By: Stephanie Sweat, Senior Counsel
In October 2023, California passed AB 1033, a measure that allows municipalities to permit Californians to subdivide and sell accessory dwelling units (“ADUs”) on residential lots. The purpose of the law is to increase the amount of available housing and the number of opportunities for people to become homeowners. Although other states like Oregon and Texas are seeing success with the sale of ADUs as condominiums, AB 1033 leaves it to local governments to decide whether ADUs may be sold separately – which will inevitably lead to political fights across the state as some residents will be concerned about the impacts to parking, traffic and strain on other local resources.
The new law allows property owners who live in a city that permits the sale of ADUs to leverage the equity in their properties in a new way. However, the ADU sale process presents several pitfalls that property owners looking to take advantage of this new law should be aware of. Here are four key issues to be aware of before selling an ADU:
- Consider Existing Lender Requirements. Residential and multifamily mortgages alike will almost always consider the sale of a portion of a property encumbered by a mortgage without the lender's consent as an event of default under the loan documents. Therefore, the first step in selling an ADU is to determine (a) how the applicable loan documents deal with the sale of a portion of the encumbered property and (b) whether the loan documents will need to be modified to account for the ADU sale. Otherwise, the existing mortgage may need to be refinanced to permit two new mortgages on the subject property: one for the ADU and one for the remainder of the property. Given the recent rise in interest rates, refinancing an existing mortgage with a low interest rate to account for an ADU sale may make the sale of the ADU less financially feasible.
- Review Recorded Encumbrances. If the property is subject to CC&Rs or other recorded encumbrances such as an easement, the recorded encumbrances and any applicable homeowners’ association rules and regulations should be reviewed to see if a subdivision and sale of an ADU is prohibited or restricted in any way. A survey should be obtained for the property to ensure the ADU is not constructed within an easement area or other portions of the property where construction is prohibited or restricted. Otherwise, the sale of the ADU may not be financeable by prospective buyers.
- Create a Plan for Friendly Neighbors. While a seller may know and choose (subject to Fair Housing laws) the first buyer of the ADU, the seller may not have control over future owners of the ADU. Before an ADU is sold, sellers should consider future use issues and what restrictions, if any, they want to impose on future ADU owners. For example, a seller needs to evaluate how a shared driveway may be used and how the cost to maintain it would be split between the seller and the future ADU owner. Other considerations include separately metering utilities, access issues, use and occupancy restrictions for the ADU, and rules governing future construction – all of which must comply with other aspects of federal and California law. If the ADU and other improvements are to be attached to one another, additional factors for maintaining shared improvements must be thought through in detail. While larger HOAs have management companies and boards to help enforce the terms of applicable CC&Rs, it is critically important for properties not subject to an HOA's governance to be included in an agreement between adjoining property owners to enforce use covenants down the road.
- Davis-Stirling Common Interest Development Act and the Subdivision Map Act. The subdivision of the ADU from the subject property must comply with the Subdivision Map Act and with the Davis-Stirling Common Interest Development Act. It will take time to create a subdivision map or condominium plan to divide the subject property into multiple lots, and to process that map or plan through the local municipality.
AB 1033 is poised to come into effect on January 1, 2024, but which municipalities will enact local ordinances to permit the sale of ADUs on residential lots – and how property owners are able to take advantage of this new opportunity – remains to be seen. Even so, it is essential that property owners considering selling their ADUs under the new law take time to consider the legal issues before moving forward to ensure the best outcome for themselves – and any new neighbors.