Will Adding ADU’s in Los Angeles Turn my Triplex into Commercial?

Question

Hey Y’all!

I just closed on my first househack deal! It’s a triplex in LA. I’ve got a 600 sqft garage that I may expand to make 2 studio ADUs. My concern is that doing so will result in a breach of my loan with the bank, or convert the building to commercial status?

I could also just add 1 adu instead of 2 and play it safe?

Any advice/thoughts on this?

Patrick Godfrey · Answer

Thank You guys for your input! I think I’m just going to go ahead and do it. I really plan on holding this for a long time. My terms are unbelievable and my interest rate is 1.125% so probably not refinancing. Although I may take a HELOC if it’s at all possible. Again thank you for your input!

Dan H. · Answer

Nothing you indicated is incorrect, but 1) If the F/F rule is enforced it will affect his ability to extract equity via a refinance.  In Los Angeles it is rare for loans to hit 10 years.  The property is virtually always refinanced/financed in less than 10 years.  If the property has value adds such as adding an ADU or two, there is a good chance the investor is planning on refinancing to obtain better terms and extract some of the expense of the ADU additions.  Investor may not be able to refi via F/F.  2) If enforced it already means he looses his option for conventional F/F loan for adding the first ADU which in effect makes his question moot.  Adding one or two ADUs could mean conventional F/F loan is unavailable and that he will need to look for alternate financing (commercial, portfolio loan, hard money, loan kept within the institution, etc.) to refinance.  Similar, buyers on current investor exit could have the same limitation on financing.

RE that does not qualify for F/F financing traditional sells at a significant discount compared to property that can obtain F/F financing.  Note with current rates, 1% rate increase amounts to nearly 25% cost increase.   The discount should reflect the cost increase.

As I indicated I am aware of cases where the F/F rule against financing ADUs added to multiplexes were not enforced.  However, I also have heard of cases where it is enforced.  A local lender could maybe provide a good risk assessment.

Like many things in life, do your research.  I do not want the investor to add the ADU being unaware of the rule.  They then go to extract their ADU costs and place the financing into a nice F/F loan to be told "sorry the RE no longer qualifies for F/F financing and the loan I can get you is so bad that it does not make sense in your case.".

Matt Devincenzo · Answer

Like @Dan Heuschele mentioned F/F does not allow for underwriting a new loan on a MFR with an ADU(s), but there is no provision allowing them to call your loan if one is added that I am aware of. There is a rider that states you won't have the property 'rezoned', but the addition of ADUs isn't a rezoning, so I don't believe they'd have much to pursue there. So while it is definitely something to consider with regards to resale/exit, you could still build and keep your F/F loan in place.

Dan H. · Answer

I want to start with verifying that you know Fannie/Freddie guidelines currently do not allow their use when an ADU is added to a multiplex??? I have seen this restriction ignored, but I also have heard of it being enforced. If you are not aware of this F/F restriction, I suggest you do your research before pursuing an ADU addition to a multiplex.

Note if F/F financing is not available with the addition of a single ADU, it implies that you already are losing the traditional conventional residential financing when adding 1 ADU and your question on adding 2 ADU units is really the same as adding a single ADU unit.

If the F/F rules agaist financing a multiplex with ADU is enforced, a conventional residential loan is not available after adding one ADU.  Any financing will need to be other than F/F.

In the case where the F/F rule against financing a multiplex with an ADU is enforced, adding 2 ADUs is similar to adding 1 ADU because in both cases the traditional F/F financing is unavailable.

I suggest you have a discussion with a lender that you trust before adding a ADU.

Good luck