ADUs and ADU Bills with John Arendsen #671

Aaron Norris is joined this week by John Arendsen of Backyard Homes and several other companies to discuss accessory dwelling units. John is a licensed general contractor, manufactured home contractor, a licensed real estate broker and manufactured home dealer. This makes him a quadruple threat. He’s been Aaron’s go to for the last several years about accessory dwelling units. They met because of an introduction by Linda Scott out at SDCIA, and they’ve just had a great time getting to know each other. He gets to nerd out with legislation, anything around accessory dwelling units for the last year, and his whole family is actually involved in the business. His son and daughter run the main operations for on-the-level general contractors. His wife operates MH Processing LLC, and she’s been a great resource for lending around the manufactured space. Aaron always bugs her about questions regarding ADUs. 

Episode Highlights

• When it comes to ADUs, how many people are even aware of them or know what they are?
• What is an accessory dwelling unit, and what types of structures fit in this category?
• What is the unique code Aaron uses to better understand the exemptions of where ADUs can’t be built?
• How could a septic system make or break a deal?
• What were the different bills that passed over the last year regarding ADUs?
• What was the biggest loser when it came to the several bills passed?
• How does a Junior ADU differ from a regular ADU?
• When it comes to specific bills, what does AB-68 cover?
• When it comes to opportunity zones, should you buy commercial real estate in California right now?

Episode Notes

Aaron is learning that accessory drilling units are still not on people’s radar even though they’ve been talking about it for a year. They don’t get it, and it’s not all their fault. Aaron spoke in Long Beach last week at NARPM, so the National Association of Residential Property Managers, and the vast majority of the property managers in the audience had no idea that this had come up. This has been part of state law since 2017. Aaron asked John why this is the case, whether it is lack of marketing or because people just don’t know.

John said there’s been a chronology here. He remembered in 2017 when the first laws first hit the street, including 1069 and AB2299, which all came out at one time. He was invited down to SDCIA. At that time he wasn’t a member, but he soon thereafter joined and was invited to speak a little bit about ADUS, and the first thing he asked was for people to raise their hand if they had ever heard of an ADU. Almost nobody raised their hand. When he asked if anyone had heard of an ADU ever in their life, only one or two people out of two or three hundred raised their hands. That was in 2017. In 2018, he was in front of a group that was a pretty large crowd. He asked the same question, and about half the people raised their hands. A year later, and about 50 percent of the audience knew of them. This is an audience that was tuned in to ADUs. It wasn’t just a random audience. This was an audience that was there to gather information about an ADU. This taught John another lesson. This year, just a month or so ago, he was asked to deliver a presentation to a large group of folks at San Diego City College. There was probably three or four hundred people there. He decided to change the question around and asked if anyone had never heard of an ADU. Not one person raised their hand.

The word is getting out. Slowly but surely, people are becoming more savvy. The only problem they’re running into is frustrating for guys like him who are responsible for building these things. The laws are changing, and the ordinances in their respective jurisdictions statewide are changing about as often as you change the sheets on your bed. It’s absolutely ridiculous. The minute you think you get your arms around the whole concept and get a grasp on it, all of a sudden a whole new entourage of changes are coming into play. That’s what’s going on with this last entourage of new laws. October saw four accessory dwelling unit bills. One that caught Aaron off guard passed in August, and he didn’t know how it got through. He thinks it will cause a lot of problems.

In case you’re new to ADUs, or accessory dwelling units, you’ve seen them. They’ve existed all along. Granny Flats, casitas, mother in law suites, backyard homes, converted garages. These are the little units inside existing square footage, detached properties. It stands for anything that’s an accessory unit to where you can live, sleep, eat. They need to be complete. This started in September of 2016 when three separate bills were signed by the governor into law to address housing shortage. Depending on who you talk to, we’re anywhere from one point five to three million short in housing in the state of California. What’s so brilliant about the conversation right now is it just lands at such a unique time. Prices are hot in California. It meets a lot of economic goals for the state and creates jobs. ADUs are environmentally friendly because they leverage existing infrastructures, so it helps with the urban sprawl. We’ve got the social issues that it addresses, everything from homelessness, from seniors trying to downsize into smaller units.

