5-Unit Listed as a 4-Unit - Is this cause for concern?

[William Reed]

I am considering purchasing a multi-family property in Northern New York.  It's listed at $103k as a 4-Unit with an office, however the owners have the office rented as a 5th unit.  They told me that they don't report the 5th unit because the financing and taxes would have been greater because it would be considered a commercial property.  As a new investor, I'm concerned of the ethics of not reporting the 5th unit and assessing it properly but am not sure if I'm making too much of the situation.  I would imagine that a home inspection and appraisal would  uncover the fallacy.  Would it be best for me to finance it as a 5-unit or keep it as-is?  Personally, I would rather have a 5-unit because I can directly force the appreciation as opposed to a 4-unit that is dependent upon comps in the area.  

Would there be any ramifications on the current owners if it is assessed as a 5-unit during an appraisal?  The owners made it clear that their main goal with all of their investment properties was to avoid taxes (they've  informed us of some other practices where they don't report cash rent payments and income from a washer & dryer).  Ultimately, I want to be honest and transparent in all of my business practices - if it causes me to pay more in taxes and financing, so be it.  If anyone has any insight or advice, it would be greatly appreciated.

-Will

[Chris Mason]

Hi @William Reed,

Sellers probably intend to have the 5th tenant not be there, and the oven removed, prior to the appraisal showing up. If you can't cook in it, it's not a 5th unit. And they will lean the bed up against the wall, throw a tarp over it, throw tarps or blankets over everything else, call it a storage area, etc. Not the newest trick in the book, oldie but a goodie. Now, if there is a residential tenant in there, with a lease in place, and this is hidden from the appraiser, they are being sneaky and naughty. I'm guessing you want no part of sneakiness? Good for you.

To cover YOUR butt and ensure YOU aren't committing fraud:

Without a 5th tenant and 5th oven, it's not a five unit. (I am not a lawyer, check with a lawyer, this is not legal advice) You can write in the contract "Property is a 4 unit building. Seller to deliver property as a 4 unit building, with no more than 4 kitchens, 4 tenants, and 4 leases in effect." The difference here is that their appraisal trick is sneaky, and if you know about then that could put your behind on the line too. So you don't want it merely "appraised as" a 4 unit, you want it DELIVERED as a 4 unit.

What he did, and how he got his mortgage before, how he makes that tenant go away, and if he exposes himself to liability for violating that 5th tenant's rights (both now, and historically), are not your concern. You just need to ensure that you aren't on the hook for any of it. New property owners inherit the lease, rights, responsibilities, obligations, etc, of the former owner, so you don't want tenant #5 in there, with a lease in place (verbal or otherwise), at closing.