The problem with non-permitted additions in real estate

Non-permitted additions can cause huge problems. Last week I wrote about how I valued a garage conversion without permits, and I wanted to follow up with some expanded thoughts. As I mentioned, in this situation I gave value to a conversion because I was able to show the market was willing to pay for it. Yet it’s not always that easy, so let’s dig deeper. By the way, props to Cynthia, Gary, and Bryan for stellar blog comments that prodded me to follow-up. Any thoughts?

54025005 - demolishing the old kitchen - exposing the studs, existing plumbing and electrical work

Issues when dealing with a lack of permits:

1) Lenders & Appraisers: Here’s the bottom line. Some lenders don’t want to lend on properties with non-permitted additions. In short, a non-permitted area might have legitimate value in the market, but some lenders will tell appraisers NOT to give the space any value. At the same time other lenders are okay with value being given, but they want appraisers to show a few comps with similar non-permitted areas to prove the market is willing to pay for the space (that’s tricky to find).

2) Illegal: Does the addition conform with what zoning allows? This is a key question. For instance, if zoning only allows one unit and the seller has a non-permitted second unit that hands-down would never be allowed, it’s an enormous liability for an appraiser to be giving value to something like that. Likewise, imagine if an addition was built within the setbacks on a site, which would make it illegal and maybe even a safety issue.

3) Building Department Reaction: Is it likely the non-permitted area can become permitted? What is it going to cost? This is where it’s worth giving the building department a call. I don’t recommend mentioning a specific address at first so you don’t raise red flags, but call and maybe ask about a hypothetical situation to see what the cost and feasibility might be for getting permits. Remember, not all markets are the same either. For instance, since 1976 the City of Davis has had a program where building inspectors visit all properties before they close escrow to ensure there are no code violations. In short, you can’t get away with non-permitted additions in Davis if you plan to sell (but you can elsewhere).

4) The Struggle of Different Opinions: A friend gave me a call to talk through a situation with a garage that was converted into a second unit without permits. The appraiser gave little weight to the addition because of zoning issues, but the seller thought it should have carried more weight. There was a solid back-up offer on the table, but regardless of whether this addition was worth more or not, the thing I told my friend was there was no guarantee a future appraiser or lender was going to see the situation any differently. Owners in scenarios like this tend to say, “The lack of permits wasn’t a problem when we first bought the house”, but guidelines and what appraisers report might have changed over time. Moreover, not every appraiser or lender is going to see things the same way.

Advice about non-permitted areas:

1) Minimal value: Expect there is generally going to be less value for something not permitted than something fully permitted (thanks Captain Obvious).

2) Bigger is Bigger: Buyers seem to ignore smaller-ticket items that weren’t permitted, but the bigger something is, the more likely it is going to be a bigger deal that it wasn’t permitted. For example, there is a huge difference between a non-permitted covered patio and a 400 sq ft addition that was not permitted.

3) Glorified Storage: Keep in mind an appraiser might be instructed by a lender to count a non-permitted area as storage instead of living space. So that second story attic conversion might be really sweet, but an appraiser might end up treating it like storage instead of extra square footage.

4) The Easy Answer: Getting permits can help avoid future loan problems. Be sure to keep a copy of the permit too so any appraiser or buyer can see everything has been signed off.

NOTE ON GIVING VALUE TO SOLAR: This is off-topic, but there was a recent class on solar and it was apparently mentioned I do not give value to solar systems. That’s not accurate. However, I have said a LEASED solar system does not get value because it’s personal property. Just wanted to clarify. You can read this post and another for some thoughts on solar.

sacramento-appraisal-blog

Questions: How have you seen a lack of permits impact a transaction or appraisal? Would you buy a home if it had an addition that was not permitted? Did I miss something? I’d love to hear your take.

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Comments

  1. says

    Thanks for the honorable mention Ryan. Also, I’m glad that you said it is wise to ask questions anonymously to the building department. Appraisers have a duty of confidentiality and spilling the beans could result in an unhappy client (depending on who that is).

    • says

      Thanks Gary. There have been situations where appraisers or others have called a building department and “spilled the beans” as you say. That’s not a good situation to be in to say the least.

    • says

      Thanks Jeff. Yeah, that’s another layer of what makes this so complicated from a valuation standpoint. How can appraisers find comps with a lack of permits if that type of thing is not disclosed in MLS?

      On a related note, an appraiser colleague emailed me this morning and says a particular city in Southern California does not allow a non-permitted area to become permitted. Period. So in areas like that a lack of permits could be a HUGE deal.

  2. says

    Wow, lots of good info. here Ryan. For those people that have unpermitted additions you have given them food for thought about what to expect. For those owners thinking of saving some money by NOT getting a permit, think again. The money you save upfront may be less than the amount of money you spend in the future to get it permitted after the fact or the loss in value your property experiences when that extra attic addition gets little to no value.

  3. says

    Fantastic post Ryan, Cynthia, Gary, and Bryan!

    I totally believe more value should be given to permitted areas because they cost about 4-5 times more to do than non-permitted!!

    I had the misfortune of being red-tagged once while doing a renovation and it cost me dearly in terms of dollars…

    but I gained a valuable lesson and I now use the pulling of permits as a marketing tool when I sell my houses.

    I’m proud to show off the permits and it’s also nice to do the work out in the open! ;))

    But it definitly takes a huge chunk out of my profits and can even be a deal killer on some properties that just aren’t worth fixing up due to the cost of the permits and the extra time permitted work adds to the timeline.

    …and having to use astronomically priced “licensed” contractors!

    I find in the Phoenix market that buyers tend to appreciate permitted work and will pay for it. πŸ˜‰

    • says

      What a solid comment. Thank you Bev. I appreciate the value you are adding here. I think it’s human nature to not want Big Brother to be looking over our shoulder, yet permits do mean something to the market. I would personally pay more for a permitted remodel. There is just too many ways to cut corners, and if it was permitted there is a better chance things were done the right way.

      It’s sad to me that the permitting and building process can be so expensive at times that some properties won’t work. Why can’t it be like those reality TV shows where the property is bought at $220K and then it’s sold for $450K while they made $200K in profit? πŸ™‚

      Keep up the great work.

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