Aaron loves talking about NIMBYs, not in my backyarders. The builders call them BANANAs, Build Absolutely Nothing Anywhere Near any Thingers. The state has just said enough; because even though we live in a very liberal state, what was happening is that when ADUs made their way down to the local level, city council members are not so politically driven. It’s not Democrat versus Republican. You represent your constituents. When development comes their way and you get the squeaky wheels who don’t want it, especially when it comes to affordable housing, it just gets shut down. In this latest round of laws, the state has tried, and there were a lot of games that then played the last couple of years. There was everything from charging you $50,000 to keep you from building that 600 square feet to limiting the minimum and maximum size you can build where effectively you just couldn’t build at all. There were a lot of games being played by the cities trying to stop this going to affect. This is why Aaron had a lot of questions for John, some he did not even know were coming.

Aaron came up with a simple code for investors to process some of this through because he thinks there are some narrow exemptions of where ADUs can’t be built. Aaron landed on the “HUH Method.” The first H stands for Health and Safety. U stands for utilities. The final H stands for Historic and Environmental areas. When it comes to health and safety, the way he is reading the code is it’s updated now and there will be some exemptions if health and safety are a concern. John is reading this the same way.

With utilities, you’re just not going to get out of some utility issues. It’s like if you’re on a septic system and you think you’re going to triplex size the lot. That’s going to require a lot of extra infrastructures. You might be at a utility and not have enough water or power. Utilities and lines overhead was an issue with the Los Angeles Department of Water and Power. The utility is owned by the ratepayers. If you looked ahead and saw a line, the city wasn’t necessarily going to let you build an ADU because if there were a fire because of a down line, the question is who gets sued. Effectively, it is the taxpayer. You still have a few issues there, and it might be a safety issue in the utility department.

Finally, with the historic and environmental areas, Coastal Commission’s, downtown areas that are already very dense and there’s no parking can point to health and safety. He still thinks that this might be an issue. Aaron is trying to cover investors going into buying something assuming that they’re going to be able to build, and they get stuck. He wants them to do a lot of research before they buy.

In regards to the utility issue, John is now working on a project involving septic issues, which can make or break a deal. He has seen this kill a lot of deals for a number of reasons. He had an interesting thing crop up the other day. The property was on a septic system. However, it was a large parcel over an acre. Subsequently, the people had owned the home for over 20 years; and subsequently, they had the opportunity to have a sewer line brought up close to their home to accommodate a new development that was being proposed. Right now, they are in the process of deciding whether they are able to actually tap into that sewer line and pay that extra meter fee, which they’re more than willing to do, because if they can’t do that, then they can’t have an ADU.

Aaron said in Florida, where they’re building, he has been exposed a lot more to septic. In California in general, it depends on where you live. Just living in Southern California, when you say septic, people look at you like you’re gross and don’t understand why you’re talking about it. However, it definitely has a brand here in California. In Florida, in the areas that they’re building, it’s very different. However, when you go from a three-bedroom, two-bath to a four-bedroom, it expands the requirements for your septic system and then the health department can get involved. It can really blow up the cost of a project, especially if it’s an existing house. It’s something that you better know going into the project. You don’t want to cheat and say it’s a three-bedroom with a den, and then you’re putting bunk beds in all the rooms. There is a max. You’re going to max out the system; and you might think you’re being cute and saving money, but it has to be functional and that can cause a lot of other problems. You need to do it right. There’s a reason why we have the Health Department.

They next went on to discuss some of the things that passed. AB 670 was approved by the governor back in August, and it had to do with HOAs. It basically made CCNRs illegal that didn’t allow you to build an ADUs. Specifically, it says, “It is the intent of the legislature in enacting this act to encourage the construction of affordable accessory dwelling units and junior accessory dwelling units that are owner occupied and that are used for rentals of terms longer than 30 days.” There are a few juicy things there. The “affordable” word comes up as well as junior accessory dwelling units. Aaron owns condo rentals in California, and just for fun he showed up at one of the HOA meetings a couple weeks ago. He told them he was not going to do this, he just wanted to bring it to their attention. He told them he technically could convert his garage to an accessory dwelling unit and there’s very little that they would be able to do. The look on their face was pretty priceless.

