowners wishing to build or upgrade an ADU.
Expansion of Eligible Improvements: As a result of the policy revisions, ADUs have joined the list of improvements that qualify for financing of FHA new construction loans.2 This means if you are considering building an ADU from scratch, you might be eligible for a loan. Moreover, appraiser guidance has been updated to incorporate ADU-specific instructions, ensuring a thorough and appropriate appraisal process.
Why Is This Happening?
The overarching motive to recent policy revisions is multifaceted:
Addressing the Housing Crisis: There is an evident shortage of affordable housing in several communities. By expanding loan criteria to consider ADUs, there is an encouragement for homeowners to increase housing supply, especially in high-demand areas.
Bridging Gaps: Homeownership and income disparities have historically been among different racial and ethnic groups. These changes aim to diminish those gaps, offering equal opportunity for all.
Building Wealth: As shared by the FHA commissioner, this policy is a stepping stone for many to maximize the advantages of homeownership and establish financial stability. By renting out ADUs, homeowners can generate a steady income stream, paving the way for long-term wealth creation.
Looking Ahead
While these updates from FHA and HUD are progressive, it is essential to understand that similar efforts have previously faced local opposition. However, there has been a growing public endorsement for ADUs as viable solutions to the housing deficit in many regions.
There is a unique opportunity in states like California, where zoning allows for ADUs and rents are higher than in most states. Homeowners can benefit from these revised FHFA policies and the regional infrastructure to genuinely harness the potential of ADUs.
Considering the average sales prices in Orange County and Roseville, CA as of October 2023, and using the current average high-balance FHA interest rate of 8.30%, an estimated cost of $200,000 to build an ADU, and average rental estimates for these areas (that is expected to increase), this is how an ADU and non-ADU purchase can be two very different scenarios.5
The introduction of new legislation in California, which facilitates the construction of Accessory Dwelling Units (ADUs), represents a notable advancement for homeowners. These additional units, such as guest houses or garage conversions, have the potential to increase property values due to their ability to offer additional living space or rental opportunities. The easing of restrictions on ADU construction has made it more feasible for homeowners to enhance their properties, potentially leading to an uptick in home value.
However, this development presents a challenge for appraisers, who are tasked with determining the value of homes. When ADUs have separate ownership from the main house, it becomes more complex to assess the overall property value. Appraisers must carefully consider market trends and lending standards in their evaluations.
Senate Bill 9 (SB 9) further complicates the residential landscape by transforming traditionally single-family zones. SB 9 aims to address these issues by allowing more homes to be built in these areas, which could help with the housing shortage and make neighborhoods more inclusive. However, this radical change has sparked concerns among residents about potential declines in property values, parking scarcity, and alterations to neighborhood character.
As California navigates the challenges of providing sufficient affordable housing, appraisers are adapting to these legislative changes. They must evaluate the added value of ADUs in conjunction with the evolving dynamics of the neighborhoods. These professionals are at the forefront of interpreting how such legal shifts will reconcile the objectives of equitable housing access with the desire to maintain the integrity of community standards. Until there are enough arms-length market sales of homes with ADUs with separate ownership, it will be a significant challenge for appraisers to determine the market’s reaction.
In Conclusion
These policy revisions present a golden opportunity for prospective and current homeowners. Whether you are a first-generation homebuyer or someone looking to leverage your existing property, the doors are now wide open. By embracing the potential of ADUs, you are not just investing in a home but a sustainable financial future.
Owning a home with an ADU presents a notable financial advantage for first-time buyers, especially with potential rental incomes, as highlighted in the scenarios above. This approach not only aids individual homeowners but also addresses the broader housing crisis by providing rental options. However, the benefits come with challenges, like property management and sharing space. Despite these, ADUs can be a strategic solution for younger generations, enabling them to remain in preferred areas rather than relocating for affordability to stay closer to family and friends. This is a welcomed update from Federal Housing Finance Agency (FHFA) to allow the inclusion of ADU rents to aid in the fight for home ownership affordability.
Sources:
1 U.S. Department of Housing and Urban Development. (2023, October 16). FHA info 2023-81 Publication of Final Policies for Accessory Dwelling Units . Hud.gov. https://www.hud.gov/sites/dfiles/SFH/documents/SFH_FHA_INFO_2023-81.pdf
2 U.S. Department of Housing and Urban Development. (2023, October 16). Federal Housing Administration expands access to mortgage financing for homes that have or will include accessory dwelling units. HUD.gov / U.S. Department of Housing and Urban Development (HUD). https://www.hud.gov/press/press_releases_media_advisories/HUD_No_23_237
3FHA. (2023, November 5). FHA loan with rental income and rental guidelines. FHA Lenders. https://fhalenders.com/fha-loan-with-rental-income/
4 SFH: 203(K) Rehabilitation Mortgage Insurance. HUD.gov / U.S. Department of Housing and Urban Development (HUD). (2023, October 1). https://www.hud.gov/program_offices/housing/sfh/203k
5 Figures are based off internal Valligent and Veros Real Estate Solutions data and analytics as of October 2023.
Additional Resources:
– Lee, S. (2023, October 16). FHA expands policies to boost financing for homes with adus. National Mortgage News. https://www.nationalmortgagenews.com/news/fha-expands-policies-to-boost-financing-for-homes-with-adus
– SB 9: The California Home Act. Senate CA Gov. (2021, August 10). https://focus.senate.ca.gov/sb9
– Los Angeles Times. (2023, January 18). A new California Housing Law has done little to encourage building, report says. Los Angeles Times. https://www.latimes.com/california/story/2023-01-18/new-california-duplex-law-housing-sb9-homeowners
