Are your hands tied trying to close your real estate transaction?

Reader Question: It is 5 days before closing. Today, the seller notified us the 3 unit building we are buying is legally only a 2 unit building. I do not want to rent an illegal unit, and we need that income to carry the mortgage. On top of that, there is a relative living in this illegal 3rd unit who does not want to leave by the closing date. I am feeling discouraged. My Realtor keeps acting like our hands are tied and without a legal 3rd unit I think we overpaid by about 20%. We have paid $16,000 in earnest money. Can we can that all back? Can we back out of this deal? Can we seriously renegotiate? Any advice is welcome. Eileen D.

Monty’s Answer: Hello Eileen, and thanks for your question. Either your agent is blinded by the thought of the commission evaporating or they do not know what to do. They may not even realize their inaction affects how their competency is viewed. Regardless of their agency relationship, they have an obligation to disclose material adverse facts in a transaction and it appears on the surface this situation fits that description.

Seek legal counsel

Run, do not walk, to a qualified real estate attorney and bring the signed contract with you. I suspect they will conclude you were misrepresented, and you can recover the deposit, but they will need to see the contract to know for certain. Do not take my word for it. Leave your agent at home for this.

Based on this information, your negotiating position appears solid. It is possible the seller is just as surprised by this turn of events, or, they were trying to pull a fast one. The fact they disclosed this problem to you is an indication it is the former. Once advised of your options, you can decide if you want to pursue buying the building. The seller may or may not be open to it, but selling to the next guy at the same price will likely be very difficult until they address and correct the issues.

Determine the severity of the problem

Income producing property sells primarily on the amount and quality of the revenue stream. While there are other factors that come into play if the legal unit issue with the city cannot be rectified, the building is probably worth less. With only 2 other rental units, the lost rent could be a significant factor for the building. It is a simple calculation to determine the purchase price adjustment to retain the same “Return On Investment” (ROI) for which you initially bargained. The key questions are; can the unit be modified to meet the city code? What will modification cost in real money?  How much rental income will be lost during the completion of the tasks?

Ask the seller to remove the relative

Depending on the lease and the terms, occupancy issues with the relative can be problematic. Tenants have rights regardless of their relationship to the owner. If they will not do their relative’s bidding, what will they do for a stranger? Your attorney will have good advice about how to handle this, but amending the contract to condition the closing upon receiving a vacant unit requires the seller to clean up their own mess. Under these circumstances, consider re-evaluating the market rent in this illegal unit. Occasionally, leases with relatives are not what they appear to be.

Good lessons in this experience

If it is determined the illegal unit cannot be brought into compliance, and the seller declines to negotiate, consider the circumstances that placed you in harm’s way. It is possible there is nothing your agent could have done to prevent it, but on the surface it appears “acting like our hands are tied” may be cause to interview other agents.

Sometimes, representations by sellers seem so obvious a buyer fails to verify them. In this case, there are already 3 occupants in the building. It must be legal. The old saying, “Trust, but verify” comes to mind.

Practically, all your reasons for buying an investment property are still valid. This “hiccup” could happen with any property going about your due diligence. It is part of the learning process. By turning the discouragement you are feeling into a potential opportunity this transaction may ultimately be a positive event.