In essence, the bill makes void and unenforceable any CCNRs that prevent you from being able to build a reasonably built structure. Thinking of this from the perspective of an HOA, he wondered how you could stop it. The only place that he has landed is that if the HOA has a limit of how many rentals can exist inside an HOA for reasons of lending, unwarrantable condos are always an issue. If you have one investor builder who owns too many units or there are too many non-owner occupied within an HOA, it can cause issues with lending. Aaron sees this as reasonable. He is not sure if he sees many HOA condos being able to convert into garages, but he wondered if anyone had asked John about it. He said yes and that it was all over the place. These new laws are very confusing to most people. There’s a lot of what-ifs. This seems to be the main verbiage. What if this happens? What if that happens? What are they going to do here? What are they going to do there? A lot of these things are overtly superseding or overriding the California constitution by way of congressional vote. People are at a loss and wondering what’s next. All the rules and regs are changing. So they’re waiting for the next shoe to drop, and they are in a huge quandary right now.

The biggest loser of the 18 real estate bills that passed in October is definitely municipalities. They’ve lost all control. Aaron doesn’t know how this snuck through. John had heard just yesterday on another webinar that 40 percent of California residents are impacted by some type of an HOA or CCNR. This opens up the opportunity to add an ADU to your property for millions of people that were otherwise locked out.

A junior accessory dwelling unit can be a converted garage. In an HOA, like the condos that he owns, he doesn’t own the land. He can’t bump out his square footage and add square footage. However, he can reconfigure some of the internal square footage and then leverage the garage to make this happen. With at least two of his HOAs, parking is not an issue. To find out that the HOA couldn’t stop him is crazy because some of these HOAs are a real pain. He is ready to sell all his condos.

John said he was looking for condos just a couple of weeks ago. The HOAs are the big impasse. He has no use for the HOAs that are businesses and like property management companies. They manage around 10 or 12, even 20 associations. They’re not really HOAs looking out for the interests of the people that live in the particular development. They’re just big businesses. They’re just big property management companies. Aaron understood as he doesn’t like being a private letter ruling by the IRS or a case study. This is good in theory, it just makes him nervous because if he decided to try to go down that route and then the HOA tries to sue him to stop him, he doesn’t know what that looks like because the law is very clear on the municipality’s side. One of the things that changed was a city has 60 days to process a permit for an existing property, adding an ADU. It’s different if it’s a new construction and you’re adding an ADU as part of the project. They have 60 days to approve it. If they don’t, it’s considered approved. That’s not really clear on the process of getting approval at all. He doesn’t know if he would still have to go to his board and present the plans, attach this bill and have them say he is going to go have to approve it at this board meeting or by the next board meeting. If not, they are just going to proceed. That would not be good.

As a property owner of condos, Aaron is not sure how he feels about people converting. He doesn’t like when it messes with the pricing for the product. We just have to be careful. This is good in theory, but he’s not sure how he feels about it just yet. It is providing housing, but at what cost? John feels bad for the folks that don’t have the opportunity to own a home or even live in a place. That’s a whole other story in and of itself. It does come with a price and the jury’s still out. What scares him to death is that a single-family residence, under all these new laws, can now go from being a single-family residence to a triplex. The state of California actually links to a site that actively promotes triplex sizing a single-family residence, so adding a JDU and an accessory dwelling unit in the back.

Johns gets questions from individuals he’s trying to do business with and help design and build ADUs for, and he can’t I can’t give them honest answers all the time because he doesn’t really know them because things are changing so quickly. It’s incumbent upon him to know these ordinances in the jurisdictions that he’s working in, but they’re changing so fast. He’s not an attorney and walks around with an earplug in his ear listening to everything that’s coming up on every point. It’s impossible.

Aaron said the things they are talking about today specifically apply to state rules when it trickles down to the local ordinance, it’s setting the base and giving permission. Each different city is going to approach this in a very different fashion. For instance, the city of Riverside, if you’re a nonprofit, is currently going to allow tiny homes, which technically falls under the Department of Motor Vehicle Rules. It has nothing to do with Title 2425. It’s personal property. It’s not real estate, so it doesn’t even include a reassessment of the property, which is exciting. Cities like San Jose are going all in, and then you’ve got other cities that are just making it so onerous and doing everything in their power to make it not possible. You really do have to dig down deep, and you can’t make assumptions. You have to call. Before he spoke in Long Beach, he called the Planning Department in Long Beach. He had heard rumors that they were a little bit difficult to work with. He called, and they didn’t seem very happy because they hadn’t even looked at the new rules. These rules don’t go into effect until January of 2020, and he’s already been warned. If you start early and you contact the Planning Department now and you start in the process, it doesn’t mean that you’re going to get grandfathered into some of the goodies discussed later in the show. Just know upfront that it is difficult to follow. You do have to get very local, and you need to make sure that the rules are going to apply when you decide to start your product.

