How a Million Small Cottages Can Make a Giant Difference in California’s Growing Housing Crisis
How a Million Small Cottages Can Make a Giant Difference in California’s Growing Housing Crisis
California can use our collective buying power to help Los Angeles recover – and to address our statewide affordable housing and homeless crises by unleashing economies of scale in ADU construction
Would you want a backyard cottage to rent or sell if there was no upfront cost to you?
Marshaling our state’s response to the Los Angeles fire emergency is a once-in-a-generation opportunity to act creatively to address our statewide housing affordability crisis.
California can rapidly and dramatically increase our supply of affordable housing by leveraging economies of scale in the construction of accessory dwelling units (ADUs) and unlocking low-cost state loans. By using the state’s ability to buy in bulk and the authority to issue lease-revenue bonds, we would give Californians access to deeply discounted ADUs at no upfront costs with all taxpayer costs repaid through small monthly rent payments.
History supports this approach. In the aftermath of the devastating San Francisco earthquake and fire of 1906 local governments and agencies quickly built over 5,000 earthquake cottages to house those made homeless by the earthquake and subsequent firestorm. The cottages were “rent to own” with families paying $2 per month toward a total cost of $50, (which would be the equivalent of $168 today). Families lived in the cottages as their homes were rebuilt and for generations after these small backyard cottages were part of San Francisco’s affordable housing supply.
Right now the cost of housing in California is driving people out of state, driving businesses to relocate, driving millions into poverty, and driving our shocking homeless crisis.
Addressing the California housing shortage, which is estimated to be up to 2.5 million homes, has occupied legislators for years, with law after law being passed to make it easier to permit homes and apartments.
But while speeding up permitting does lower costs, the main drivers of our brutally high housing costs are the cost of land, the costs of construction, the cost of capital (borrowing), as well as the type of housing being built by the private sector – which is essentially nearly all market-rate housing because that is the only type that will “pencil out.”
Backyard cottages like those created by this program would be “affordable by design” because they are small and far less costly to build. And one of the key successes of the recent surge in Sacramento housing policy has been making these Accessory Dwelling Units (ADUs) legal nearly everywhere in California.
Certainly, not everyone wants to live in smaller homes, but many do if it means financial stability, less stress, and the ability to pay for other needs. By focusing on building homes at a fraction of current costs we can also unlock the ability of more Americans to own small “starter” homes, because under California law these new backyard cottages can also be made into condominiums and sold separately. My city, San Jose, was the first in the state to adopt this new reform.
Currently our property tax structure still incentivizes “empty nesters” and others to stay in homes that have likely become too big for their needs. A backyard cottage that allows parents to move to smaller quarters while their kids take over the larger family home is a cultural practice so prevalent in the past that small cottages and lower floor units used to be called “granny flats.” Again, these units would not be for everyone, but making it deeply affordable to site a backyard unit will make it much easier to utilize our existing housing and land with much more efficiency.
Would you want a backyard cottage to rent or sell if there was no upfront cost to you?
These cottages are not just more affordable because they are smaller and less costly to build, but because the land is essentially “free.” In Los Angeles, for example, the cost of the land makes up more than 50% of home values. With a new backyard cottage significant land costs are essentially zeroed out for these new homes.
Manufacturing homes at scale in a factory will also help address the shockingly high cost of construction in California, which will go even higher as we work to rebuild Los Angeles in the middle of labor shortages and supply chain issues. The cost per construction in Los Angeles was already between $400 and $700 per foot in many places – meaning replacing a 2,500 square foot home is up to $1.75 million dollars in construction alone – before all other costs. These new bespoke homes will never be affordable.
Using state bonding authority to issue lease revenue bonds to pay for these ADUs would generate dramatic additional cost savings. Right now the most expensive capital in housing construction are the initial “construction loans,” which can be between 12 and 20 percent. The average interest on a new California state lease-revenue bond is just over 4 percent. (Lease-Revenue bonds are those bonds that are paid off with a future revenue stream like rents, not by taxpayers).
Many have heard the term “the China Price.” It refers to what happens when you apply mass manufacturing techniques to a commodity – and what happens is the price plummets. Think color TVs which used to be a major investment and now, because of advances in manufacturing, are a mere fraction of the price and have dramatically improved in quality.
If we do to small manufactured backyard cottages what we did to color TVs we will dramatically lower the costs – and improve quality. Again, think of homes that are much more fire resistant, have solar, battery storage and other features that will make them safer and more sustainable.
