Granny flats: CA’s big success over NY

California has succeeded in using Granny flats as a tool to bolster housing production in metro hubs of California like LA. If California can do it why not New York

Recent California housing legislation demonstrates that CA leaders are interested in and capable of reforming housing policy.  I wish the same could be said of NY. An article from the NY Times titled A Housing Crisis Has More Politicians Saying Yes to Developers is going viral in CRE communities. When the article is shared, it is accompanied by sarcastic remarks because it is a reminder to the reader that officials in NY city and state have not done a good job to encourage more housing development.  There are some promising articles of legislation that California has passed recently that will contribute to more rental apartment units in the state. Today I’ll focus on basement units, otherwise known as granny flats.

Granny flat reform

California: Bills: S.B. 1069 and A.B. 2299

In 2016, the Senate bill (S.B.) 1069 and the Assembly bill (A.B.) 2299 legalized the development of Accessory dwelling units (ADUs) in California. ADUs have a variety of names like granny flats, second homes, or even basement units. ADUs are smaller, secondary homes that exist in conjunction with primary homes/dwellings. They will typically have the plumbing and mechanicals such as bathrooms, showers, and kitchens required to be used independently from primary homes. Granny flats are abundant in the United States and come in varied forms: on top of the garage, on the second floor of larger homes, or even in the basement of the home (think brownstones in Brooklyn). Policies around what is legally possible to do with ADUs in the sale of a property or in the construction of a property vary widely across states and even within states. California’s new-ish state law clarified all these rules and guidelines.

The premise behind these bills was to use economic incentives to increase the supply of housing in California. The legalization of ADUs makes sense because ADUs already exist in much of California. It’s much easier to permit existing structures and fit them to meet guidelines than to go out and build ground up apartment buildings. Legalizing existing structures is less capital intensive, takes less time, and most importantly, it avoids the political controversy that often plagues new real estate development.

Since the law’s passing in the summer of 2016, ~60,000 ADUs have been permitted in California and ¼ of the homes built in Los Angeles in 2021 were ADUs. This is a notable increase in housing, directly attributed to successful new legislation.

Source: California Department of Housing and Community Development

New York

No legislation that legalizes basement units, or ADUs have passed in NY. The closest thing to success was former Mayor Bill DeBlasio’s pilot program in East New York to offer low-cost financing for conversions of illegal basements into legal living spaces. The Basement Apartment Conversion Pilot Program (BACPP) began in 2019 but failed hard. The HPD sponsored program and its affiliate non-profits identified 8,000 target owners that would be eligible for the program. But as of May 2020, a year after the program was rolled out, only 9 owners were approved to move forward with application and 0 projects were started, let alone complete. The program was defunded, partially due to Covid, and its operations ceased. This is a let-down because the opportunity here is vast. As of October 2021, there were roughly 764,592 residential buildings in the 5 boroughs of NYC, according to Pratt Center. 91% of those were 1-4 unit buildings. If even 10% of those properties could support the conversion of a cellar into a legal living space, that would unlock 70,000 rental apartment units and increase total rental housing supply by 3%!

Why did the BACPP fail?

1. High cost: the cost to convert a space into a legal basement, or cellar unit was estimated at $250,000 to $310,000 by Deblasio’s team. The program offered to extend loans of up to $120,000 and the owners would have to finance the rest themselves. That means an owner could have to pay up to $190,000 out of pocket. That might be more than many homeowners paid in down payment to even purchase their properties! Tough ask and very prohibitive to homeowner participation.

2. Wrong target audience: the program capped eligibility by income levels which thwarted its success. If you owned a home with your spouse and each of you made a pre-tax salary of greater than $70,500 you were not eligible for this program because that was more than 165% of area median income, the effective cap. The less you make, the more chance you have of getting into the program. But, by that rule, the out-of-pocket cost for the conversion is a greater share of your yearly earnings. This doesn’t make sense. The program bars those with higher incomes but the cost to participate rules you out unless you have a high income. The intention here is to help the mom & pop landlord community. Great! But that also means the program is targeting those who are least literate in the building codes, arguably have the least amount of time and labor resources to oversee projects like these, and stand to lose out the most on rental income (as a % of total income) if they are forced to vacate their basement units for extended periods of time to perform the renovation. If somehow owners got excited about this program despite all the above, I am sure the 47-page primer, dampened that excitement really quickly!

3. Too many priorities: the program’s goal was to a) make basements safer for tenants, b) legitimize basement units for homeowners renting them out under the table, and c) increase affordability in NYC by increasing housing supply. That’s kind of a lot to juggle. Further, the city was offering to guarantee that tenants who were moved from illegal units would be allowed to return to their apartments after construction was finished. This requires a high level of coordination.

4. No zoning flexibility: the most meaningful thing that De Blasio could have worked to get correct is to align his program with the Department of Buildings (DOB) and Housing & Preservation and Development (HPD). Prioritizing building codes that were non-negotiable and those rules that could be bent temporarily to allow owners to ease into the conversion program could have helped amortize the costs of the program over time and reduce the up-front complexity, thus inviting more participants in. This didn’t happen and the requirement that owners obtain a new certificate of occupancy presented a huge obstacle to this program succeeding. The only thing harder than obtaining a new certificate of occupancy in NY is perhaps to build a new building.

5. Bad Timing: the program was launched right about nine months before Covid forced the wide-spread shutdown of all stores in NYC. The real estate priorities of officials shifted quite a bit towards preventing evictions and managing owner grievances. Just bad luck.

Following the failed pilot program at the city level, some State Assembly members of NY and Governor Kathy Hochul proposed a more focused bill that aimed simply at legalizing granny flats to create more housing options, rather than solving for broader issues of safety and legitimacy. The bill had political strings attached that ruled out its success. It would make the units de-facto rent stabilized and would force owners to keep the spaces rented to tenants, less there was ill-doing. In other words it was legalizing basements units combined with Good Cause Eviction. That was tricky. Further, in the wake of Covid, there were competing priorities on the real estate agenda that were more pressing.

The California investment housing market is the most similar in many respects to NY – high price per unit, fast appreciation, low cash-flow, and lots of rent restrictions. But it differs importantly in how its leaders are tackling the problem of rising rents and housing costs. California leaders have had success in passing legislation that has, and will continue, to stimulate housing production. One could argue they have found a way to be at once progressive and pro real estate development. New York leaders have gone the opposite direction toward laws that stifle development. If the housing strategy is working in California and California is the best analog available to NY’s multifamily housing market, then why couldn’t it work in NY?

Sources: The Atlantic, The New York Times, American Planning Association, Fannie Mae, The Real Deal, NYC.gov, City Limits, Pratt Center