Aaron next went on to talk about AB-68. It’s an update for land use for accessory dwelling units. Some cities are really fooling around with the square footage saying it has to be so big or so small in both the square footage of a lot as well of what was being built, effectively making it impossible to build an ADU. They really set some standards of minimum and max. Aaron asked John if he dealt with that in the San Diego market with some cities making it more difficult just by codifying that square footage was going to be an issue. John said yes because this is the card they play every time they can. With these new laws going into effect the first of the year, they’re not going to be able to get away with that.

The question is if they are really embracing these laws or if they are they going to take it to the wall? He heard some of these jurisdictions are being outright stubborn about it, and they’re almost bucking the system and telling them to sue. One city even said they plan on not complying and suing the state. John has even heard talk about class action lawsuits from multiple jurisdictions coming together and going against the state on a lot of these things. The jury is still out.

If you’re in the middle in the middle of building one of these and you get caught up in that, that’s not fun. Aaron always recommends that investors right now, before January of 2020, call and know the stance on accessory dwelling units now because a few of the bills that passed has a moratorium on cities not allowing for non-owner occupied properties to build ADUs. For example, if Aaron called Moreno Valley or Riverside and tried to get a permit for an ADU for one of his rentals, they wouldn’t even talk to him if I didn’t live on the property. Meanwhile, the city of Corona would have no problem. He would need to know that now because, as an investor, if he’s going to spend $100-$150 grand on an accessory dwelling unit and doesn’t know if they’re going to be friendly to him in five years after the moratorium ends, that’s just a mistake. You better know what’s coming, especially if it goes through.

John asked what it would mean if 2025 comes and goes and the law is basically repealed. Does that mean that all of a sudden you as an investor are out of luck or you have to take up occupancy there? Aaron said he is looking a little far into the future, but what they could do is something like what Anaheim did for vacation rentals. They basically said, “Enough. You have until 2021.” There was an extension, but they had until then to either convert the rental away from Airbnb and convert it back to a long-term rental or you need to sell. Those were your two choices. In five years, after the non-owner occupied moratorium ends at the state level, the state could decide to renew it. There is still a shortage on housing at the state level, so reinforcing it is a possibility. Or, if it goes back down to the municipality they could say, “This has gone great. We’re fine leaving the moratorium in place. It doesn’t have to be owner-occupied.”

But, if you get a city that says this has gone horribly, the density is a problem, we don’t like the traffic, and we’re going to go ahead and require you to convert it back to the primary and the ADU being one tenant or you need to sell. This wouldn’t be bad if we were in an upmarket. However, what if we’re in a recession and we still don’t have enough comps for ADUs and you are forced to sell or rent into a market that’s soft? That’s what makes Aaron nervous, and he doesn’t like the thought of spending $150 grand. If he goes into a city like Corona right now that’s already ADU friendly, he feels that’s a manageable risk. On the other hand, if he is talking to a city like Moreno Valley and Riverside who are not pro ADU as of now, he least wants to understand that risk going in. That doesn’t mean he can’t get vocal and involved and petition and provide lots of good case studies to the local politicians. You just have to know the risk and know how to play the game.

The city of Oceanside is just now rolling out its ordinance and their whole plan. John happens to own some BRBO properties in the city of Oceanside. John, being an ADU developer and builder and also a BRBO investor and owner wondered what would happen if he decided he wanted to put an ADU on his property that’s already and deemed a short-term rental since they said you can’t short term rental ADUs. That’s almost a dichotomy. There I go. Okay. He hoped to put this extra structure on his property to generate extra BRBO revenue. When he was told he couldn’t, he asked what happens. It turns out if you do that, not only does that ADU you put on the property become a long-term rental, you’ve just converted or lost your right to continue short-term renting your primary structure.

What’s interesting about that is a lot of the bills are going to get rid of the ability to do the ordinances locally. They’re upset, and unfortunately, it’s going to bring a lot of attention to short-term rentals because a lot of people want to do this. From what Aaron is seeing, a lot of the code is going to say less than 30 days. It doesn’t mean that you can’t do furnished vacation rentals for over 30 days. It might be more difficult to rent, but it’s still a possibility. You just have to play a different game. John said this is true as long as you’re meeting that 30-day requirement. However, he was thinking more of the weekender or the short term or the one week guy. That would all be waived or that would all be revoked. Aaron was a little confused as he did not know how they’re going to track all this stuff. He doesn’t want to be the case study and be doing it wrong because that’s a big deal, and that’s a lot of money if you screw that up.

