Properties with building or municipal code violations often present attractive opportunities for experienced flippers.
Code violations usually deter conventional buyers for a multitude of reasons:
- buyers are uncomfortable with uncertainty
- conventional lenders are often reluctant to finance severely distressed properties
- buyers may lack the funds and construction knowledge to resolve problems themselves
- the property may not present well at market
- sellers may prefer a fast ‘as-is’ transaction
Hence, the opportunity falls to property investors.
A pricing gap is created between what the property is worth today and what it could be worth once repaired and brought into compliance.
This is where the skills of investors are put sternly to the test.
They need to understand exactly what the local authority requires to bring the property into compliance including:
- whether existing work was permitted
- how much remediation will cost
- whether fines or liens exist
- whether the planned renovation may uncover additional compliance requirements
For the experienced flipper or investor, resolving this complexity is part of the value creation.
Not all code violations are equal
Code violations occur when a property, structure, improvement or use fails to comply with an applicable local or state requirement.
Building and property enforcement is primarily administered locally, hence the exact rules and processes differ between California cities and counties.
But not all violations are equal.
They may be relatively inexpensive to remedy or they may have a major structural or legal issue.
Maintenance or nuisance issues
These tend to be relatively inexpensive and straightforward to remedy:
- excessive rubbish or debris
- overgrown vegetation
- broken fences
- exterior deterioration
Building safety issues
These are potentially much more significant:
- structural damage
- unsafe decks, stairs or railings
- non-compliant plumbing or gas installations
- electrical hazards
- fire safety issues
Use and occupancy violations
These problems can materially affect the investment thesis.
A common example is when an investor sees four bedrooms at inspection but discovers the public record only recognises three.
This matters if the resale valuation relies on a fourth bedroom.
Be on the lookout for:
- garages converted to living spaces
- unapproved bedrooms
- illegal second units
- commercial use in an area not permitted
- occupancy of spaces that were not approved as living areas
- any additions that were not approved
Unpermitted construction
This is the granddaddy of all problems, potentially taking time and money to address.
Unpermitted construction is a major red flag and can materially change the entire rehab budget.
For a property to become fully compliant, a local authority may require the owner to:
- obtain permits retroactively
- open walls for inspection
- upgrade work to current standards
- modify the improvement
- remove work that cannot be legalized.
Check the public record
You don’t know what you don’t know.
That’s why it is so critical for investors to check the public record before buying any property, especially ones in any form of distress.
Most of the relevant information will be held with the local county recorder, some of it may be held by the county assessor.
Occasionally, the information may be available online – usually, it won’t be. Every county differs.
Investors need to investigate the following with the relevant county:
- permit history
- inspection records
- code enforcement cases
- notices of violation
- certificates of occupancy where relevant
- recorded liens
- planning/zoning information
Compare what exists with what was permitted
When the public record has been accessed, an investor can compare what physically exists with what was permitted.
Even a beautifully renovated space can be a liability if it was never legally approved.
Questions to consider are:
- Does the listed square footage align?
- Are all bedrooms and bathroom accounted for?
- Were additions permitted?
- Was the garage legally converted?
- Were ADUs or secondary unites approved?
- Are permits still open?
- Are there unresolved inspection corrections?
Assess what remediation is necessary
Once a property’s legal status has been unveiled, important decisions can be made about the practicalities of purchasing the property.
Ideally an experienced contractor, architect, engineer or similar professional should be engaged to help price anything substantial.
Before making an offer or bid, investors need to fully assess the cost of the rehab by establishing the following:
- What must be corrected?
- Does existing work need to be demolished?
- Can it be legalized?
- Will plans or engineering be required?
- Which permits are required?
- Will walls need to be opened?
- Will bringing one area into compliance trigger additional upgrades?
- How much will likely permit and professional fees cost?
- How long could approval and inspections take?
Check for liens, assessments and enforcement costs
With the rehab costs established, there is one final piece of the puzzle needed before deciding whether to proceed with purchase.
A preliminary title report is necessary to identify the property’s ownership history, liens and encumbrances.
Depending on the jurisdiction and circumstances, code enforcement or nuisance abatement can potentially result in assessments or liens.
The investor needs clarity on:
- what obligations will be cleared at closing
- what follows the property
- what the seller must resolve
- what the buyer is agreeing to assume
Price the compliance risk
Now comes the critical part of the equation.
Price the compliance risk, factoring all the known worst-case scenarios into your budget, before committing to the acquisition.
Then and only then, can an investor make an informed judgement about the merits of purchase.
For example:
Purchase price: $500,000
Cost of normal rehab: $80,000
Expected resale: $700,000
The numbers look good on the surface but imagine code research identifies the following:
Structural remediation: $25,000
Architectural and permitting costs: $15,000
Cost of legalising previous work: $12,000
Additional holding costs of two months: $3000
Suddenly the expected profit margin shrinks from $120,000 to $65,000 and the ROI from 24% to 13%.
Why properties with code violations remain attractive
Even with an ROI of 13%, the acquisition may still be worth it to the experienced flipper or investor.
It’s the complexity of the rehab, the technical prowess required and the trouble of having to acquire all the necessary public records and permits which dissuades other buyers.
That is where the value exists for flippers!
Experienced flippers should have:
- contractors already available
- familiarity with permitting
- a strong ability to estimate rehab costs
- access to short-term capital
- the capacity to buy as-is
- greater tolerance for properties that conventional buyers cannot finance
The opportunity exists when the expected profit compensates for both the visible work and the uncertainty.
Get hard money finance and support today
Code violations should not automatically disqualify an investment opportunity.
But they should never be treated casually.
Opportunity exists when the investor can identify the issue, understand exactly what the local authority requires, accurately price remediation and still acquire the property with enough margin to compensate for the additional execution risk.
But distressed properties are difficult to finance with traditional lenders.
That’s where hard money comes in.
Hard money financing places greater emphasis on ARV, rehab scope, investor relationships and exit strategies.
Equidy is a hard money lender that can finance flippers and developers in as little as 48 hours.
They stand by their core belief that anything is possible and they strive to prove it every single day.
Even in tough times, they are determined to reward entrepreneurship and resolve to help their clients crystallize their wealth creation dreams.
And if you seek reassurance about your convictions to buy a distressed property, Equidy can offer you a second opinion.
Equidy has an intimate and personal history with all aspects of property development in California and has done so for well over 40 years.
They will assess your prospective purchase to ensure your rehab and code compliance estimates allow you to maximize your return on investment without putting yourself at unnecessary financial risk.
Equidy enjoys long and established relationships with serious investors, sellers and real estate professionals while leveraging their reputation and trust, using clear communication to minimize the risk to all parties.
Contact Equidy today to book your free strategy call.
