What risks come with renting out an illegal in-law suite?

Question

Hi all! I'm a beginner in the Chicago area and I'm just learning the ropes around REI before purchasing my first rental property. I've seen a lot of properties that have finished basements that could be rented out for additional cashflow, but these are typically considered "illegal" in-law suites.

Despite being illegal, it seems everyone is renting out these units, and a lot of investments wouldn't make sense without the cashflow provided by these units. What are the risks involved with renting out an illegal unit? How should I account for these risks when evaluating a property?

Prashanth Mahakali · Answer

@Jonathan Klemm Thank you for mentioning me! @John Schulz Your question and predicament is quite a common one. Here is one way to answer it. Have you ever gotten a traffic ticket? What went through your mind? Were you not fazed by it or did you want to handle it right away? How you react to a potential "at fault" situation will help you make a decision. Some people are unfazed and let a building violation drag on as long as they can with a good attorney's help. Some cant go to sleep unless it is handled. Buying an investment property is supposed to be about numbers in a proforma. What one doesnt account very often for is the price of emotions.  If you get a bnuilding that has an illegal unit, chances are you will have to deal with it eventually. Just a question of when? My recommendation is to get a building that has an open basement. Understand the process of establishing a legal unit there and get it done eventually. If an opportunity only works due to the rent from the illegal unit, you have to account for what if you cant have it anymore. The summary is to be careful and understand the risks. Good luck!

Nathan Gesner · Answer

First, there may come a time where the city decides to crack down on them and fine you for an illegal residence, much like they do with short-term rentals.

Second, when you go to sell it, you may have a hard time finding a buyer willing to continue breaking the law.

I don't recommend cheating - even a little - to build wealth and get ahead in life. It's a shaky foundation. If you can't do things right with a little, then you won't do things right with a lot.

Jim K. · Answer

What do you expect to hear about it on an open forum? Go for it, #YOLO, make that good green money.

John Warren · Answer

@John Schulz I would try to run numbers without the illegal unit when possible if it is truly illegal. Now non conforming could be a different story as you can have a legal but non conforming unit and be totally fine. To make matters even more confusing for newer investors, the suburbs are much more aggressive in general at enforcement than the city when it comes to illegal units.

There is a great podcast from the Straight Up Chicago Investing podcast that covers this in depth if you want to listen. Even as a real estate professional I get a lot of value out of these.  https://www.straightupchicagoi...

John Mocker · Answer

John,

I wanted to point out one situation where you could have an issue with coverage.  If your building is a 4 family and the basement unit would make it 5 units there could be a problem.  Most Dwelling/Fire policies are for 1-4 family buildings.  The guidelines the companies file with the state for the policy will state that to be eligible, it must be 1-4 family.  Since they would not write coverage on that 5 unit with the dwelling/fire policy by their filed guidelines, it could present an issue if they discover it (they might cancel) or at claim time.

There are commercial policies that are used for the 5+ unit properties.  Discuss with your agent which is better for you in the event of a claim.

Joe Splitrock · Answer

Generally speaking densely populated cities have turned a blind eye towards cracking down on illegal units. Code enforcement on these type of things is usually only done if there is a complaint. That would be a disgruntled neighbor or tenant.

The bigger risk in my opinion is liability if someone gets hurt. Your insurance company could deny coverage. Worst situation would be wrongful death litigation due to something like a fire and inability of the tenant to escape. I would specifically discuss this with your insurance provider. Disclose that you have tenants and have additional liability coverage.

Mark B. · Answer

@John Schulz

What happens if the place burns down? Who cares why or who is at fault. If someone dies, injured or permanently disabled in the illegal unit who pays for the defense and the liability claim? Are you really insured? Ask your insurance agent if you are doing something intentionally illegal for profit if are you covered (if they say yes, get it in writing).

I get that if the unit is otherwise to code that a zoning restriction is frustrating-but you are still likely not insured.

Chris London · Answer

@John Schulz

I don't know Chicago specifically however you might look into if the city can require you to stop using it as a rental mid-lease. Now imagine you don't have grounds to evict so you have to re-house at your expense. That would be pretty terrible for all.

Angela Smith · Answer

What makes it illegal?  Is there a way to use the space for a roommate as opposed to a tenant?

Jonathan Klemm · Answer

@John Schulz - I think the best person to start with is an architect.  Maybe @Samuel Pavlovcik or @Prashanth Mahakali can provide some comments.  Then the next person I would talk to is an attorney if you are really worried about it.

In all honesty, everyone has illiegal units in chicago and the only time you will ever have an issue is if you have a bad tenant or neighbor who calls you into the city.  But even when they call you, the problems can still be delt with you just need to make sure you have the right team behind

What risks come with renting out an illegal in-law suite?

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