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PACE may help finance accessory dwelling unit boom in California

LOS ANGELES — Accessory dwelling units may become the next frontier for PACE financing in California.

As the state grapples with a massive shortage of housing, ADUs, in which an apartment unit is added to a single-family home, are among the few potential solutions that lack widespread opposition in a state where the entitlement process for an apartment building can drag on for years.


ADUs can take the form of an add-on to the house, the conversion of an existing space like a garage, or a separate unit in the backyard.

Local elected officials and state lawmakers have been scrambling to change zoning laws to make it easier for homeowners to build so-called granny flats or in-law units, to ease the housing crisis.

The state has “changed the law and permitting of code to make it easier, faster and cheaper to build units,” said Dan Passage, a partner at Winston & Strawn and co-chair of the law firm’s structured finance practice.

As zoning laws change and cities create programs to reduce permit costs for ADUs, lenders are being approached to create a financing vehicle.

Property Assessed Clean Energy financing originated in Berkeley in 2008 as a means to finance energy efficiency projects such as solar panel installations. PACE allows residential and commercial property owners to accept voluntary tax assessments, repaid typically over a 15 to 20-year period, that can back municipal bonds. They've been adapted to uses beyond the original energy efficiency goal, and ADUs may be next.

One southern California PACE financier said he has been approached to create a housing bond structure to fund construction of the rental housing units.

Michael Chapin, founder of San Diego-based Figtree Financing, and the state’s first lender to use municipal bonds to fund a PACE program, said he has been contacted by affordable housing developers in Orange County about developing a financing model involving housing bonds.

“Back in the day, I did affordable housing work,” Chapin said. “One of the partners of the company I used to work for in Orange County said they are getting overwhelmed with clients wanting to do granny flats – and asked if I could create financing for it.”

Figtree is in the process of developing a structure, Chapin said.

Gov. Jerry Brown has signed two bills since 2016 to ease permit costs and zoning regulations to boost ADU construction.

Los Angeles has created a program that provides tax breaks to residents who build a tiny home in their backyard that provides housing to someone who is homeless. The city received a $1 million grant Monday from the Bloomberg Foundation for its ADU program.

Passage is also working on efforts to create a financing structure to finance garage conversions and ADUs construction.

“It is early stages,” said Passage, who represents a large private equity fund, whose name he would not disclose, that has $50 million to fund loans and equity for the units, also known as granny flats.

The first securitization is anticipated second quarter next year, Passage said.

“I think we will be the first to the market,” he said. “The reason the space is interesting is not that there are huge volumes, but the trajectory looks a lot like PACE, which came out of nowhere in 2014 and quickly built to billions in securitization.”

Los Angeles has taken the lead in easing planning and zoning restrictions for homeowners to build units in their backyards. The city had already passed an ordinance making garage conversions legal, and encourages homeowners to build new structures to ease the city’s housing crisis.

The city is working with affordable housing financier Genesis LA on how best to deploy the Bloomberg money, according to a spokeswoman for Los Angeles Mayor Eric Garcetti.

The number of applications from Los Angeles homeowners to build ADUs has grown from 84 in 2013 to 8,600 this year, according to the mayor’s office.

“The state is quite aware there is a massive problem with homelessness and people losing their homes, because housing is not affordable,” Passage said.

The state loves the idea of the dwelling units for two reasons, Passage said: it doesn’t cost the government any money and as with PACE, it sends an environmentally friendly message.

Though PACE would seem like the quickest course to fund the demand, there may be limits to how far the PACE model can go toward financing ADUs.

Chapin said the security and collateral on new construction is different from PACE, which provides financing for retrofits to existing properties.

“A new structure introduces construction and building risk,” Chapin said. “There are a lot more uncertainties with new construction. That is why new construction was carved out of PACE.”

Figtree only covers retrofits that add energy efficiencies with its financing, he said.

What Chapin envisions is something more like the financing program for affordable housing that existed before the state’s redevelopment agencies were eradicated in 2011.

He envisions a program involving pooled mortgage bonds or lease-financing backed bonds, where people meet certain criteria and financing is made available through a local government or county, he said.

The pooled structure would be take-out financing for second mortgages used to build the dwelling units, he said.

Renovate America, a national PACE lender, has been financing energy retrofits to ADUs, but only if the changes provide energy savings, said Greg Frost, a spokesman. The company does hope to grow that aspect of the business, he said.

Though Frost isn’t aware of efforts to expand PACE to cover construction of the unit or renovations unrelated to energy savings, he said there have been expansions of PACE beyond the original concept.

In Florida, he said, the state has allowed homeowners to use PACE financing to repair roofs after a hurricane or to add retrofits to make roofs stronger.

Brown, California's governor, signed a law in September that will allow homeowners to use PACE to do fire prevention upgrades, Frost said.

“We are in the process of talking to our issuing partners to make sure they would allow us to do that,” Frost said. “It is a second example of the ability of PACE financing to be used to address public policy challenges that go beyond clean energy.”

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