How to execute a fixer upper deal with illegal units/construction

Question

Hi all,I'm a new investor to the fixer-upper game, but generally have been interested in buy and hold strategies. I've found a run-down property I like where I'd like to live in an ADU and rent out the house long-term. Couple questions I'd love to get BP's input on:When looking at properties with illegal units/construction, what's the best way to approach the execution process? I've listed my high level outline below, and welcome any feedback.1 - obtain all building permits for the property - understand what's legal and what's not2 - talk to the city development person to see whether I can legalize the current illegal units and bring it to code, or if I'll have to remove it3 - after understanding what needs to be done with the property, talk to a home inspector to identify which units are in compliance and what's not (also get all the standard inspection items)4 - work with a general contractor to get a $ quote for necessary jobs on the property5 - bake those numbers into analysis to determine whether to buy6 - discuss property details with lender and get an appraiser's input7 - submit offer after passing all criteriasAs a first time home buyer, what else have I missed? This feels like more of an advanced deal to take on, but I view this as a good learning experience, whether or not I actually go through with it.Any advice on how to structure the offer (e.g. contingencies)?How to make sure I fully understand potential financing options? Given that bank lenders will only lend for the appraised sq. footage, should I negotiate the price down with the seller to account for this?Also, for local investors, do you guys have any recommendations for contractors, architects, and inspectors out here in San Francisco / Peninsula? I've largely been looking through Yelp, but any input here would be super helpful!Thanks all in advance.

Sean Walton · Answer

Hi Robin, That is a lot of work to do in a hot market where you may get out bid in the end. Do you have a good real estate agent? While you don't have to have one if this is your first property I would recommend it. You could increase your chances of getting your offer accepted if you let the seller's agent also represent you (double commission) some won't to avoid conflict of interest. If it's already listed someone is going to get that 3% might as well get a good agent to help you negotiate and teach you a lot about the process.1. Good idea you can look a lot up online however it's hard to tell sometimes if the inlaw was added before the records started or more likely it was just done illegally. Most listings will state unwarranted unit in garage or something like that it usually isn't something they try and hide.2. Good idea in theory but don't give the address to the official. Generally ( do your own due diligence) as long as there is a safe egress path out of the unit i.e. a swing door not the roll up garage door, and there is an egress window out of every bedroom you should be able to make it legal. They may make you tear open walls to show the plumbing and electrical is up to code but at least it is possible.3. Typically you only get an inspection after your offer is accepted so I probably wouldn't pay the $500 or more prior to getting my offer accepted.4. Similar to the inspector most contractors unless you've given them a lot of work in the past will want to get paid to walk a house with you.I'm not sure exactly how the in law appraises. A lot of it has to do with legal finished space but all else being equal the in law may increase the value a bit compared to dead garage space but not nearly as much as legal square footage.You can put an appraisal contingency, inspection contingency and a financing contingency which covers you pretty wall but a clean cash offer even if it's less will probably win out. This guide is pretty helpful http://www.sf-planning.org/ftp/files/plans-and-pro...

Robin J. · Answer

Thanks Sean for the awesome advice! Your input here, especially as a professional architect, is truly helpful and appreciated. Looking forward to catching up at the next Bay Area meetup

Sean Walton · Answer

Also a tenant can sue your for some of their rent back if they lived in an illegal in law not sure how that would work if you are living in the illegal unit and they are upstairs. They might argue they were put at risk by potentially faulty wiring?

Ryan Heywood · Answer

Also be aware that the property may have to meet habitability standards to qualify for a conventional loan.

Ryan Heywood · Answer

I've curious how the ADU provisions are playing out, I've got some places I'm looking at that work if an ADU is added. Here is a link that should help, it is put out by the city.http://sfdbi.org/unitlegalizationHope that helps, please share what you learn here!

Josane Cumandala · Answer

Residential real estate appraiser here. That line made me go, "...Wait, what?"The square footage of the property should be available in the public record and appraisers generally go by that, at least in my market. Property taxes are levied based on its assessed value, so if the local government didn't have an idea of the size of the property they would not be able to tax you appropriately. Now, sometimes the GLA on public record is erroneous, in which case the appraiser will have to reconcile their measurements with what has been recorded but usually there is a explanation for the difference.Along with the overall square footage there should also be a certificate of occupancy on file which will describe the legal use of the property. If the certificate of occupancy describes four legal above-grade apartments and an unfinished cellar, but in reality the property has two additional apartments in the basement below grade, this is an illegal use and you will have to rectify this. Taking the time to dig up this free, publicly available data will make your job a lot easier. Now, how to negotiate the deal beyond that or what the exact cost to rectify the deficiencies on your specific property I can't say. That is where you need the expertise of a contractor. A home inspector should be part of your due diligence as well but their job is to identify structural issues like the roof, the foundation, the presence of things like mold or termites, environmental issues etc. Bringing a property up to code is a bit of hassle and expense beyond a normal rehab and you should factor that into your offering price. The more data you have to back up your number the better. Good luck!