Duplex with zoning issues

[Beaker]

I'm looking at buying a duplex as an investment property, but it has an odd zoning issue that I'm not sure how to handle. After the property was built the area was rezoned to Light Industrial (ie, workshops, mechanics, warehouse, etc). The property was grandfathered in with a Non-Conforming Use permit.

However, one of the stipulations on the permit is that if the structure is more than 60% damaged, it has to be rebuilt in accordance with the current zoning. So if it burns down it couldn't rebuild it as a duplex, it would have to be something industrial. According to two insurance agents I've talked to, homeowner's insurance won't cover rebuilding the structure into something different - they only cover rebuilding to a similar kind and quality of structure. So the structure is basically not insurable against major damage. In addition to the added risk, the lack of insurance also means I can't get conventional financing.

One possibility is that I could try to line up unconventional financing to purchase the property, fix the zoning problems, then switch to conventional financing later. Clearly that involves extra work and risk above a typical purchase arrangement.

So...
1. Is there some sort of unconventional insurance and/or financing product that might handle this situation?
2. Is my idea about buying now and changing the zoning a reasonable one?
3. If I do buy it with the zoning issues, what's a reasonable discount to the purchase price to justify the extra work & risk?


Thanks in advance.

[I-Ti]

This is funny. We are in a similar problem. We have put in an offer for our second investment property which is a duplex in walking distance to us. The numbers which the anticipated duplex rent made sense, we have a renovation loan in place to put two central ACs etc.

All looked good until it turns out our neighborhood is now strictly zone single family. The seller is a 94 year old lady (who was raised in the house). She lived there since 1982 by herself but left it as a duplex (second half for guests/storage) which it was from the beginning (1920s). We have a portfolio loan lined up (which does not care about the issue) but are worried about the insurability which then may cause loan trouble.
Also, the neighbors immediately put a code enforcement complaint in, the minute it hit the market. The whole street is owner occupants, worried about rentals/students. So no hopes to fly under the radar and continue nonconforming use with a presumed grandfather status.

Our main problem is that the listing agent and seller do not acknowlegde the zoning problem and don't want to give a reasonable discount so we can make it a single family for which the numbers still work for us. They countered our offer that was given before the issue surfaced (offered asking price minus 2500$ for duplex) with full price counter (+2500$) and added statement that they make no representation that it is a duplex (double metered, separate structures, separate entrances - hello?). After this surface, we - like you - would have actually expected some discount....

So I will be curiously following what the experienced real estate investors tell you about those issues. Good luck!

[anastrophe]

One possibility is that I could try to line up unconventional financing to purchase the property, fix the zoning problems, then switch to conventional financing later.

What are you imagining you could do to "fix" the zoning problem if you do buy the property? Convert it to a light industrial use?

[Fuzz]

You might want to talk to a local zoning and land use attorney, as opposed to the internet on this one. In some jurisdictions, that would be fairly simple and straightforward. In other jurisdictions, it's a non starter. Good luck.

[Beaker]

One possibility is that I could try to line up unconventional financing to purchase the property, fix the zoning problems, then switch to conventional financing later.

What are you imagining you could do to "fix" the zoning problem if you do buy the property? Convert it to a light industrial use?

We've come up with a few possible avenues, though not having done this before I'm not sure what the odds of success are.

1. We could try to get the Non-Conforming Use agreement changed to say that in the event of a disaster we could rebuild the property as a duplex.

2. We could try to get a variance. Typically variances are only good for 12 months though, so we'd need a special one that's good for at least 30 years.

3. There's already a provision in the code itself that says a destroyed single-family unit can be rebuilt, even if the zoning has changed. I think we're pretty clearly inside the spirit of that, but not the letter. We could try to get that changed to include a duplex.

4. We could try to change the zoning for the area. This would require ~6 neighbors to sign on as well, which seems unlikely given the makeup of the area.

5. We discovered that Light Industrial zoning allows a "live-work space." If we rented out one unit as an office you could call it that, if you squint at it a bit. Not my favorite idea, but it's potentially a workaround.

We also discovered that the city's development plan calls for the whole area to be made into residential. Those plans are a little vague and there's no timeline, but at least we're trying to go with the flow instead of against it.

