Hi,

Sorry if this has been covered before. The only thread I could find on this topic was pretty old ...

I have a 4 unit building in Los Angeles that I am considering adding two additional ADU units. I have heard mixed answers to the question of if I build these two accessory units, will I have to use commercial finance going forward, and or will this limit my buyer pool to those with commercial lending?

The bulk of the information I have seen is that we are in a sort of grey area, especially because the ADU laws around apartment buildings are fairly new in Los Angeles. Some have said that because these are accessory units not physically connected to the existing building that I can (i) maintain my current residential financing and (ii) I should not need to use commercial financing should I wish to refi/ a future buyer should be able to get a conventional mortgage. Others have advised that no, it will be considered larger than 4 units and thus require commercial underwriting/ loan.

Does anyone have any practical experience with this?  I will certainly consult with my mortgage broker when I am closer to pulling the trigger but am also hoping for a wider pool of experience.

Thank you very much!

@Kevin Z. for starters, this entire topic is grey area so you are not wrong. What I have seen in my experience is the choke point will be what the property is ZONED for. Meaning if you are zoned for four units, you will be in the residential 1-4 category. In LA you can legally build 1-2 ADUs/JADUs (property dependent) for extra cash flow but when it comes time to refi, at the writing of this post you will most likely not be able to use the rents received from the ADUs. You're nodding you head right now how dumb that sounds huh? If you have 6 units that are permitted by the city, then why can't you use the income? Zoning. On paper, why would a 4 unit have 6 rents received? Appraisers only appraise based on Zoning**** I want to be clear though, this is a maybe, sometimes, probably situation as we MAY change and adapt. There MAY be lenders willing to lend on these types of properties in the future, but what I am seeing is MOST lenders do not lend on properties that depend on rental income from ADUs at this time. 

So If you can cash flow on the 4 conforming units, then that would be your strongest foot forward but until then, build ADUs only for the cash flow and not for the appreciation. 

Hi,

Thank you for your reply.  The property currently cashflow and is fairly stable with the 4-units in place.  I believe the property is zoned for more units and at one point, this building was actually 6 units (several owners before me).  The current CofO is for 4 units.

I am less concerned about relying on the ADU income for refinancing purposes but that I or a future buyer will be forced to use commercial lending with less favorable terms if the ADUs are in place.

Thank you again!
 

It sounds like you have a bit of digging to do with your local city/muni/county requirements. We have a muni here. Not sure who you need to check with but start with your local authorities. Your lenders will be a great resource as well as a realtor. I'd make sure that both of them are investors as well. It sounds like since these regulations are new that an investor minded professional will be on the cutting edge of whats going on and will be able to think outside the box. For example, sometimes I'll have a client buy a 5-plex with residential financing but we will decommission a unit to make it a 4-plex. Maybe you could do something like that for an appraisal. Checking zoning and land use is probably a good idea too. Ultimately, you'll have to comply with local building codes, zoning and land use so starting with those authorities will ensure things go smoothly. Where I live anything above 4 units is commercial. Sometimes we can bend those rules if the additional unit can qualify as a Mother-In-Law but again you're getting into a grey area and have to know all the specific rules so you can abide by them in a very VERY specific situation. So many times the most profitable place to be is riding right on the line of what you can and can't do. One wrong step could cost you a lot but that's what makes you a ninja! Best of luck. 

I cant speak to the lending aspect for sure but would agree it would largely depend on YOUR lender. If your main purpose is cash flow, then adding ADU's to your property would be the most beneficial from a cash flow standpoint and my guess is that in several years down the road when more and more ADU's have been built and sold, there will be enough "comps" to allow lenders and appraisers to properly allow/account for their values from both a construction cost basis and an income approach. For now, count on building and holding ADU units for at least 5 years and if you can cash out refi (pull equity from the existing property) to pay for the new ADU construction, that would be the most cost effective means. Or that plus a combo of other financing (either short term or long term) and use the added cash flow to pay it off.

Yeah this is a grey area. I have not been in the exact situation of being above four. But I can say that the last two times i have appraised a primary home plus ADU, the appraiser essentially just added the square feet and beds/baths together. This makes for a weird comp (7 bedrooms?) but i dont think it would make a bit of difference on income method.

I think your best bet would be to meet with several lenders, and argue with the lender on the zone, as mentioned above.  You should be able to find someone that will package it as a 4 unit, but add in bedrooms and sq ft of the ADUs.  

In general, in California, ADUs have been considered more like an addition than another house (in fact, until recently was not allowed to be built by investors).  ADUs can be detached or attached, and you can sometimes also play the game of "how attached" by putting in a breezeway or something.  You may want to ask your lenders if that would matter to them.

YES it will limit your buyer pool @Kevin Z. Look up @Chris Mason and see his responses to some of the other forum questions on this topic. I don't believe you have to modify or do anything with your loan now, but when you refi it does put you in the commercial category.

Originally posted by @Jason Hsiao :

YES it will limit your buyer pool @Kevin Z. Look up @Chris Mason and see his responses to some of the other forum questions on this topic. I don't believe you have to modify or do anything with your loan now, but when you refi it does put you in the commercial category.

 Link to Fannie rules. If a lender or bank follows Fannie rules, they get to sell that $500k mortgage off for $520k one month after closing, $20k of back-end profit for them that doesn't have to come from you. For the bank, there's also a "velocity of money" play going on, they can recycle that same chunk of $500k a half dozen times a year. All of that goes away if it's a non-Agency ("portfolio" is often the term used) loan, which makes the rates, fees, terms, etc, get staggeringly worse, such that you will just say to yourself "well, if it's that bad, I might as well use commercial," at which point a commercial lender might respond to your inquiry with "ok, and just to confirm, these additions are permitted and you went through your local gov't to get this parcel rezoned for 5+ units right?" - the takeaway shouldn't necessarily be "oh well I can just use commercial," that's far from a sure thing (but also not an instant black/white "no" like it is for Fannie). 

Also some pretty clear implications there for the California "JADU" crowd. 

Hi Kevin, 

Wondering if you have anyone that will do the floor plans for your ADU's? If not we can help you out with that process? Good luck with the financing...

Also, we have only done ADU's in SFR, we have not done one to apartments yet