Three-unit zoned as a single family - can I finance as a SFH?

Question

Hi, everyone. Thanks in advance for any help you may be able to offer. I believe I have found a great property to purchase as my first investment. It is one continuous building on a residential-zoned lot; however, it does have 3 separate entrances and can be viewed as a triplex in the sense that there are three separate living spaces, separate meters, etc. After seeing the property, my plan is to occupy one of the units and use the others as short-term rentals.

My understanding (from the limited knowledge that the seller has provided) is that the main house was originally built as a SFH and then the two additional units were added over time to turn it into a "family compound" with in-law suites, etc. A few years ago, the property was foreclosed on by a bank, and a "flipping team" then purchased the property and has held it since. All three units had previously been connected via hallways so you could walk from one unit to the next inside. However, the current owner/flipper sealed off those hallways with walls so that the units are entirely separate from one another.

After speaking with a lending officer that I was referred to, he told me that I am not able to finance this as single-family purchase - my options would either be 1) FHA or 2) conventional with 20% down since it is a 3-unit. It is listed on the state's assessment site as one building with "1.00 Units", so I asked him why I would not be able to finance as a SFH with a conventional loan with <20% down (as I would like to stay away from an FHA loan if at all possible). His reason is that once someone from his appraisal team goes out to the property, they are going to realize it is a triplex and deem it is as such.

My questions are this:

Who is the party that ultimately decides if this property is a SFR vs. multi? Would the appraiser even be the one to decide this, as I thought that would be determined by the municipality? As I mentioned, it is currently listed as a 1.00 unit single family on the state's records website.
Could this just be a situation where I need to talk to multiple lenders (which I planned on anyway) until I find one that agrees to finance this as a SFH?
What is the determining factor for what constitutes a multi-family? For example, if I knock down the new walls that were put up to separate the units and replace them with doors - would that be more likely to be viewed as a single family?

I understand that should the day come where I want to turn these into long-term rentals, I will likely encounter issues with this not being zoned for multi-family use and will likely require costs to have it rezoned at that point in time if that's the route I plan to go.

Brenden M. · Answer

Extremely helpful, Joe - thank you! Seems as if more obstacles are popping up every day, which isn't always a bad thing, as some opportunity usually comes with obstacles. But I am not sure the risk/reward is quite as appealing to me now as it originally was. Thank you again.

Alexander Szikla · Answer

Oh, so a 3 family "acting" as a single family.Yes, then it is a 3 family

Joe Splitrock · Answer

Appraiser will override what is in the state records. It is very common to have discrepancies due to errors or unpermitted changes. The bank will go with how the structure is today. Every lender that is writing FHA or conventional (Fannie - Freddie) loans will follow similar guidelines. The lender would have to misrepresent the property and hope the appraiser didn't flag it, which is unlikely. Due to dishonest practices that were common prior to the housing crash, appraisers and lenders are under considerable pressure to not misrepresent information. Multifamily has separate living spaces, which in this case is determined by walls separating the spaces, separate kitchens, separate bathrooms and separate meters. There is no doubt this is a three unit property. How you plan to use it makes no difference, although your stated use is as three separate units.

Jonathan R McLaughlin · Answer

@Brenden M. One issue you may have is these owners may not have gotten approval to separate those units. If you can walk from unit to unit that might go under the radar as a single family, but if they sealed it up? Make sure you don’t buy it and have the city say “nope” you can’t run it as a multi and take down the walls. It’s happened, which is a big part of the reason banks do t touch it

Teri Feeney Styers · Answer

@Brenden M. If you plan to occupy one unit for at least a year then what is the problem with going FHA? It is actually an ideal situation (house hack). Low money down, super low interest rates and you can legally "escape" in a year and rent the third unit. It is a very cheap way to buy a tri-plex and start earning passive income.

Kevin Sobilo · Answer

Shopping multiple lenders probably won't help. The lender doesn't care! lol. The lender has an underwriter who needs to make sure the loan conforms strictly to the guidelines for the type of loan you are being given so they can resell it on the secondary market. If it doesn't conform they screw themselves. So, it isn't "the lenders rule" that you are running up against. You have a 3 unit, get financing as a 3 unit, the fact that other sources like the assessment database has errors doesn't help you. You are also correct that you may have a zoning issue later on. You might want to deal with that sooner rather than later.

Elise Marquette · Answer

You will run into an issue with the appraisal. This is not an issue of an incompetent lender. The appraiser will go out to the property and say it is a multi and not a SFH. Once that happens you'll run into a whole host of headaches and the long and short is that it will not pass appraisal, thus rendering the property inelgible for financing. And you likely will not get the several hundred dollars you spent on the appraisal back.

Brenden M. · Answer

That's a concern of mine as well. I'm having my agent get in touch to find out if they did pull permits and receive necessary approvals, but my guess is no.

Brenden M. · Answer

It seems others are taking the opposite stance. Can you provide any explanations? I think a big factor in the current situation is that the sellers have permanently separated the units with walls. So when an inspector/appraiser/whoever comes through, they are going to see that all units are separate. So, although it was previous a SFH with connecting hallways, in it's current state, I believe it would be viewed as a triplex - which, again, brings up the issue of the zoning issues that it seems I will inevitably run into.

Brenden M. · Answer

I was simply hoping I'd be able to finance with a conventional loan rather than an FHA for two reasons: 1) I have very strong credit and was hoping to take advantage of that with a conventional loan, unlike an FHA that has a fixed % for the PMI amounts (i.e. 0.80% annual with a 5% down payment) and 2) to avoid the costs of refinancing out to avoid the PMI as opposed to the PMI automatically falling off once I reach the 20% equity threshold. I know those costs can be rolled into the new loan, but again, I was just trying to avoid those if possible.