[anastrophe]

In this case, I think you really should consult with both the planning/zoning officer and a local land use attorney (ideally one who has experience with your town's regulations and has an idea of what reality vs. law is like where you are). Like Fuzz says, this could be possible or it could be laughable, and a lot of it depends on the specific politics of your community, which is not something the internet can help you with.

[TrulyStashin]

In this case, I think you really should consult with both the planning/zoning officer and a local land use attorney (ideally one who has experience with your town's regulations and has an idea of what reality vs. law is like where you are). Like Fuzz says, this could be possible or it could be laughable, and a lot of it depends on the specific politics of your community, which is not something the internet can help you with.

+1  I'm a land use attorney in Richmond, VA and of all the types of law to practice, this type of law is one of the most unpredictable.  It varies not just from state to state but even from one county to a neighboring county.   It is also highly relationship driven.   Find an attorney in your area who has been doing land use in your municipality (not a neighboring county) for a long time and consult with him/ her.

[jnik]

5. We discovered that Light Industrial zoning allows a "live-work space." If we rented out one unit as an office you could call it that, if you squint at it a bit. Not my favorite idea, but it's potentially a workaround.

We also discovered that the city's development plan calls for the whole area to be made into residential. Those plans are a little vague and there's no timeline, but at least we're trying to go with the flow instead of against it.

Being somebody who knows nothing about zoning or real estate, the live-work idea sounds smartest to me. There's lots of "convert old factories to artist live-in studios" and the like out there, and if future zoning is in doubt that may be most flexible. That sort of usage would fit in either light industrial or residential. Probably be a fair bit of work, but could be fun, if that's your type of fun.

[TrulyStashin]

Another thought..... check your municipality's website and find the land use/ planning department.  Call and ask  for an appointment with a member of the planning staff.  These folks are professionals in urban planning and they are the ones who create a community's vision of what it wants to be.  Tell the planner about the property and ask for insight on where that neighborhood is going and what kinds of activities that property could be used for.  Let him/ her know what you have in mind.

They'll give you the inside skinny, for free.

[Beaker]

Thanks for the ideas, everyone. We've ended up following some of the advice here. The wife did a fantastic job of poring over the zoning code, buddying up to someone that works with the zoning commission (turns out they're both from Southern families that were in oil & gas) and the city councilperson for the district. She convinced them that the live-work unit is practically the same thing, and that they should give us an official letter that says we could rebuild a property of "similar kind and quality" under that theory. That's precisely what insurance wants to hear so they should be happy, which should make the mortgage people happy, so it looks like we can get conventional financing. It's not all 100% absolutely for-sure settled yet because the city insists on using snail mail for everything, but it's looking good.

Unfortunately the seller was not at all willing to reduce the purchase price. The property is already cashflow positive for him, so he just had no motivation to discount it at all. On the plus side, this gave us a reason to learn a lot about zoning laws and alternative financing that might be useful in the future.

[TrulyStashin]

Outstanding!  The epitome of Mustachian philosophy at work -- DIY-acquired knowledge + effort = substantial financial advantage!

Congrats.

[AlmostIndependent]

Glad to hear you got your problem solved. At least one of them.

It's odd that you can't get insurance. I am under contract on a non-conforming 8-plex. It was built before the zoning laws effected that part of town. I just talk to State Farm and they said they would insure it but if it is damaged and has to be rebuilt they would just sell off the lot and pay me the difference. They would just add a clause acknowledging that the property couldn't be rebuild as is if it was destroyed.

[Beaker]

I just talk to State Farm and they said they would insure it but if it is damaged and has to be rebuilt they would just sell off the lot and pay me the difference. They would just add a clause acknowledging that the property couldn't be rebuild as is if it was destroyed.

Actually that turned out to be what the insurance agent meant, it just took a couple of conversations to get to that point. So in the event of a disaster we would've netted out about 30-50% of the insured value.

In our particular case it's a distinction without a difference, because we don't want to sustain that kind of loss and it was a problem for conventional residential financing anyway. I wouldn't be surprised if lenders for an 8-plex are more flexible about that sort of thing.

