Are we paying too much for a house hack?

Question

Hey all. My husband and are under contract on a great 2 flat with illegal basement unit off of Logan Blvd in a desirable location in Logan Square with a lot of rental demand. We got it for $635k, thinking we'd be able to rent out 2 of the units (including basement) and live in one. However, the more we thought about it, the more we realized we do not have the risk tolerance to rent out the illegal basement unit and would rather make it legal. However, that requires us to dig down the basement floor to meet the ceiling height requirement (it's got the egresses and 2 exits already), and I think that can easily cost us $100-120k. So all in, including some priority repairs we'd want to do aside from the basement, we're looking at about $750k on this house.

We make $205k combined. After renting out the finished basement and one of the main units, we'd be paying a very comfortable amount for our part of the mortgage, and upon moveout we'd be breaking even with PITI + maintenance, capex, vacancy which is what we wanted to achieve. However, we're having doubts because:

1. we wouldn't be able to afford the PITI on our own for longer for >6 months without the help of rents, so we're depending on the house hack to be able to afford this house, but not sure if that's a bad thing or not and

2. not sure if this house is too much house for us financially and we're in over our heads about what we can afford.

We've been super excited about this place until we realized the issue with the illegal basement and now we're overwhelmed with the thought of potentially not even moving forward with the house. We really want to make it work, but don't want to financially screw up. Are we overthinking and this is actually a sensible deal for us, or would you say no?

Also, any insights on how hard it is to get a zoning change approved to make this a legal 3 flat? It's zoned as RS3 and I believe we'd need it to be RT4 if I understand correctly. And, I looked and we're not within the limits of the ADU pilot program unfortunately.

Thanks for all the help!

John Warren · Answer

@Nilusha Jayasinghe you have received a lot of great advice here. One thing no one mentioned is the opportunity to LIVE in the basement unit. All of the risks that come from illegal units are related to tenants creating issues or insurance problems. No one ever comes out and tells owners to stop living in their own basement.....

I agree with others on here that the devil is in the details. Is this truly an illegal garden unit or is it a non-conforming? There is a huge difference. Chicago is full of nonconforming or grandfathered in units. The city is aware of the issue and has not figured out how to solve it. The cost is prohibitive to make them fully compliant by adding ceiling height, windows, doors, electrical upgrades, plumbing upgrades, etc, but the city is also aware that it can't lose all of these truly affordable housing units.

As to whether this deal is a good idea or not, how long would you be in Logan Square for? If you think you might put down roots here, then this could work out well for you in the long run. Debt will eventually be cheaper most likely, and you can be opportunistic about refinancing or paying it down. You can contest taxes. You can raise rents. You can optimize the property. Over time, owning real estate tends to work out really, really well.

If this is something you just want to live in for a year or two and then move out of state, then no this doesn't make sense. It is all about the time horizon on investments right now.

John Warren · Answer

@Nilusha Jayasinghe if you use the basement as additional non-living space, and specify this in the lease, then you should be fine. That is what a basement is!

Any other possible use seems to make you uncomfortable. I wouldn't push things now to make the deal work. You are undoubtedly in the attorney review period, so this is your get out of jail free card if you need it. Make sure you are happy with the deal, and if not, move on.

Paul De Luca · Answer

I can't say if it's a good deal for you without seeing the numbers, seeing the property, and seeing the inspection report. I would lean on your agent for guidance.

Paul De Luca · Answer

@Nilusha Jayasinghe

Sounds like a lot of work just to break even. And based on your statement "the more we thought about it, the more we realized we do not have the risk tolerance to rent out the illegal basement unit and would rather make it legal" it doesn't sound like it's a good fit for you. I'd recommend either going for a legal 3-4 flat or a 2-flat that is duplexed down or up.

It's a good idea for your agent find out if any of the units are "non-conforming" or "illegal" before you take the time to show the property and make an offer. This affects the value of the property along with your financing. Plus, you should have a transparent conversation about your interest in properties with these units. Every investment comes with a certain level of risk.

There are usually clues on the listing such as # of units listed vs the type of multi-family. For example, there may be three units total but the agent may have it listed as "Two-flat". Any phrases such as "finished basement or attic", "in-law suite/arrangement", "seller nor listing agent can confirm the legality of the basement/attic unit" are a few common ones.

Tom Shallcross · Answer

@Nilusha Jayasinghe - agreed with everything @Paul De Luca stated. One more item is the zoning variance in Chicago is no gimmie, and even if you do get it upzoned, it will take months to get it upzoned. From there you can submit plans/permits, and from there you can begin your rehab. So it's a long road before you have any income coming in from that garden and there is absolutely no guarantee it will ever even get upzoned.

If you truly are dependent on legalizing the garden unit, there is a lot of risk involved in this equation.

Twannisha Jackson · Answer

sounds like a lot of work. doesn’t hurt to keep looking as long as you are looking.

Drew Sygit · Answer

Why don't you just live in the basement and rent the other 2 untis out?

Pretty sure the nonconforming/illegal basement unit issue doesn't apply to owner-occupants of the basement, only if you try to put tenant in it.

Nilusha Jayasinghe · Answer

@John Warren it's an illegal unit unfortunately. And you point out an important detail about long-term plans- yes we are looking at this as a buy and hold hopefully for decades to come, where we'd do everything you said: contesting taxes, refinancing when possible, raise rents when appropriate. So I think it seems like a good purchase even if it cashflows negative for a while at the start.

@theresa I agree.. the more I think about it, the more skeptical I get that even if the Dept of Buildings approve it as an Airbnb, if that's enough grounds to stand on legally if an Airbnb client reports/sues me because of, I don't know, a medical injury because of hitting their head on the short ceiling (even if I disclose info about the ceiling upfront on the listing).

@Marcus R. Yeah we've thought of that too. But going off of what I said to @Theresa, I think we're having all these doubts about being able to use this space for anything at all without liabilities since it's an illegal unit. Our plan just yesterday was to rent it out together with the floor above it as a duplex down (once we move out). But I don't know if 1. there's a specific process we have to go through with the city for it to be recognized as a duplex down and 2. we plan to say in the listing that the tenants cannot use the basement as living space, just as rec space/office/etc, but I don't know if that's enough to cover me in the event of a lawsuit for example that there's a fire down there and someone sleeping down there gets hurt. Basically, I just don't know if the status as an illegal garden unit (the lack of ceiling height and zoning allowance) prevents me legally from using the space for anything at all.

I know people all over the city use illegal units for all sorts of things, but my goal is to maximize profits while ensuring I'm doing things legally. Anyone have any thoughts on these questions above?

Marcus R. · Answer

If the basement is in decent shape is there anything else you can use it for?  Ex: Rentable podcast studio, general storage, photo shoot, airbnb experience, luggage storage for people waiting to check into their STR, etc...Check out Peerspace for some creative ideas

Theresa Harris · Answer

It is interesting that you can use it as an airBNB, but not a long term rental.

Are we paying too much for a house hack?

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