By: Zachary Burg
As the housing shortage becomes more and more notorious companies have begun trying to come up with solutions to provide alternative living situations. Multiple business models have been built around installing additional dwelling units in people’s backyards and garages — increasing the amount of livable space on a parcel of land. With influence from different industries and even the government, these startups are hoping to provide a solution to increase housing options. While companies in this space exist throughout the U.S., the scope of this article will focus mainly on California.
Housing’s Past in America
Housing has had a tumultuous past in American society. For a long time, buying a house was the ultimate goal of the working class. The purchase signified not only an accomplished level of wealth but provided a haven to raise a family. And most importantly, a house was a high-worth asset that could one day be sold to finance retirement. This pompous joy of owning a home was intensely juxtaposed with the burden of debt and interest rates as ambitious Americans defaulted on loans, and failed mortgage-backed securities poisoned the U.S. economy in 2008. For a little while, we didn’t look at housing the same as we once had.
Now over ten years later, our economy has bounced back and enjoyed the longest bull run in its history, with the housing market rebounding for the most part. But as a new generation of home-buying Americans emerges, immensely plagued by student debt and other financial liabilities, buying and owning a home is not so attractive.
And what is the cause of all this? The answer, consisting of a complex combination of reasons (wages, labor outsourcing, gentrification, etc.), calls for an entire article in itself. Still, the general takeaway can be made that housing in many places has become unaffordable. In a place like California (which is on the forefront of a housing shortage), thirty to forty percent of people’s incomes goes straight to rent. The problem is even worse in urban centers such as Los Angeles and San Francisco, with inhabitants easily paying over half of their income to make monthly rent. And while people may have become accustomed to doing this and accepted it as the norm, many argue against this — believing it should be anything but.
Where ADUs Come In
To help address these problems spurred by housing’s past and the current trouble around the shortage and affordability, a subsect of entrepreneurs, crossing over experience in the technology and real estate worlds, have begun building additional dwelling units in the garages and backyards of already built homes. More specifically, these ADUs are defined as “secondary residential units that share a lot with an existing, stand-alone, single-family home.” The term “additional dwelling unit” may be new to you, but this is what you know as a granny flat, in-law unit, or backyard cottage.
In 2017, Governor Gavin Newsom and the California state legislature passed a group of bills to make ADUs legal in all California cities. On January 1, 2020, new provisions went into law to make the process of permitting and building an ADU even easier. And why were these laws passed so quickly while politicians struggle for others? Simple: California’s housing shortage is clear to everyone — and even our elected officials want there to be a solution.
Another reason this specific solution has so much support is its affordability. While prices to build ADUs can range and permits/regulations/utilities can increase costs, the overall price is much lower than that of building an entire house. The California Department of Housing and Community Development is a massive fan of this housing style’s low cost saying, “ADUs are an affordable type of home to construct…they do not require paying for land, major new infrastructure, structured parking, or elevators.” Without having to take on immensely large-scale construction projects, ADUs present companies a new way to build comfortable housing at a cheaper price point.
The ADU Market
Since the ADU does provide a new living option on the main house’s property, the main house owner can begin to rent out the ADU to a tenant. This not only provides an affordable living option while making passive income to the homeowner, but creates an entirely new type of market for housing rentals. With over 600,000 eligible properties in Los Angeles at $1000 a month in rent, the total addressable market would be $7.2B annually — in one city. Of course, 100% penetration of this market may seem like a long-shot, and I’m not saying it is possible.
It is important to note that residential areas outside of cities continue to expand and provide relatively cheaper housing options than those in urban areas. So logic follows that if people want more affordable housing, they’ll just move farther away. No big deal — except the target demographic of ADUs most likely makes up the many members of the multi-million-member workforce inhabiting Los Angeles. This large cohort would likely prefer to live closer to their jobs than farther away. Also, while it may be cheaper to live further away, a lengthy commute can disrupt the quality of a person’s life, especially when it comes to aspects such as expenses, raising a family, and time spent on the road.
Companies in the Space
As mentioned previously, many companies have begun entering this space and are truly taking advantage of everything these new laws have allowed. Compared to traditional real estate developers, startups have started exploring alternative construction techniques and imploring data in their ADU business. Cover and United Dwellings are both startups in Los Angeles focused on this market. Cover is a bit more tech-savvy, using modular design and efficient construction to create very Instagrammable units. They’ve streamlined the entire process from idea to final build, removing a ton of friction from the user experience and allowing peace of mind for their customers.
United Dwelling has innovated more on the business model aspect, creating a financial structure that allows a person to put zero dollars down to have this structure built in their backyard. Unlike other companies that charge a homeowner to install an ADU, United Dwelling fully finances the construction of the unit. The company then uses the monthly rent revenue to pay the loan payment, takes a percentage for itself, and rewards the rest of the money to the lot owner. This creates pretty easy passive income for the lot owner while eliminating any financial risk of a loan.
Additionally, some people may read this and inevitably think, “Why would I want a stranger living in my backyard?” I’ll gladly point them to Airbnb — a company that has already eased the idea of leasing living space to a stranger. Plus, besides this, people have been leasing rooms in their houses for years, so if anything, the concern around this pain point should only alleviate more.
Future of ADUs
Both of these companies have found ways to create uniquely innovative businesses in this space, fortifying their own respective sets of value propositions. This, if anything, shows the potential for diversification and continued entry in the market, catering to a vast spectrum of customers, needs, and wants.
Lastly, like with many of today’s innovative business solutions tackling societal problems, no one can look into a crystal ball and say, “This is the one.” These companies and markets will take years to play out, and like with many problems, probably a myriad of factors are poised to jointly contribute to an overall resolution, rather than one concrete fix. Regardless, it is people that must continue to push solutions on all fronts, from all backgrounds and perspectives, and ADUs are no exception to that.