It’s nice to see so many accessory dwelling units lately, but is there such a thing as too many? Well, maybe according to Fannie Mae. Let’s talk about this.
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FANNIE MAE GUIDELINES:
Fannie Mae allows only one ADU on a parcel for a one-unit dwelling, but there are zero ADUs allowed on a parcel of a 2-4 unit dwelling. In other words, if you have a duplex, triplex, or fourplex, Fannie Mae is not cool with an extra ADU. Of course, this guideline could change, but here’s some language straight from Fannie Mae as of April 2024:
FREDDIE MAC DIFFERS THOUGH:
It looks like Freddie Mac will purchase mortgages for a 1, 2, or 3-unit property with an ADU. It’s interesting to see that they won’t do this for a 4-unit property. Remember, a residential property is up to 4 units, so it gets a bit interesting when there are 4 units and an accessory unit. But Freddie Mac is also clear that it’s NOT okay to have two ADUs on site, and the ADU needs to comply with zoning and land use regulations too.
Straight from Freddie Mac’s website as of April 2024:
GIVING GOOD ADVICE:
Why does this matter? It’s important to know the rules so we can make informed decisions and give advice. So, if an investor asks, “Should I add two extra accessory dwellings on my duplex parcel?,” let’s talk about potential pluses and minuses. I think a knee-jerk respond here would be, “Bro, extra units are awesome. Do it.” But there’s more to consider in light of future financing. My advice? Know enough about loans to have conversations like this, but defer to a loan officer to speak definitively about loans.
AN INVESTOR IS HESITANT TO BUILD:
An investor recently asked me about Fannie Mae guidelines for ADUs, and while he is legally allowed to build two ADUs at his local duplex, he is hesitant to do so since it could damage future financing options due to Fannie Mae not allowing this. The reality is so many investors pull money out of their properties to continue to invest, but in this case adding two extra income-producing units could ironically tie up his money. Even Freddie Mac does not allow two ADUs (though Freddie Mac does allow one ADU for a duplex or triplex).
POLICY MATTERS:
People often say real estate is all about supply and demand. Okay, that’s true, but the older I get, the more I realize how much policy shapes the housing market more than anything. Things like zoning, interest rates, and available financing make all the difference in the marketplace. In the case of ADUs, Fannie Mae policy in early 2024 could stifle some accessory dwellings from being built at 2-4 unit properties. Is that good or bad? You decide.
COMPS GET TRICKY:
Imagine a duplex with two accessory dwelling units that were legally built with permits. What would you do for comps? Do you think you could find another duplex with two ADUs as a comp? It’s easy to use a fourplex, but is that the same thing in the eyes of the market, city, and lenders?
EXTRA UNITS AREN’T WORTH NOTHING:
It doesn’t mean there is no value just because Fannie Mae does not allow an ADU on a 2-4 unit parcel. The truth is an investor is going to pay for something that was legally built, conforms to zoning, and produces income. Yet, I could see some investors being hesitant to buy a property that might not qualify for financing in the future. So, do these units take a hit to value because of this? I guess that’s where we have to look to the market to really know. That is, if we’re lucky enough to find comps.
TATTOOS & CHANGE:
Lenders are starting to allow some income from ADUs as qualifying income, and I have to think guidelines will emerge to address ADUs at 2-4 units also since we’re going to be seeing more of these situations. In short, rules often change when they no longer work. I think about how workplaces not that long ago used to disallow tattoos from being visible, but now they are everywhere. Yeah, I know that’s something different, but we’re seeing an explosion of accessory dwellings being built, and that’s going to affect future guidelines.
Thanks for being here.
Questions: What are you seeing out there with ADUs right now? Anything to add to the conversation? I’d love to hear your take.
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Good info Ryan! I was not aware. Any insight for VA or FHA in regards to ADUs?
Hi James. I wish I would have addressed that. Maybe I can in a different post after researching more. I do know FHA allows some income from an ADU for qualifying (they made a press release to that point), so clearly at least one ADU is allowed. I am not sure about multiple ADUs. I welcome anyone to comment who knows.
Such a helpful perspective. Thanks for covering this topic.
Thank you so much Debbie. I hoped this would be informative and interesting. It’s good for conversation I think.
Great stuff but I’ll comment on the tattoo analogy. I still don’t allow tattoos to be visible in my appraisal company and I’ve let visible tattoos influence my hiring decisions. I feel like our profession is different than a barista or a performer. We are asking for trust to enter someone’s home. Most people are comfortable around people with tattoos these days, but some people are not. Imagine an elderly woman living alone who may be used to seeing people with tattoos in her circles. When I was a kid, my brother was trouble and involved in drugs and gangs and his tattoos were symbols associated with that behavior. It’s still hard for me to see beyond that even though I live in Portland where tattoos are very common. It is our job as appraisers to put owners at ease and feel comfortable, just like trimming our hair, wearing nice clothing, and looking professional for an interview. Keeping the tattoos covered is going to appear more professional for more people. No look is perfect for every situation and tattoos are getting to a place where they are fine most of the time, but I’m adamant that visible tattoos do not help in some professional situations.