They next went on to discuss further AB-68. It further clarified the requirement to replace parking when parking is demolished as a result of you building a junior accessory dwelling unit is out the door. If you convert the garage to a JADU, they’re not requiring you to replace the parking. His biggest concern with this is he thinks there’s still going to be local ordinances that will squash this only because when you’re driving around in West Hollywood, for example, there is no parking. It’s terrible to the point where it could become a safety issue because it’s just too much. There’s nowhere to put all those people. The play is that they’re trying to get it to where people aren’t using cars, but California mass transit is not there yet. Aaron said he would be careful with that as that’s a red flag for him. Their setback requirement from five is now at four feet. This really had to do with converting, for example, the tool shed that was in the backyard that wasn’t up to code. This was their way of trying to help a little bit. Aaron asked John if a one-foot difference is a big deal on the setbacks in his experience, but he said not really.

Something else interesting is this particular bill clarifies an expansion at one hundred and fifty square feet from an existing structure still counts as being substantially within an existing structure. You can bump out the garage 150 square feet, and it’s still going to count as a junior accessory dwelling unit since it still counts as being substantially within the existing structure. Aaron asked if this would impact fees paid and why it would matter. He wondered if there is a benefit to building a JADU compared to an ADU. John wasn’t able to connect the dots on this one, but this actually made Aaron feel better he wasn’t the only one. He said he was going to do some more research.

The city must allow for a minimum of an 800 square foot accessory dwelling unit. More flexible on ADUs and permissible on single-family and multi-family lots. This was mind-blowing to him since it requires a local agency to allow approval of at least one accessory dwelling unit and up to 25 percent of the existing units in a multi-family building can be expanded. If he owns a 10 unit apartment building, this code basically gives permission to the city to allow him as a property owner to subdivide internal square footage and expand the number of units by 25 percent. John had just heard one lady on a webinar who had 200 apartments, and she has parking for all of them. She is going to be able to convert 50 of those, and what she’s going to do is eliminate 50. This isn’t even within the apartment, these are ADUs on the property. She’s going to take away 50 of the 200 parking spaces and build ADUs. John wished he knew who she was since he would sell her manufactured components that he has. If that’s the case, that’s going to change the dynamic drastically on apartment buildings.

Aaron thinks there’s some huge opportunities for some funding buckets in several different categories that people might not know about. Check with your utility to see if there are rebates for things like appliances that are energy-efficient or air conditioning. You might be surprised, especially in the commercial space. In L.A., for example, they have a retrofitting fund for older buildings that need to be retrofitted for earthquakes. There’s some money. The utility has some money on everything from appliances to insulation. Some really bad news is the L.A. controller came out last month complaining that out of the $1.2 billion that they raised with their affordable housing fund that the city is in control of, they have nothing to show for it in almost three years. What looks like is going to come out his costing them $530,000 per unit. Aaron said he would not be surprised if they don’t start converting that into more creativity and funding projects like the concept of splitting up units.

On top of this, when it comes to opportunity zones, it doesn’t make a ton of sense right now to buy commercial in California because prices have really gone up. However, if you know you can go into these units and split them up, invest your money. This might be a really interesting play in the opportunity zone space. There are some cool opportunities there. It doesn’t mean that the city is going to allow it. It might take you going to city council saying, “Hey, you really need to look at this if you’re serious about affordable housing.” Specifically, this bill addresses the Housing and Community Development Department at the state has the ability to review the ordinances and send it to the attorney general if they’re not in compliance. It basically has teeth. Before, it was just the state was cute. Now, if it goes to the attorney general, they can start making it difficult to get funding for things like the community block development grants, which funds a lot of non-profits and a lot of the redevelopment dollars that cities use to do cool projects. He expects some litigation on this front with cities in the state, but the state’s given itself some power.

The Norris Group originates and services loans in California and Florida under California DRE License 01219911, Florida Mortgage Lender License 1577, and NMLS License 1623669.  For more information on hard money lending, go www.thenorrisgroup.com and click the Hard Money tab.

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