New Retirement Living Option - And Income Source

Thanks to a recent wave of residential zoning changes in bedroom communities scattered across the country, many late Boomers and leading-edge Gen-Xers have a retirement-planning and investment option their older brothers and sisters didn’t have.

Well- and deeply rooted in their pleasant suburban neighborhoods, these forward-looking people in their late 40s, 50s and 60s are putting savings and home equity to work by building separate, secondary houses on the same building lots as their existing family houses. Called Accessory Dwelling Units or ADUs, these new, smaller houses can be used for multigenerational family living or for rental income.

Better Alternative Housing – and Extra Cash

Unlike so many "granny flats" that are awkwardly carved out of existing interior spaces and underused because of their drawbacks (the damp basement, the airless attic), the new houses can be designed with workable kitchens and livable spaces right from the start. Amenities such as solar panels, radiant heating, baby gates, and wheelchair-width halls and doorways can be planned into the new house. 

If no one in the family needs to live in the unit right now, the ADU can be an investment for tax-free growth, with the income feeding into a self-directed IRA. The only limitation is that the new house must be independently managed by a third party and used strictly as a rental, and the renters can't be family members. While you can't own real estate within a 401(k), you can borrow up to 50% of the funds up to $50,000 – money that could be a bridge loan during construction. If you’re considering these options, professional advice on the legalities of arms-length ownership and the risks of 401(k) loans can help you make an informed decision. 

Why Residential Zoning is Changing

During the post-Levittown era of suburban sprawl, population density was seen as undesirable. Even older residential areas that permitted a discreet garage or basement room with a bathroom usually banned including a kitchen. In the new zoning, however, the typical main restrictions are on size – usually 800 to 1000 foot maximums – and on style so that the new structure will fit into the surrounding neighborhood. The owner may be required to live on the property, whether in the new place or the original house, to prevent slum-lording. Providing a feasible legal way to add ancillary units cuts down on illegal ones that skirt tax laws and fire codes.

Many municipal governments favor ADUs as a new source of tax-base broadening. They create affordable housing that doesn’t involve the conflicts of eminent domain issues or the drawbacks of commercial infill housing that’s aesthetically out of step with the town.

Housing diversity to allow for a range of incomes is important in cities that need residents to fill a range of jobs. In the Washington, D.C. greater metropolitan area, including parts of Virginia and Maryland, auxiliary housing may be permitted as long as it is designated for people with lower incomes. In this region, ADU is also used to stand for affordable dwelling unit – for example, permitting some ADU-classified attached townhouses in what is otherwise a single-family, detached-house development. Income restrictions apply, as well.

Different Places, Different Spaces

The tide of change is national, but has a stealth aspect, because it washes over one place at a time, with each locale working out solutions on its own terms.

The exception is California, where the city of Santa Cruz wrote the book, literally – a how-to manual with ADU designs and approvals systems that it developed under a $350,000 state grant on the condition that the Santa Cruz model be made available for free throughout California. Santa Cruz’s smart-growth goal was to increase density while protecting a greenbelt around the city. A few cities in other states, such as Ann Arbor, Mich., are adopting the Santa Cruz model now, and there will be more.

It’s no surprise that famously green, crunchy and socially aware Portland, Ore., is another trailblazer: On June 1, 2014, it held its inaugural Build Small, Live Large: Accessory Dwelling Unit Tour, showing eleven finished ADUs, one under construction and six tiny houses intended to be on wheels. Interest was high; tickets to the citywide tour sold out well in advance.

Portland’s zoning code was modified in 1998. When a 2010 waiver discounted the city’s infrastructure-development charges by as much as $11,000, the number of ADUs built by permit zoomed from about 30 a year to 200 in 2013.

Seattle calls them “Portland houses,” and Portland nicknames them “backyard cottages,” but one 600-square-foot carriage house is actually in the front yard of Edith Casterline and Don Golden’s property in Portland’s Sunnyside neighborhood. It cost its creators $110,000, plus sweat equity, in 2009. The owners drew on savings and a home equity line of credit. The carriage house has solar panels that support both houses during the warmer six months of the year. The new place is used as a rental while the owners live in the primary house, happy to have income from the little house paying half their mortgage.

Carriage houses, or “alley houses” originally for servants, are a Victorian Minneapolis tradition, but for more than 40 years they have not been allowed as independent living units – much to the frustration of Jim Graham, an urban planner (and resident) of the Twin Cities’ Ventura Village, the only area that does permit ADUs. Ventura Village is a community planned for affordable housing in the early 2000s that proved its point to his satisfaction. 

Across the river, St Paul’s upscale St. Anthony Park is currently debating a plan for ADUs within a half-mile of a new light-rail line. The St. Anthony Park Land Use Efficiency action group is behind zoning-change initiatives and in May 2014, it announced the formation of a task force to make recommendations on appropriateness. The Park Bugle, a community newspaper, has been covering “the strong opinions” expressed locally both for and against the ADU zoning initiative, and the outcome looks far from certain.  