Thanks Gary. I appreciate hearing your take, and I get why you think that too. I don’t know that there is just one answer here also. I do know society has changed so much from even 25 to 30 years ago regarding tattoos. So, my analogy isn’t perfect here, but there is some truth generally. Even I draw lines with my boys and what I hope they’ll do. I’m fine with them getting tattoos, but I tell them no face tattoos. 🙂
I thought this would happen as ADUs become more visible in the residential landscape. Incidentally, there is a good discussion of ADUs by the erstwhile Sacramento appraiser Abdul Malik , SRA, ASA , who now operates here in Portland Oregon, Look him up for some valuable insight into the subject.
Right on. Thanks. I’ll have to check out what he wrote. It seems like the line between ADU and second unit is in a place where it’s getting a little blurry. I’m eager to see how lending guidelines and the perception of appraisers change in the future. We are in the midst of a learning curve. I like to see Sacramento County now publishing data on ADUs too. Like I said, there is a learning curve ahead for everyone, and hopefully the way data is published will even improve.
Seems the term “ADU” might be being used to mean different things. Some jurisdictions define an ADU as being smaller as the main residence (I think). Is FNMA calling any additional “dwelling” an ADU?
For example, 30 years ago I lived in one unit of a 4plex. It was originally a 3plex, and an additional apartment was built over the garages at a later time. That upstairs apartment was 2+2 and 1200 sq.ft. I would hardly call that an “ADU”.
Thanks MaddieB. You know, there is a disconnect at times between what Fannie Mae says a unit is or isn’t and what a city might think. I think we are living in blurry times in some regards. Yet, Fannie Mae does have a definition, and Freddie Mac does also. It’s important to keep in mind a jurisdiction might define something differently, and a buyer or seller might call something an ADU. But that doesn’t mean it is one. The wild part is local and state law might allow a certain number of units, but Fannie isn’t on the same page to date.
From Fannie Mae:
https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B2-Eligibility/Chapter-B2-3-Property-Eligibility/1032991541/B2-3-04-Special-Property-Eligibility-Considerations-09-02-2020.htm?touchpoint=Guide&fbclid=IwAR3CvOWiQcQ5-NO_qtq475J5rXmvBdeE4yvQYokpBltH3IRkcxRljAY_Nj8#Accessory.20Dwelling.20Units
“The following table describes the requirements for classifying an ADU.
Requirements
– Only one ADU is permitted on the parcel of the primary one-unit dwelling.
– ADUs are not permitted with a two- to four-unit dwelling.
The ADU must
– be subordinate in size to the primary dwelling.
– have the following separate features from the primary dwelling:
* means of ingress/egress,
* kitchen
* sleeping area
* bathing area
* bathroom facilities
The ADU may, but is not required to, include access to the primary dwelling. However, it is not considered an ADU if it can only be accessed through the primary dwelling or the area is open to the primary dwelling with no expectation of privacy.
The kitchen must, at a minimum, contain the following: cabinets; a countertop; a sink with running water; and
a stove or stove hookup (hotplates, microwaves, or toaster ovens are not acceptable stove substitutes).
An independent second kitchen by itself does not constitute an ADU.
The removal of a stove does not change the ADU classification.”
Anyway, there is much to unpack there. And this is why someone might say there is an ADU in the backyard, but it’s really just a casita (or whatever we want to call it) because it doesn’t have a kitchen. Also, if it doesn’t have a kitchen, what was it permitted as? I just asked this question to an owner who had a storage area that was converted to be living space without permits. No kitchen? Hmm, that was a clue I should ask more questions. No permanent heat source? Ask more questions.
Is there a requirement that the ADU be built after the primary residence? If I buy a property with an old, 750sq.ft house on it, and build a new 2500sq.ft primary residence, how do you classify the smaller house? (My mind is boggled.)
I would defer to local building departments on that. I have seen something like that happen before, but was it really legit? That I don’t know. I recall a property in Loomis where this happened (maybe even twice if memory serves correctly). But backing up, how can a unit be an “accessory” dwelling to a different dwelling that doesn’t exist? That’s a big philosophical question about existence. Haha. I’d love for any onlookers to pitch in thoughts and experiences in this regard. Personally, I would hope there would be a provision for something like this to legally happen. The instance in Loomis was a situation where an ADU was present first, and then there were plans for a huge house. Not sure how financing played a role here though as that could matter.
