What rehab elements tend to increase appraisal value the most?

Question

Specifically in Chicago, any advice on which types of rehab elements an investor in multi-family properties should focus on or give more weight to when deciding how to rehab a multi-family property? For example, in some parts of the country you might simply focus on adding square footage wherever possible. Should I be focusing on adding bedrooms for example? Hardwood floors? Premium kitchen upgrades?

On a related note, I'm still trying to wrap my head around the whole garden unit topic, which as a newbie I find extraordinarily confusing, especially since it seems to have the power to make or break cash flow. Conforming/non-conforming, legal/illegal.... I believe I've heard non-conforming can't be used for appraisal value, so does that mean I should analyze a garden unit differently when doing my numbers? Since I am cash-flow/BRRRR-minded, spending the extra money to convert an unfinished basement into an extra rental unit seems like maximum value vs. dollars invested for cash flow purposes, yet it seems like I'd need to consider that as sunk costs for the BRRRR side of the equation since (if I'm understanding it correctly), performing that basement upgrade would not add any appraisal value. Am I correct in my thinking here?

Prashanth Mahakali · Answer

You purchase a zoning certified 2 story 2 unit building with a basement. Basement appears to have a unit and there is no permit on record for the same. It is not illegal yet. Based on the zoning, only a single family can be established on that lot. Now you have a legal unit, a non-conforming unit and an “may become illegal” unit. You rent all 3 units and continue to collect rental income.You place a tenant in the basement and have a disagreement and on their way out they call the city and you now have an “illegal unit” violation. Now you have one non-conforming unit that has been grandfathered and one illegal unit. You apply for a permit to remove the illegally erected walls and fixtures. Once restored to an open basement, violation is removed and case is dismissed. Illegal unit is now gone. You are now at a 2 story 2 unit building with an open basement. You have two choices:First: Apply for a building permit to duplex the first Floor unit unit into the basement and put it to use right away. Permit process should be relatively easy.Second: go through a zoning process and legally convert the basement into a legal unit. This not only makes the basement unit legal it also makes the existing non-conforming unit into a conforming unit. So you have all legal conforming units. Without any community opposition this could cost up to $7k-$10k for legal and filing fees and take up to 3-4Months. Not a big deal for the savvy investor.Non-conforming: does not meet current zoning or building codes. Usually established before current codes came into being. Think OLD. Generally accepted to continue to exist as long as there is no expansion or change of use. Either one would lose the “grandfathered” status. Ok investment strategyIllegal: created specifically without permits or permission clearly and willfully ignoring the codes in place and work performed while codes are in place. Can exist until someone files a complaint or court forces you to remove the unit. Risky investment strategy particularly for the investor without a team.So while you can go ahead and acquire a building with a non-conforming unit or an illegal unit, continue to earn rental income, understand and prepare for the worst case scenario. With the right team, you make a seemingly unattractive building into a cash cow. Rinse and repeat. Hope this helps.Prashanth

Prashanth Mahakali · Answer

@Alex Martinez I was referring to zoning districts. Mostly RS-3 which is the most common residential zoning district. Please note that zoning certificate of number is dwelling units is typically a real estate closing document. If I get a zoning cert for 3 units and after closing go to apply for a building permit, zoning department which originally issued the certificate will not accept its own certificate. I would have to go through the whole discovery process and prove the legality of the unit in question. The most definitive proof of a legal dwelling unit is a previous permit or historic water records. You can get a copy of these by filing a FOIA request.

John Warren · Answer

@Ryan Monty sometimes legal non conforming units are grandfathered in and they are super old. There might not have been a permit pulled for decades. In the suburbs, most of the towns have an inspection before a sale and everything is very clear on that inspection. In the city it is a bit murkier.... but if you have a rock star agent and RE attorney on your team you will be fine.

Mark Ainley · Answer

@Ryan Monty I just shared with you a local podcast episode talking about conforming vs non conforming. Duplexing down and adding the square footage to unit 1 where it will count on an appraisal vs hoping the appraiser counts the basement unit or not that is an approach I like to take. Regarding improvements I think the details don't matter as much and is relevant to the comps you think the appraiser is going to be using. A lot of value is put into the bedrooms, baths, basement condition, garage size, bathroom updated, kitchen updated, & square footage. Improving these 7 items will give you the largest up tick. Now if you have access to the appraiser and are able to give them an itemized list of improvements then you can try to make all of the little things mean something more.

