Zoning Issue with a Falsely Advertised Multi-Family

[Brian Green]

I purchased a multi-family property in the Summer of '15 that originally showed very positive cash flow and potential appreciation. The property was listed on the MLS as a 3 family + in law suite so my strategy was to buy the property, fix it up to increase the rents, and file for a special permit with the town to make the in law suite a legal 4th unit. (value add)

I recently began the permitting process which included updating the building a bit to bring all units to code and hiring a surveyor because no survey existed on file. Through the process I discovered the property was actually only a legal 2 family despite the appraiser having it registered as a 3 family. Further, the planning and zoning boards have declined my request for the special permit because one of the 4 units is a garage apartment which doesn't meet code because its detached. The garage unit was one of the 3 "advertised" units on the MLS listing by the seller's agent.

The town did say that they would provide a special permit to make the 3rd unit legal but I would have to remove the garage apartment.  Or I could cancel my application for the permit and leave everything as is without enforcement from the town. i.e. keep operating the 4 units but they will not provide a CO which clearly limits the up side down the road when I decide to sell the property. At that time I'd either have to sell it as is or shut down the garage apartment and secure the legal permit for the 3rd unit making it a clean 3 unit with garage. 

So my question is this....what should I do now? 

I keep operating as is because the property has ok cash flow which may increase over time as rental rates increase. Worry about legality of the units down the line when I want to sell it. 

Shut down the garage apartment, get the permit now for the 3rd, and operate as a 3 family but at that point it will not produce cash flow.

Sell the property as is and recoup the entire investment. I'm confident it can be sold as is or as a 3 family now at a break even price. 

Pursue legal remedy against the previous owner and agent that misrepresented the property as a legal 3 family in advertisements and in person. 

Or if you see another option let me know!!! 

[Frank Chin]

@ Thomas N. 

Glad you asked this. I used to wonder how banks handles it, and how insurance companies handle it. I bought rental properties from 30 years ago, and refi'd some over the years.

During the refi's which took place about 15-20 years ago, the bank actually had inspectors come in with floor plans. I thought they were looking for illegal conversions. Not exactly. They seen enough of these 2 families with the 1st floor illegal unit, all they want to see is if it has two exits. Then, the same room count is the same as the plans. 

Same thing with insurance. They want to know if the illegal unit has two exits. If yes, that's OK. Many illegal conversions has units where if a fire takes place, the occupants have no where to run, gets seriously injured or killed. I used a very good insurance agent thru the years, and they checked it out.

Ironically, the problem comes with evictions. If you have a legal tenant on the 3rd floor, you want to evict him, his lawyer would check, and aha, it's one of those properties that usually contains an illegal unit. If the owner goes to court, the court will have the case dismissed because the owner has unclean hands. I would have to evict the tenant in the illegal unit first.

I hired a lawyer who used to be a legal aide lawyer working with tenants, and I had a 3rd floor legal tenant I want to evict. It was two single guys, one of them a drug addict. So he had me work out a deal where the other roommate, the good one, submitted his notice to me to vacate, and return the key. Then, based on this, I can legally lock the other guy out, because one roommate can give notice for both. My lawyer said if he represented my tenant, he would have my case thrown out.

And I don't have LLC's for my rentals. I rely on insurance. I do have other businesses in LLC's, C Corps, and S Corps, so know what they are.