I have appraised quite a few 4-plexes that had a mix of unit sizes, like 1 efficiency, 2 1BR and 1 2BR. Fannie says no ADU on a dup or tri, but couldn’t the ADU upgrade a duplex to a triplex? The real problem is adding an ADU to a 4-plex. It goes from a residential SRIP appraisal I can do for $1200, to a $3-4,000 narrative appraisal by a General cert in this market. And Fannie & Freddie do not buy commercial loans. The Washington legislature has banned single family zones and as the cities and counties revise zoning to comply with the state law, H&BU for 5000 sf lots, currently improved with 1 SFR, may allow up to 6 dwelling units.
Thanks Barry. It seems like were are on the cusp of change, and how we think about real estate and highest and best use could really change ahead. I think there are some definitions that could get blurred ahead. I’ve also seen some multi-unit properties with varying sizes, and if an ADU has a very similar size and quality of construction to the other units, at some point it starts to feel more like a 3-unit property instead of a duplex with an ADU. But ADUs are traditionally pretty small in size, so that may keep them feeling subordinate. If an ADU can be up to 1200 sq ft though, that gets to be a pretty decent size for many multi-unit properties.
Hi Ryan,
I looked into the Sacramento County regulations on ADU awhile back. At the time I believe one can not add more than one ADU onto an existing property.
On my one residential lot I have two houses, so they said I could not add any ADU.
However, there is another new law allowing lot splits with quite loose parameters. So I could split my lot, creating two, each with one house and each then being able to have an ADU.
Since the ADU regulations allow closer setbacks and such, many lots could support an ADU post split.
I stopped pursuing it once I contacted the Assessor Office about how lot splits affect my prop 13 tax savings. It got murky and it got put on the back burner for now.
Thank you so much for sharing Don. I appreciate hearing your experience. I suspect rules are constantly changing since this is an emerging trend.
The City of Sacramento allow for two units (but both units need to be no more than 1200 sq ft together for some reason). https://www.cityofsacramento.org/-/media/Corporate/Files/CDD/Building/Forms/CDD-0423-Accessory-Dwelling-Units-ADU-Hangout.pdf?la=en (PDF)
It looks like Sacramento County allows one ADU and one JADU. Notably, they cannot be used as short-term rentals through standards today at least. https://planning.saccounty.gov/Documents/Accessory_Dwelling_Units_Handout_v5_11.17.23.pdf (PDF)
Many years ago it was very common to advertise in a listing…”Buy one, get one free!, Two for the price of one!” Today there is less of that and more of an expectation for a market value for an accessory unit. The confusion comes later. Not all markets react the same, and not all ADU’s are the same.
Thanks Jerry. Yeah, some real truth in that. They are not all the same. The truth is an ADU at 1200 sq ft with a 1400 sq ft house is probably way more meaningful for value than a 600 sq ft ADU with a 10,000 sq ft house. 🙂
Great info., Ryan. Good to know the rules that Freddie Mac and Fannie Mae have regarding ADU’s. It is good for appraisers to have a basic understanding of this so that we can have an educated discussion with clients.
Thanks Tom. Agreed.
I will timorously forward this to an investor that bought a triplex listing from me a couple of years ago. It had been built 60 years ago with a fourplex design. The ground floor unit had been used as a bootleg in its early years but was converted to a storage basement for decades. Last year, he got an ADU permit to convert the storage basement into a 4th unit. Legally this time. The same size as the other 3 units. The FNMA rule against an ADU for duplexes and triplexes seems arbitrary when looking at that particular property as that ADU is now the best of the four units, since all its guts are brand new.
Thanks Jim. And this is where it gets weird. I think the line between ADU and full-fledged unit is getting very blurry in some situations. I hope Fannie Mae will change their stance eventually. I’m really not sure why they have this to be honest. I’d love to hear from any onlookers in the know.
I know ADUs are quite the rage right now. Thanks to legislative action in Sacramento, ADU construction is allowed in single family neighborhoods. The attraction of additional income for rent or having family members live in an ADU behind a primary residence is projected in a positive light as a way to increase rental inventory. However, there are some negatives to ADUs. What is the setback from the property line? Are ADUs allowed to be built right up to the property line without a setback? That impacts the neighbor who not only has this negative visual impact, but will probably reduce his property value due to this visual encroachment. In addition, since a garage is probably not included in an ADU, parking on the neighborhood street is negatively affected in a crowded look to what was a more visually open feel on the street. There is no free lunch here. The neighbor who does build an ADU may gain, but the neighbor loses in more ways than one.
Thank Bob. This is where thoughtful design and standards are important. I don’t know the answer to your question without looking it up, but we have to think through stuff like this.