Alex Martinez · Answer

@John Warren can you define legal nonconforming? It seems legal nonconforming means a unit was established in accordance with zoning code effective at the time it was built but is not in accordance with the current zoning code (i.e. legal unit that was grandfathered in). How would you verify that a unit is legal nonconforming? Would a 2 flat with a legal nonconforming basement technically/legally be considered a 3-unit and be viewed as such by lenders? I think this can help clarify things for the OP and many others. @Samuel Pavlovcik @Prashanth Mahakali @Jonathan Klemm maybe you guys can chime in as well. Thanks.

Andrew Syrios · Answer

From what I've seen, if you can add a bathroom (assuming the house has 1 or 1.5 baths) or upgrade a half to a whole, that tends to adda good amount of value on an appraisal.

Ryan Monty · Answer

@Alex Martinez - +1! I wanted to ask the same clarifying questions you posed, and my understanding was also the same in regards to "It seems legal nonconforming means a unit was established in accordance with zoning code effective at the time it was built but is not in accordance with the current zoning code (i.e. legal unit that was grandfathered in)", but I am not very confident in that assessment. @John Warren @Jonathan Klemm - I want to reframe Alex's question a little differently as well: is the main difference between a non-conforming illegal vs. legal unit that one was created originally with the proper permits pulled and one was not? Scenario A: a building was zoned in a such a way originally that allowed the conversion of an extra garden unit. At that time in the past, the owner applied for the permits to finish a basement and use it for extra income (with separate utilities hookups, etc.). Years later, the zoning was changed but since it was done legally to begin with, it's 'grandfathered in' and marked now as 'non-conforming' yet legal? Scenario B: same situation as above, but this time the owner did not pull permits. Same building, same construction, same owner, same code changes, only difference was the owner was too lazy to get the permits. Now I want to buy this building. I must somehow find out if permits were originally pulled because if not, it's now non-conforming and illegal unit, no? @Jonathan Klemm - you said everyone has illegal units and I have certainly seen that written elsewhere many places too. So it's not really that risky for me to go into a property with an unfinished basement (within Chicago limits) and do the conversion without permits? Also, how can you tell if a property's zoning may even just allow legally finishing the basement or not? Better to do it the right way if you can, I'd think. When I look at the zoning map at areas I know are littered with 2 and 3 flats, almost everything is RS-3

Jonathan Klemm · Answer

@Ryan Monty - Chicago is confusing in general, so you are not alone.Everyone in Chicago has illegal garden units and usually, there are not any issues with them unless you have a problem tenant or neighbor. You are right when you say they can't be used for the appraisal, typically the stove needs to be removed and the gas has to be capped, so I would run your numbers in both cases but assume the worst make sure numbers work that way.Chicago isn't too different from other areas of the country, the highest ROI items are typically kitchen and baths, but if you can add additional bedrooms or SF that is where the real value is added.Is there a specifc area you are looking to purchase in?

John Warren · Answer

@Alex Martinez it sounds trickier than it is. Legal non conforming means the same thing as grandfathered. It means you are totally fine. Lenders will lend on it and the town is fine with it. Illegal non conforming means illegal. Lenders won't count it as revenue and the town will come down hard on you because it isn't legal!

John Warren · Answer

@Ryan Monty when it comes to garden units, don't get too down on non conforming use. A lot of these buildings were built a long time ago and the codes have changed. The city of Chicago and also the surrounding municipalities will often times change the zoning in areas so that you can't build more multifamily. This is very common in the suburbs where I operate my portfolio. Berwyn and Forest Park both do this a lot and what it means is your unit is legal unless the place burns down more than 50% or goes vacant for a year. That all might sound scary, but think about it for a second. Most of these structures are 100% brick and masonry and they will outlast you and me. They are not going to burn down 50% and you aren't going to let it go vacant. Your lender can lend on these and they are a non issue. In fact, almost every 3 unit I have sold in my career has been non conforming. Now when you talk about illegal non conforming that is different. In the city, we have clients who take the risk of renting it out as it is a common thing that is done. In the suburbs I see this less as the suburbs are pretty tough on this and they have point of sale inspections where they hammer these illegal units. I would tread lightly around illegal, non conforming units.