Urban planner Jim Graham disagrees: “It’s definitely coming,” he says. Graham well knows the AARP study in 2000 that advocated ADUs for older people downsizing their homes. He has visited Vancouver,  B.C., to study that city’s well-established carriage-house use throughout the city – even surrounding its city hall. “It’s ideal low-profile, high-density housing,” he says, “that’s affordable for a growing population and adds to the tax base without adding infrastructure costs.”

In 2002, working with a grant from Fannie Mae for Ventura Village, Graham and his colleagues devised ways to build multiple 1180-1190 square foot units with different exterior appearances and variable interior layouts, but using certain standard components and Ikea techniques to contain costs to $59-60 a square foot. Those architecturally high-end ICF-constructed (insulating concrete form) units were designed to be hurricane proof as well as “nearly zero-sum” in energy use. That was a dozen years ago. Today, Graham says, a similar individual 1000+-square foot carriage house over a three-car garage could be built from scratch for approximately $100 a square foot – coming in at approximately $100,000.

A New Solution for Boomers and Gen X

ADUs provide one route that's especially helpful to the younger part of the huge Baby Boom generation. A Great Divide is playing out between early and late Boomers: The early Boomers (born 1946-1952) started working when defined-benefit plans prevailed – typically pension plans providing regular monthly payouts and certain guaranteed healthcare benefits for retirees. They tend to be fairly confident about their finances in retirement. 

By contrast, the late Boomers (born 1958-1963) have more often had access to defined contribution plans – that is, 401(k)s or Keoghs and 403(b)s. The most common 401(k) payout is a lump sum, which makes the individuals responsible for their money management from then on.

This generation, now in their 50s or early 60s, burned by the mortgage meltdown and bruised by the career turmoil of the Great Recession, have significant uncertainty about their futures – only 25% are confident of having financial security in retirement. Late Boomers expect to keep working until age 72. More than a third still are financially supporting an adult child, and many have drawn down retirement savings to ride out job losses. No wonder they’re having the anxious hot flashes of peri-retirement. They know additional retirement income will be needed to keep their money from running out.

Seniors and future seniors planning to work longer need to keep living near their jobs. Also, they may love their neighborhoods and dread the social isolation of relocating away from people they know; downsizing next door does have appeal. And some just plain do not want to live in seniors-only housing – “geezer ghettos,” as Margaret Wylde, president of ProMatura Group, calls them. A recent State Street study found that late Boomers believe real estate has been their best investment to date: “Investors clearly have an affinity for the tangible – cash on one hand and real estate on the other,” the study concludes. ADUs can deliver both.

Finding the Money

Borrowing from a 401(k) isn't the only way to fund an ADU. Home equity loans are making a cautious comeback. It is still possible to refinance at a low mortgage rate, so some families tap the equity in their existing house. And there’s the magic age of 59 1/2 when early-withdrawal penalties no longer apply on retirement-savings accounts, another potential source of cash.

AADUs are also a way for more-entrepreneurial Gen Xers to take control of their future retirement housing and income needs. Rental income is likely to keep pace with the cost of living better than Social Security benefits will, they believe. According to recent studies, Gen Xers – born 1961-1981 – are family- and community-centered. Compared to other generations, Gen X ranks highest in volunteer work, with 3 out of 10 active. A recent Metlife study found that 20% of Gen Xers are spending an average of 11 hours a week caring for their parent or another older relative, helping with tasks such as shopping, household chores, making meals or providing transportation. More than 15% provide 20 hours or more of care per week – an additional reason why an ADU could be useful to both the older relative and the caregiver.

When Generation Glue Trumps the Geezer Ghetto

The Generation Gap doesn’t seem to be driving mid-life Baby Boomers and their Gen X families apart the way it once did. The Great Recession has made many families more interdependent. Generation Glue often develops while generations are sharing a roof, and necessity turns into affinity.

Hands-on grandparenting and regular childcare is a happy reprise for many active retirees in the late Boomer and early Gen X generations who’d been working parents themselves, rushing through their children’s young years. ADU housing could begin with the older adults using the new structure as an income property or to house children just starting out on their own. 

Later, the seniors could move into the ADU, turning over their larger home to the next generation of parents and grandkids. Having the younger family next door will mean older seniors can postpone the wrenching move to assisted living or nursing care and avoid some of the higher costs, easing fears of outliving their money. Lacking family members to use it, the older generation could move into the ADU and rent out its larger home. No wonder investing in a secondary house next to their present one appeals to many in mid-life: It’s multigenerational as well as life-cycle housing.

The Bottom Line

“Families that hive together can thrive together” could be these families’ motto. Others like ADUs as a way to downsize as they age and receive income in retirement. Municipalities that change zoning to permit these units benefit from increased diversity in housing and a larger tax base without costly new infrastructure. As Minneapolis/St. Paul urban planner Jim Graham says, “The time is right.”