ADUs could remedy America’s housing crisis, but obstacles remain

Industry veteran Bill Dallas, chairman of Dallas Capital and former president of Finance of America, says accessory dwelling units (ADUs) still face major hurdles before they can become a reliable solution to what he calls the nation’s “largest social challenge:” affordable housing.

“One of the challenges… is that the laws are so difficult and varied by not only by state, but also by federal, state and local laws that all have to align,” Dallas said in an interview with HousingWire. “I think the way to think about ADUs, is that Fannie Mae and Freddie Mac and Ginnie Mae were created for owner-occupied, single-family homebuyers and the single-family home has materially changed in its use.”

His comments come as lawmakers in D.C. push to make ADUs more accessible. In July, Reps. Sam Liccardo (D-Calif.) and Andrew Garbarino (R-N.Y.) introduced the SUPPLY Act (H.R. 4568), a bipartisan bill that would help homeowners finance accessory dwelling units (ADUs), also known as backyard cottages, granny flats or in-law suites. 

If made into law, the proposed bill would allow homeowners to access federally backed, second-lien mortgages to help fund the construction of ADUs, which have otherwise been financed through home equity loans or savings.

Several housing organizations, like the National Association of Home Builders and Mortgage Bankers Association, have expressed support for the legislation, arguing that it will open doors for homeowners and would-be homeowners to build generational wealth and equity. The move would also address the nation’s housing supply crisis.

Still, industry leaders caution that federal backing alone won’t solve all the obstacles. Challenges around valuation, underwriting and builder capacity remain barriers to scaling ADUs into a widespread affordability solution.

A curveball to the GSEs

According to Dallas, how to appraise and build an ADU are two nuances that could vary, adding to the overall “risk” of the product.

“If you let everybody on the planet build an ADU, they will all build it differently, right? That’s an appraisal problem. In addition, Fannie and Freddie are in limbo, so they’re not going to do anything that exacerbates the current challenges they have…you have no established market for a mortgage secured by an ADU. Agency validation is in limbo,” he said.

Dallas says that ADUs are essentially a curveball to the GSEs. “If you think about the crux of the challenge, Fannie Mae and Freddie Mac are built upon owner-occupied single-family dwellings to one borrower and one use. So when you add an owner-occupied property and you sort of now make it an income-producing property, you thwart the entire practice of how the agencies operate.” 

A clear-cut loan type

Scott Bailey, the co-founder and co-CEO of Bequall, a company that designs, manufactures and installs ADUs, says that this potential law is a step toward establishing ADU policy that will help to eliminate the risk and underwriting concerns often associated with the product.

For instance, Bailey says that if a borrower wants to build an ADU in their backyard, the bank will likely only give them a HELOC, which is based on the equity already in the house, not the future value that an ADU might add.

Banks don’t have a consistent way to appraise or underwrite the new use (the ADU itself), so financing is limited. A federal framework for valuing ADUs would give lenders the confidence to finance them more widely, Bailey says.

“There are a lot of things that are hard to underwrite, [but] if you could have someone like HUD create a standard for how that gets completed or valued or structured, that they then kind of guarantee or ensure, or whatever the mechanism becomes to doing that, then you incentivize private lenders to get into the space,” Bailey said.

Additionally, there needs to be a clear-cut loan type for ADUs, Bailey says. “But the problem is, right now, a second-position loan is assuming fixed risk, so that’s like one of the other challenges. And maybe, it just may be you have to break the loan in two, where it is basically a bridge loan for the construction, but then a much more favorable, low-cost permanent financing that incentivizes the banks to want to do it.”

Federal financing needs to accommodate the modern-day buyer

Dallas commented that the use and building of ADUs in densely populated areas builds upon a shifting culture of multi-generational housing and an ever-changing consumer. And, as a result, federal financing giants need to accommodate the modern-day buyer or investor.

“Everyone wins, right? The homeowner wins, the property investor wins, the tenant wins, labor wins, the environment wins. We get to use existing housing and we get to help solve this issue. There’s a green effort, and there’s a social effort of being a part of solving a very complicated problem,” he said.

A bigger issue at hand, Bailey points out, is the barrier to entry for small builders, especially as ADUs become more popular amid the housing inventory shortage. In Sacramento, for example, Bailey says that 75% of new homes are built by big, public companies.

If HUD or lenders created scalable financing products for small “infill” builders, it would lower barriers, let them grow and shift more housing production back to local builders who are invested in their communities. “When you’re smaller, you can be more nimble, you can react more to local dynamics. You know the neighbor you’re building next to,” Bailey said.