The sad truth is that while labor productivity in the United States has soared productivity in the construction sector has actually fallen. This is not unexpected because homes are still essentially made by hand. If these small homes were made in factories we could dramatically lower the price and improve quality.
And just as we once did with solar energy, California can use our scale and vision to be “market makers” to spark this housing affordability breakthrough.
Back in the 1970s the cost of a watt of energy produced by solar energy was over $100. Today it is less than 5 cents – and the actions of states like California, which began to induce demand and create a market for mass manufacturing, contributed to this exponential drop in costs.
So let’s have history repeat itself. I propose in response to both the fire crisis, the homeless crisis, and our ongoing housing affordability challenges, that the State of California essentially act as a housing purchasing agency and release a request for proposal for at first tens of thousands and eventually up to one million manufactured backyard cottages.
We can site these new homes first in the fire zones after cleanup, so the displaced have somewhere to live while their homes are being rebuilt – just like what happened after the 1906 earthquake and fire. After homes are rebuilt the backyard cottages can become rental housing or host extended family members, just as earthquake cottages once became part of the rental stock and “granny flats.” Just as with the earthquake cottages, the entire costs can be recouped through small monthly leases with interest. And federal disaster relief funds could also help jumpstart this process.
While I don’t think we should limit where the ADUs are manufactured in the initial emergency stage (the residents of Los Angeles need shelter now), we could consider a “buy local” or “assemble local” incentives, prompting the creation of new factories and the expansion of existing factories in California and the good jobs (and frequently union jobs) that come with them.
Again, homeowners in the fire zones should have first priority, but once their needs are met, the program should be available to homeowners anywhere in California, along with cities, counties, and non-profit groups looking to scale quick build housing programs to address our homelessness crisis.
My city, San Jose, has focused on this kind of quick-build housing to bring our homeless neighbors indoors and we are one of the few in California to actually be lowering the rate of homelessness. We could go faster if we could lower the costs of these units even more – which this program would create through massive economies of scale.
And the impact of up to a million new affordable homes on our homeless crisis is significant. Our city, and every city, could house many more people in transitional tiny home villages if we could dramatically lower the costs of the units. But beyond that, if we simply had more affordable homes fewer people would fall into homelessness and we would help keep people who have incomes but are struggling, in safe and decent albeit small homes.
To meet California’s housing shortage in recent years Sacramento legislators have doubled down on the concept that we need to increase density and punish cities that don’t meet housing goals. We should increase density where it makes sense – and this program will do so. Essentially it is helping to make each lot nearly twice as “productive” when it comes to housing utilization.
But the challenge with current state mandates for housing production – and frankly the inconvenient truth almost everyone already knows, is that these goals are simply unachievable with current cost structures. The state can order cities to build more housing but cities don’t build housing; for-profit and non-profit developers do. And at the current cost of construction, new production doesn’t come anywhere close to meeting our housing needs.
For-profit developers are frequently not breaking ground on already permitted projects because they don’t make economic sense because of land, construction, and capital costs. For example, in my city there are over 6,000 apartments already approved by our city that are not being built because it doesn’t make economic sense for the developers to do so. And we’ve zoned our designated growth areas for another 62,000 units–as mandated by the state–but virtually no one is trying to entitle and build one of those parcels right now even with streamlined approval processes in place. The same is true in cities across California.
Non-profit developers build more affordable homes by using government subsidies and then restricting rent to a percentage of a lower income earner’s annual earnings, but here is the key issue – these new homes now cost up to $1 million per door to build. We will never have enough funds to get even close to our affordable housing needs at that price.
A new state program that dramatically reduces the cost of ADUs and then leases them back to homeowners will cost taxpayers nothing in the long run because the relatively low upfront costs can be easily paid back by the owners through affordable rents.
Would you want a backyard cottage to rent or sell if there was no upfront cost to you?
Certainly, we need an all of the above approach to housing – more supply at all points on the market, more investment in truly affordable homes through government and non-profit agencies AND programs such as the one we are proposing that can flood the market with affordable units at no cost to taxpayers.
Right now you can go on Amazon and buy a manufactured cottage for $50,000 or less. Imagine the cost we could negotiate if we purchased these homes in bulk and we used our buying power to negotiate even better prices and features.
Buying in bulk, a fully-fitted ADU costing $30,000 could be recouped with just a $150 monthly payment. That means they could be rented at a deeply affordable level by the homeowners who site these cottages and dramatically lower the costs for cities and agencies seeking quick-build housing for the homeless.
