Moses Kagan on Real Estate

Never Buy a Building with a Non-Conforming Unit

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I was once in escrow to buy what I thought was a 16 unit building on Clinton St. in Echo Park, one unit in which was “non-conforming”. The owner had taken a common room and turned it into a studio apartment. The listing broker assured me that this was pretty normal in LA and, indeed, if you look at Loopnet or the MLS, you do see buildings like this all the time. I went ahead and did the deal.

The LA Housing Department (LAHD) has a regular inspection program called SCEP, where they go through every apartment building in the city every three or four years. They check for code violations, safety hazards, etc. And they recently started checking for un-permitted units.

We had our regular inspection and the inspector wrote us up for having this un-permitted unit. We were required to either vacate the unit and return it to its previous use or else get it legalized.

Pause for a second and allow me to thank the Lord that the building was not rent-controlled (having been built in the early 1990s). Had it been rent controlled, we would have had to pay the tenant in the unit the city-mandated relocation fee, which in this instance would have been around $7,000, but which can go as high as $18,300. That would have been in addition to the lost rent, the lost value (because that lost rent would lower the building’s profit and thereby it’s re-sale value), and the cost of legalization (if that were even possible).

Fortunately for us, we were able to convince the tenant to move somewhere else (in part because he wasn’t protected by rent control). Even more fortunately, we were able, through an extremely painful, expensive and time-consuming process, to legalize the unit, turning what had been a 15 unit building into a legal 16 unit building (and thereby adding a lot of value to the asset). In this we were lucky… it turned out to be possible to add the additional parking space necessary. This would not have been possible with almost any other building.

But I will never, ever, ever buy a building with an un-permitted / non-conforming unit again. Not only are you paying for an income stream which is likely to go away the next time the city inspectors come through. You are also putting yourself at risk of having to pay a massive relocation fee to the tenant. Let some other schmuck take that risk.


Written by mjkagan

04/19/2012 at 7:18 am

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