Rehabbed residential property found to be zoned commercially- Refinacing impossible?

Question

So hopefully this doesn't end up on the real estate horror stories section at some point... A couple of months ago I bought a house with cash and rehabbed it. Now, I'm in the process of refinancing it to pull my money back out. However, the lender discovered it is zoned commercial. I called the city and they said that it was grandfathered in. So, it is fine right now, but in the event of a total loss, I would not be able to rebuild it as a residential property and would have to follow commercial zoning rules. Obviously this is a huge deal. Even if I was to sell it, anyone trying to get financing for it would encounter the same issues. Am I completely out of luck here? I don't know how I missed this when purchasing it, or my realtor/title insurance. I'm at a loss as to how to proceed.

Elealeh Fulmaran · Answer

You’re not out of luck—get it in writing from the city that the residential use is legal nonconforming, price out special insurance for rebuild risk, ask about a rezoning or variance path, and talk to a lender who does “nonconforming use” loans; if those boxes check, you can still refinance or sell, and if not, consider selling to a cash/DSCR buyer or keeping it as a cash-flowing hold with clear disclosures.

Axel Scaggs · Answer

I think it does affect the use of the property. You can not add on to the property in any way that adds to the "residential" aspect. No additions, upgrades that increase square footage etc. Additionally, you can not have vacancies of over 6 months or you lose your status. What if a buyer is told there is nothing affecting their use of the property and have a long vacancy and lose their grandfathered status because of omitted facts?

I would also argue that clear lending issues as well as the inability to rebuild your home in a total loss is a very important "material fact", that would influence the buyer's decision in a sale.

Scott Chilton · Answer

Hey Axel, you still have options here, even if it feels like a curveball. Since the property is grandfathered in, you can keep using it as a residence, but the concern is really about the future if the building were ever destroyed. At this point, the best step is to sit down with a zoning attorney or someone at the planning department to see if a rezoning request or variance is possible. Even if the answer is no, having it in writing helps you understand your limits and also gives you something to show future buyers or lenders. Taking that step now protects your ability to refinance, sell, or rent without this issue hanging over you.

Peter Walther · Answer

I believe zoning matters are excluded from coverage in most standard title policies but there may be some coverage if you purchased a Homeowner's form policy.  Even then there may not be coverage unless the city forces you to remove the improvement.  I suggest you submit a claim to the insurer and see what they say.  The worst they can do is deny coverage.

Diego Alvarado · Answer

Hi Axel, this is tricky situation, the seller's disclosure is something that you can take on with an attorney to investigate. It will also depend on what was written in the contract, in Paragraph 6.D you have to write the objections, it is common practice to write what is going to be the use of the property there, e.g. "residential use".

All this however will require you to go back to the seller.

Title insurance could cover zoning violations, however you have to see on the title commitment what was reported there.

If you are trying to refinance I believe you are looking for a LTR, STR, or MTR, I would assume. In that case, you can still go with it.

Commercial zoning will not be a bad thing depending on the location and the neighborhood. You can convert it to a commercial space which could bring higher cash flow.

In conclusion, there are options and if you play the game well it could benefit you, however that will also depend on your needs to resale and holding time that you are looking for the property within other aspects.

Peter Walther · Answer

I suspect you're assuming the seller knew about the change in zoning which may not be true.  In any case, if I were the seller I'd ask why you as buyer didn't investigate the current zoning.  Have you checked to see what the value of the property is zoned as commercial?  Perhaps the value is more than zoned as residential.  Generally, isn't property used as residential worth less if it is in the middle of commercially zoned property?

John Clark · Answer

"On the seller disclosure, they checked "No" under "governmental ordinances affecting the condition or use of the Property.""

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Which is a true statement. Your concern only kicks in if there is a total loss. Your seller properly disclosed.

Personally, I would call your alderman and see about getting an ordinance through the city council allowing rebuild at same-scale/kind of residential use if there was a total loss. Worst he can do is say "No."

Trevor Higgins · Answer

Sorry to hear that Axel, have you tried to reach out to the city and see if you can be grandfathered in to being able to build the exact same home in the event of a total loss? I've had a few clients that have been through this and it just took getting to the right person to get that figured out but in each case they were able to get that taken care of.

Rehabbed residential property found to be zoned commercially- Refinacing impossible?

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