It is important to consider that the cost of the backyard cottages themselves are only part of the costs of these new homes, which include leveling land and utility hookups. Frequently these costs can be as much as the unit itself, which is why we should also allow homeowners who meet certain criteria, like they will rent rather than sell these units, to draw on at least another $30,000 in upfront costs to prepare their lots for these units. That would bring the monthly payback costs for these families to $300 per month – which would still allow these cottages to be rented at deeply affordable rates and incentivize homeowners to participate in this program.
Again, it is important to emphasize that while the state would back this effort, we would be using the scale of the state and our low bowering costs and leveraging these to build and site these homes throughout California at no cost to the taxpayers. I propose we guarantee that all tax funds are fully repaid with a property assessment structure so repaying the cost of the cottage and land preparation would be part of a homeowner’s tax bill. Cities and agencies could join this buying pool and pay up front.
Yes, tiny homes are not for everyone. But they are perfect for extended families, grandparents, single people, students – and at deeply affordable levels. And these tiny homes are a vital part of any real solution to our homeless crisis.
And the benefit is not just to renters looking for affordable prices and cities looking to dramatically expand homeless housing at lower costs. The homeowners themselves will see an ongoing economic benefit, which essentially is a statewide economic stimulus program.
We can expect that the homeowners who act first to site these units will be doing so to house family members (freeing up space in other parts of the market). Other homeowners will accept these units to help make ends meet – fund retirements, college educations, start small businesses, help pay bills, (including rising home insurance costs). This rental money will be spent here in California – helping to make the homeowners more secure and our economy stronger. And it is worth noting that the rental market is increasingly dominated by Wall-Street backed Real Estate Investment Trusts acquiring rental units and single family homes. The rents from those Wall-Street behemoths are remitted to investors globally. These rents will go to California’s homeowners – largely middle- and working class families– with the money staying in and stimulating our local economy.
And with more than 30 percent of Californians paying more than 30 percent of their income in rents and housing costs – which is considered cost-burdened – lowering housing costs will mean more money can be spent on local goods and services, not rent. Again, a massive local economic stimulus.
By flooding our state with affordable units we will also dramatically improve our overall business climate. Here in Silicon Valley founders and leaders keep reporting to me their number one barrier to expansion is the high cost of housing. A backyard unit will not serve the needs of a large family, but it is perfect for that new engineer just out of college or for young couples.
California’s high cost of housing is putting our innovation economy at risk by making our state much less competitive, with lower-cost cities and regions attracting the innovative firms that grew California into an economic powerhouse. This challenge was just emphasized by the new Milken Institute study that showed California cities plummeting in economic competitiveness largely because of high housing costs.
And more important still, a bold plan to address housing prices can lift millions of families out of poverty. California has the highest effective poverty rate in the nation when we consider the Supplemental Poverty Measure, and the number one factor is the high cost of rents and housing. We have relatively high-wages, but brutally high housing costs – driving millions into effective poverty.
A perfectly fair question is if there is a market for these small homes. In San Jose we are seeing rapid adoption of these units, with over 300 per year being built in the past few years, representing 25 percent of our new housing production. Our city is not alone, throughout California there is growing acceptance of these backyard units.
And just before the pandemic a non-partisan group conducted research on public attitudes toward adoption of backyard cottages in San Jose and they found that fully 34% of San Jose homeowners would be willing to site a backyard cottage if there was no upfront cost and they split future rents with the city until the unit had been paid off. Another study in the Sacramento area found 47% of homeowners were interested in a backyard unit.
While not necessary to launch the program, I propose we also explore workforce housing programs that will eliminate friction points for homeowners considering siting a unit. While the study showings that many homeowners are willing to accept a backyard cottage for a rental unit are encouraging, I expect that many homeowners don’t want the risks and work of becoming landlords. While this would require a change in state law, a city like San Jose could create a workforce housing program that offers our workers access to some of these units with affordable rents deducted automatically from their paychecks and remitted to the cottage hosts – meaning the hosts wouldn’t have to look to find renters or worry about collecting rents – and it would help my city attract and retain excellent workers through lower housing costs.
Also not necessary to launch, but important to consider, is the trained workforce required both to build the units and to install them and we should work with unions, community colleges, and even high schools to promote the workforce training we need to prepare Californians for these meaningful jobs. Also worth considering is using this program as an incentive for cities to speed up approval times and reduce fees – with cities agreeing to these measures getting first priority in participating in this program.
The Los Angeles fires are a terrible tragedy. But we can help heal Los Angeles, and help every community struggling with high housing costs and homelessness, by responding boldly with a plan for up to a million new affordable homes.