How will an ADU affect property taxes and resale value?

A common pitch for accessory dwelling units is that building one adds a lot of value to your property.

However, how much it costs is a bit of a mystery. And that can be a problem for homeowners looking to build a home.

An ADU is more than just extra square footage, it’s a complete home with its own kitchen, bathroom, and utilities. If you decide to downsize and rent out your current home, you can use it as a home for your family, carers, residents, or even yourself.

But here comes the problem. ADUs cannot be sold individually, at least under current state law. Instead, it is just a further improvement of your property, similar to your home base. When you sell your home, you also sell your ADU.

And when the sale takes place, there is nothing written in the contract that indicates how much the buyer will pay for the ADU. There is one sale amount for the entire property.

Appraisers estimate the value of an ADU by comparing sales of homes with accessory units to other sales in recent months of homes of similar size, condition, and location that do not have an ADU. said. But even though ADUs have been booming since the state made it easier to obtain permits in 2017 (more than 20,600 ADUs were built last year alone), many companies with legal ADUs The house was not sold. This means that real estate appraisers don’t have as much data on comparable sales that are typically needed to determine property values.

For example, according to Zillow, 642 homes with about 2,000 square feet of living space were sold in Los Angeles in the past three months, but only 106 of them included ADUs.

As such, there are many different ways to estimate the value of an ADU, some used by property tax officials and others used by lenders and homebuyers. And for some homeowners, the former will be more expensive than the latter.

ADU and property taxes

Adding an ADU to your property will increase your property tax bill. According to tax authorities, your home will not be revalued, but the value of the ADU will be added to the value of improvements to your property.

Stephen R. Whitmore, a spokesman for the Los Angeles County Assessor, said the process for determining the value of an ADU is simple: “Our staff will determine the cost of construction.” The cost is added to your property’s current assessed value and is taxed annually. The county levies property taxes at a rate of 1%, and local parcel taxes and other levies increase fees by approximately 0.25%.

So if you own a $1 million home and spend $200,000 to add an ADU, your annual tax bill will increase by about $2,500, from about $12,500 to about $15,000.

Loans for ADUs

But what is the value of an ADU that hasn’t been built yet? Lenders will need a good estimate for this. This is because it affects the size of the loan you take out.

For example, Federal Housing Administration-backed renovation loans cover up to 97.75% of the property’s post-ADU value, and Fannie Mae supports refinances that cover up to 97% of the post-construction value. Other ways to borrow money for an ADU, such as a home equity loan or line of credit, typically have lower loan limits, but for some ADUs they can be as high as 90 percent of the property’s value.

Lenders rely on professional appraisers to estimate the value added by an ADU. Additionally, Fannie Mae and Freddie Mac have issued guidelines for assessing real estate with ADUs, but they seem to apply more to existing ADUs than planned ADUs.

Appraisers typically look at comparable sales when valuing a home, and also consider rental income if the property is being rented out. But real estate experts say there’s no standard approach when it comes to ADUs, at least not yet.

“If we had one or two products that were comparable to ADUs…it would make our lives easier,” said Dennis Dessee of Metrocal Appraisal in Livermore. “It’s hard to find one or two comps because ADUs haven’t had enough time to integrate into normal transaction flows. Ten years from now, we’re going to see a lot of them. ”

Meredith Stowers, a loan officer with Cross Country Mortgage in San Diego, said she has seen appraisers assign a value of $0 to a 1,200-square-foot, three-bedroom ADU. It’s possible to adjust the valuation to reflect the marketability of the property, she says, “but you need to ask a real estate agent (for an opinion) and do some additional research.”

Anthony Dedousis of Revival Homes, a Los Angeles-based company that helps homeowners find financing and contractors for ADU projects, said his company is overcoming the lack of ADU sales in individual communities. He said he is using a big data approach to do this. Since 2017, the company has collected sales data for single-family homes with ADUs across Los Angeles County and compared them to sales data for about 90,000 homes without ADUs. After adjusting for factors such as lot size, main home square footage, and zip code, “we found that a typical ADU adds 24%, or about $250,000, to the sales price of a single-family home in L.A. County.” he said. It ranges from 18% to 35% depending on the size of the ADU.

The company uses this statistical model to predict the value of a home after the ADU project is completed. This is taken into account when calculating the loan amount offered by our lending partner. Dedousis said this approach makes ADU projects much more viable for new homeowners whose borrowing is limited by a lack of home equity.

Newport Beach Mortgage Vintage offers ADU construction loans that are financed by investors rather than traditional lenders, giving the company more flexibility in its approach to valuations. Still, the company’s appraisers consider the same thing most appraisers do when valuing a property: comparable sales, construction costs and potential rental income, said Sandy McDougall, chief executive officer. CEO) said.

An evolving approach

As Stowers pointed out, a lack of data can lead to conservative assessments of ADUs. For example, in discussions about the value of ADUs in Los Angeles at the BiggerPockets forum in 2020 and 2021, real estate experts said the appraised value was well below the cost of constructing the ADU. “Based on conversations with loan officers, for every dollar spent on an ADU, approximately 55% (55 cents) goes toward appraised value,” one investor wrote in 2021.

Stowers said she has two clients who bought homes in Burbank for $1.3 million and then added $200,000 in ADUs. After construction, an appraiser valued the property at $1.4 million, she said. That means you’ve discounted the value of your ADU by 50%. Stower added that the property ADU offered was three blocks from Warner Bros. Studios, adding, “My appraiser was very excited about this property because of its incredible marketability and rental income. “We gave it a value of $1.9 million.”

“That being said, my appraiser usually gives a dollar-for-dollar value,” she added. In other words, they value ADUs based on their construction costs, the same way county appraisers do.

San Gabriel-based appraiser Jun Ho Lee said he has found that ADUs typically increase a property’s value by 10% to 20%. But location affects the value of an ADU, he says.

“You can’t give the same value to an ADU in Beverly Hills and an ADU in Compton, even if they’re the same quality, the same materials, the same size,” Lee said.

Like government agencies that purchase mortgages, lenders that issue mortgages have significant control over how ADUs are valued. And in Dessay’s view, lenders are becoming increasingly open to alternative ways to prove value and demand.

Real estate agents and brokers are a good source of information, he said. “Because they buy and sell on the market every day.” Their views may be subjective, but if the appraiser talks to them enough, he or she can probably get a “fairly reliable idea of ​​the range of value” for the ADU.