Impact of rebuild zoning issue on property value

[Justin Park]

Hi BP, checking in with a question I probably should have asked this forum weeks ago regarding an issue that came up in the appraisal of a two-family university rental I'm under contract on.

Appraiser noted that a zoning clause in this particular area indicated that if the property were to be "totaled" so to speak, it would have to be rebuilt as a single-family home. Despite being a two-family for almost 70 years.

Initial mortgage loan fell through in underwriting because Fannie/Freddie won't touch anything like that, apparently.

Secured a portfolio loan that's actually better rate, but I am hesitant to sign the commitment since I feel like I don't understand all the possible implications.

The lender said she approved the loan because in their mind, a SFH might actually be more valuable in that unlikely event so it didn't affect their willingness to take on the debt.

I intend to buy and hold for at least 10 years, but I can imagine this issue will affect my ability to sell down the road, since a prospective buyer won't be able to get a conventional FHA loan just like I wasn't able to.

This property should cash-flow really well after some rehabbing to the one unit, but I'm realizing this limitation will also make doing any kind of cash-out refi more difficult as well.

Curious if this throws up any red flags for you veterans of the REI world that I, a relative novice, am not seeing. Would this be a dealbreaker for any of you? How would you all handle?

As always, I appreciate any help/advice you can provide! (Even dismissive, salty judgment of me and my query.) ;)