Want to split your lot and sell an ADU or two? Here’s how

Building more housing on larger residential lots
could be California's next 'gold rush.'

By JEFF LAZERSON | jlazerson@mortgagegrader.com | MortgageGrader.com | November 13, 2023

Article originally posted in Orange County Register on November 9, 2023.

Who knew? Homes on big lots, corner lots, and cul-de-sacs are the new California gold rush for anyone thinking about building accessory dwelling units, splitting the lots, and either selling them or renting them out.

The California Home Act, effective Jan. 1, 2022, paved the way for residential lot splitting (into two lots), allowing up to four separate living units to be built for a maximum of two units on each of the two lots.

In October, Assembly Bill 1033 reinstated ADU sales separate from the primary home. And AB 976 also signed by Gov. Gavin Newsom in October removed ADU owner-occupancy requirements. These two new laws offer a viable pathway for ADU construction and expansion for homeowners and real estate investors.

“Yes, arguably more housing, more affordable housing allows less expensive properties in more expensive neighborhoods,” said Guy Cecala, executive chair at Inside Mortgage Finance. “There’s a crying need for more housing and more affordable housing.”

“It’s carving up single-family homes. Most people living in those neighborhoods don’t support them,” said Cecala, referring to common NIMBY reactions to new housing development.

If you’re looking to build an ADU from scratch, stick-built construction costs will run $350 to $400 per square foot, according to Mark Lefitz, vice president of business development at EZ Plans, an architect-design firm. “Soft costs (professional fees such as architectural and engineering and city fees) are $12,000 to $15,000.”

So, for example, an 800-square-foot ADU could cost $320,000 to build (or more depending on the interior).

You can also look into factory-manufactured ADUs which are then installed on site.

“Prefabs can be more expensive than stick builds,” said Steve Lefler, a consultant with Tiny House Alliance. “Electrical circuit costs and sewer connection costs are the biggest expenses.

If a homeowner doesn’t want to go to such lengths building an ADU and then selling it, they can opt to split the lot and sell it to a developer.

Matt Lucido, CEO of Yardsworth, has been buying dozens of inner-city lots in Los Angeles. Ideally, he looks for rectangular lots, say 6,000 to 9,000 square feet with small homes already on the property.

His firm provides a $5,000 non-refundable deposit to the lot seller with a six-month escrow period. A long escrow period is needed to square up the lot-split legal entitlements with the city.

“The seller makes somewhere between $100,000 and $250,000 for the lot split sale,” said Lucido. “If we can’t get the split done, the seller keeps the deposit.”

While Lucido is working on constructing properties on certain lot splits, none are completed and sold yet. So, it’s hard to know how much money a lot-split home would fetch since these ADU and lot-splitting laws are relatively new.

So, let’s say you do a lot split but keep the primary residence. How does that affect your property taxes?

“The land carries its own base (separate from the structure),” said Claude Parrish, a property assessor for Orange County. “The city building department must approve it.”

Cities, I should note, have to follow state law. They cannot make arbitrary decisions like declining lot-split requests.

Parrish offered an example of land valued at $100,000 and evenly split 50/50. One parcel would have land assessed at $50,000 and so would the other parcel. The work involved, he said, is “not for the faint of heart.”

The Subdivision Map Act, enacted in 1974, enables cities and counties to administer, control and supervise the development of land, according to Chris Akin, a title operations manager at Lawyers Title.

“The sale of the ADU and corresponding lot split would have to conform to the Subdivision Map Act,” said Akin. “It’s a mini subdivision.”

Lots that are ineligible include those that have improper zoning (they must be zoned as single-family residential), do not meet minimum lot square footage requirements, have been previously split or exist in floodplain (property near water).

So now, how do you finance the ADU construction? Well, that comes in many forms.

Examples range from the FHA 203(k) property rehabilitation loan to Fannie Mae’s HomeStyle and Freddie Mac’s CHOICE Renovation. A cash-out refinance of your existing mortgage or a home equity line of credit also can finance the build.

If you have an existing mortgage there could be problems splitting the property lot. Mortgage lenders don’t allow for partial reconveyances, so homeowners will need to clear any mortgage liens at the time of lot sale or lot split.

If you are considering buying a residential home (or building on a property you already own) to build ADUs and do a lot split, the first thing would be to hire a licensed appraiser. He or she can objectively help you to calculate the projected completed value and what rents these mini homes will command.

Next would be hiring a construction cost estimator. You’ll need an expert to figure out if it’s worth the investment.

Lastly, if you are going to hire a contractor, check him or her out thoroughly. The worst client and reader complaints I’ve heard over the years have been about nightmare contractors who did horrible work, some of which had to be redone. Some contractors even took the money and never did the work or just disappeared for days at a time.

Have your attorney review and approve ahead of signing anything.

Freddie Mac rate news: The 30-year fixed rate fell to an average 7.5%, 26 basis points lower than last week. The 15-year fixed rate fell 22 basis points to 7.03% from a week ago.

The Mortgage Bankers Association reported a 2.5% mortgage application increase compared with last week.

Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $726,200 loan, last year’s payment was $207 less than this week’s payment of $5,078.

What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with 1 point: A 30-year FHA at 6.625%, a 15-year conventional at 6.5%, a 30-year conventional at 6.99%, a 15-year conventional high balance at 7.375% ($726,201 to $1,089,300), a 30-year high balance conventional at 7.75% and a jumbo 30-year fixed at 7.25%.

Note: The 30-year FHA conforming loan is limited to loans of $644,000 in the Inland Empire and $726,200 in LA and Orange counties.

Eye catcher loan program of the week: A 30-year adjustable, interest-only and fixed for the first five years, rate at 7.5% with 1 point cost.

Jeff Lazerson is a mortgage broker. He can be reached at 949-334-2424 or jlazerson@mortgagegrader.com. His website is www.mortgagegrader.com.

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* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.

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Jeff Lazerson - Mortgage Columnist since 2011