[AlmostIndependent]

I just talk to State Farm and they said they would insure it but if it is damaged and has to be rebuilt they would just sell off the lot and pay me the difference. They would just add a clause acknowledging that the property couldn't be rebuild as is if it was destroyed.

Actually that turned out to be what the insurance agent meant, it just took a couple of conversations to get to that point. So in the event of a disaster we would've netted out about 30-50% of the insured value.

In our particular case it's a distinction without a difference, because we don't want to sustain that kind of loss and it was a problem for conventional residential financing anyway. I wouldn't be surprised if lenders for an 8-plex are more flexible about that sort of thing.

Why would you have to take a loss? My understanding is that if the place were to burn they would pay you the value of the property minus your deductible. The insurance company would then sell the lot for whatever they could get out of it.

[Beaker]

Why would you have to take a loss? My understanding is that if the place were to burn they would pay you the value of the property minus your deductible. The insurance company would then sell the lot for whatever they could get out of it.

The way the State Farm agent explained it is that they will flat out pay you the depreciated cost of the structure, which is typically 30-50% of the face value. You pretty much always have an endorsement that says they'll cover replacement cost, but in order to get that you have to actually replace the structure and send them the receipts. If you can't replace the structure (due to zoning or whatever), then you don't have receipts, and they won't reimburse that value.

Admittedly it's not the same thing, but when our house was burglarized this was exactly how they handled replacing the stolen items. They cut you a check for 50-ish percent of the cost, and if you send them a receipt for a replacement then they cover whatever that says.

[AlmostIndependent]

Why would you have to take a loss? My understanding is that if the place were to burn they would pay you the value of the property minus your deductible. The insurance company would then sell the lot for whatever they could get out of it.

The way the State Farm agent explained it is that they will flat out pay you the depreciated cost of the structure, which is typically 30-50% of the face value. You pretty much always have an endorsement that says they'll cover replacement cost, but in order to get that you have to actually replace the structure and send them the receipts. If you can't replace the structure (due to zoning or whatever), then you don't have receipts, and they won't reimburse that value.

Admittedly it's not the same thing, but when our house was burglarized this was exactly how they handled replacing the stolen items. They cut you a check for 50-ish percent of the cost, and if you send them a receipt for a replacement then they cover whatever that says.

Depreciated value should be the "face" value. When you purchase you are paying for a 10 (or whatever) year old building and when you sell you are selling an older building. It should be depreciated from the cost to rebuild.

[Beaker]

Depreciated value should be the "face" value. When you purchase you are paying for a 10 (or whatever) year old building and when you sell you are selling an older building. It should be depreciated from the cost to rebuild.

Perhaps I didn't understand the insurance agent correctly, or I'm not explaining it well. But he made it very clear that we could be in trouble if a catastrophe happened, which is the most important point.

I think I get what you're saying - from an accounting perspective the purchase price is the depreciated value. On the other hand, that could be considerably less than the cost to rebuild - partially because it is depreciated and partially because you have to rebuild to current code rather than 1952 (or whatever year) code. Also, if you hold it for a few years the house could depreciate (according to accounting rules) faster than the mortgage gets paid down.

[AlmostIndependent]

Depreciated value should be the "face" value. When you purchase you are paying for a 10 (or whatever) year old building and when you sell you are selling an older building. It should be depreciated from the cost to rebuild.

Perhaps I didn't understand the insurance agent correctly, or I'm not explaining it well. But he made it very clear that we could be in trouble if a catastrophe happened, which is the most important point.

I think I get what you're saying - from an accounting perspective the purchase price is the depreciated value. On the other hand, that could be considerably less than the cost to rebuild - partially because it is depreciated and partially because you have to rebuild to current code rather than 1952 (or whatever year) code. Also, if you hold it for a few years the house could depreciate (according to accounting rules) faster than the mortgage gets paid down.

Im going through this exact thing right now. It took me a long time to get them to finally say "yes, if the building is lost, you will be compensated for it's market value less your deductible." They constantly used the term "depreciated value" which was confusing to me too. It was a huge pain in the ass but I finally got them to tell me what I needed to hear. It's ridiculous because if they were on the hook to rebuild they would have to pay like double what I'm asking for.