SB 9 is, however, merely a step toward increasing the supply of housing. David Garcia of UC Berkeley’s Terner Center for Housing Innovation acknowledges only the symbolic nature of the law, saying that “It signals that lawmakers are willing to take on the traditional sacred cows of housing and single-family zoning.” Despite being a positive signal, the legislation will do little to radically increase the supply of housing in the State any time soon. Dan Dunmoyer, president and CEO of the California Building Industry Association, makes the point that there are many “levers” affecting housing production that this law does not address.

As a company whose principals have experience across the fields of construction, design and development, Riaz Capital understands the drivers of consumer behavior. The talk (and in some cases, anxieties) around a coming “flood” of rental housing supply is likely overstated. SB 9 legislates a process that has already been viable for years through the statewide legalization of accessory dwelling units. And with many single-family home lots already built out, owner-builders (homeowners who redevelop their own homes) will find that the opportunity costs of substantially altering their properties outweigh the potential benefits. Considering the additional financial and non-financial incentives of single-family homeowners, whom this law affects most directly, the passage of SB 9 ultimately accounts for an insubstantial change in California’s housing supply.

Immaterial Change – New Politics, Same Policy

In 2019, the State of California passed a suite of legislation permitting the construction of accessory dwelling units in most parts of the State. By permitting the construction of additional structures on an existing property, the policies effectively allowed for a single lot to house two households – much like a duplex. Though ostensibly a way to increase the stock of rental housing in the State, there is no requirement for these additional units to be used as rental units. Many homeowners simply use them as guest cottages or backyard offices.

The only significant difference between the existing ADU laws and SB 9 is that SB 9 does not impose a size limit on additional units. This development is not a substantial change to the policy landscape of California, as homeowners have already been allowed to increase the density of their single-family properties in a similar fashion. Relatively speaking, few have yet taken advantage of it.

Homeowner Desire and Value – Single-Family Homes on a Pedestal

In American culture, single-family homes are the ultimate status symbol: there is no vision of material success that does not include living in a single-family home. To own such a home is to demonstrate ownership of personal comfort and security, things that multi-unit buildings do not easily provide.

Said more practically, single-family homes are marketable and attractive to prospective buyers who prioritize privacy. As such, many owners of single-family homes who use them as their primary residences buy these homes for the express purpose of not having to share stairways, backyards, and interior walls with tenants.

It is doubtful that many single-family homeowners will jump at the opportunity to downsize their own living space as drastically as the law permits them to. The prospect of rental income is simply not enough of a driver for someone who already owns a single-family home to sacrifice so much of what they value in the structure.

Besides the simple discomfort at the prospect of adding tenants, homeowners will likely find that converting their single-family home into a multiplex will diminish the per square foot value of the asset. Single-family homes, being the height of American status symbols, are priced at a premium per square to multi-unit buildings. Multiplexes are often valued less on a per square foot basis than equivalently sized single-family homes, especially in dense, urban cities on the West Coast.

This premium on single-family homes can be as high as 20-30%. A 3,000 square foot house valued at $500 per square foot can sell for $1.5 million. But if that same single-family house were converted to a 3,000 foot multiplex at 20% less per square foot ($400), that building would sell for only $1.2 million. For owners concerned mainly with the resale value of their property, adding units is obviously a bad deal.

Considering this, it is unlikely that homeowners will be financially incentivized to effectively destroy their home value by adding units to it.

Economic Inefficiency – No Economy of Scale

When the statewide ADU legislation came into effect, Riaz Capital analyzed all the properties in our portfolio to understand where it may be economically advantageous to add units.

Under the new policy, it would be permissible to add units to existing structures or add additional structures to the site. Considering both these options, we concluded that the limitations of economies of scale would only make such additions economically feasible if each building contained a minimum of 4-5 units. In other words, we concluded that anything with less than 4 units was not worth the effort and cost of development.

Buildings, like businesses, are subject to economies of scale. Experienced developers frequently have minimum unit counts for projects they will consider because costs per square foot respond inversely to the size of buildings. It is more financially efficient to build a large, dense building than a small one.

As written, SB 9 limits the size of projects to individual, single-family home plots. Very few plots have the physical capacity to accommodate densities with sufficient economies of scale. Professional developers, whose businesses inherently rely on economies of scale, will be unlikely to pursue projects enabled by this legislation. Said differently, any development enabled by SB 9 will be largely limited to owner-builders.

It is hard to argue with geometry. UC Berkeley’s Terner Center for Housing Innovation cites physical capacity limits, along with financial infeasibility and explicit exemptions to SB 9, as major limitations to development feasibility. This led the Center to estimate that the new law will only enable development on 5.4 percent of current single-family parcels. With the second smallest combined house and lot size in America, few California lots and homes have the capacity to feasibly add enough units to justify redevelopment.

Development is Not for the Faint of Heart

The limitations of economies of scale will all but ensure that the small amount of development made viable by SB 9 will be limited to owner-builders. Owner-builders will then quickly find that development is no easy feat. For those who determine that the inherent drawbacks of redevelopment are worth the potential revenue from rent, they will likely run into the barriers of capital constraint or limited experience with navigating the development process.

Empty nesters, who are the most likely to both value rental income and be willing to add units to their homes, will likely not have the liquidity necessary to make the needed modifications. Significant conversions can cost hundreds of thousands if not single digit millions of dollars. Such capital is not readily in the hands of many homeowners, and the prospect of taking on debt is frequently very intimidating. Capital constraint will significantly limit the reach of SB 9.

Even if capital is not a concern, a select few homeowners will be willing to dive headfirst into the infamously convoluted process of development. Subdividing lots, coordinating with an architect, and managing contractors is time-consuming, expensive, and risky. Simply put: most homeowners do not have the development skill necessary to go through a complicated development process and will consequently shy away from pursuing densification of their properties.

It is difficult for the state to wave a political magic wand and, overnight, drastically alter the behavior of local jurisdictions who ultimately have the most influence over what gets built. An additional complicating matter is the issue of historic preservation. SB 9 does not allow for simplified approvals to properties which meet the definition of an “historic resource.” As a result, we certainly will not see a flood of housing supply in older cities that have weaponized historic preservation rules to “protect” single-family neighborhoods.

Development is not for the faint of heart. With compounding procedural difficulties and cost constraints, very few homeowners will opt to build additional units on their properties, even if they are allowed to.

This policy may be best understood as a social good for homeowners with specific needs rather than an impactful solution to the housing crisis. Empty-nester homeowners with liquidity will likely benefit from this law by being able to stay in their (modified) homes and live off the extra income of rent. This is a narrow subset of the population, however. As mentioned earlier, those who do not need the extra income will find little reason to modify their homes, and SB 9 will consequently have limited reach.

Conclusion

SB 9 is a step in the right direction for the State of California, which has demonstrated its commitment to addressing the housing crisis through innovative policy in recent times. While this law will undoubtedly lead to the creation of more housing in the State, it will not be significant for the time being. The economic barriers for homeowners, combined with an aversion to the development process itself and potential privacy concerns of adding tenants to a parcel, make adding housing to single-family homes infeasible for most homeowners.