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Illegal units and their effect on the rental market

There are numerous illegal rental units in major US cities today, especially in areas where rental inventory is scarce.

Some landlords purchase one or several properties intended to generate income, only to find out eventually that one or more of these units are illegal or non-conforming rental units.  There are also others who simply decide to bypass the permitting process in order to save some money, which they use to hire contractors who can build a unit up to code.

There are different rules regarding illegal units in every city, but in most cases, these units are either brought to code and granted a certificate of occupancy or removed completely.  Some landlords however simply decide not to do anything about it in order for them to avoid the risk of getting a citation, a fine or losing rental income.

The rental shortage in California

In 2016, California’s average rental vacancy rate plummeted to a record low 3.6%.  State population meanwhile continues to outpace residential construction  Industry reports show that there are only 187 new units for every 1,000 new arrivals  in Los Angeles and only 193 new units were added for every 1,000 new arrivals in San Francisco in 2012.

California’s rental availability is affecting its renter population negatively. Many of them have no other choice but to pay unreasonably high rent, while others seek roommates who can help out with paying the increased rates.  With more and more of their salaries being spent on rent, they have less to save or to use towards a down payment.

To address this issue, California is making it easier for homeowners to add legal units, known as accessory dwelling units (ADUs) or casitas. New laws were also put in place to get rid of parking requirements for ADUs and reduce setback requirements.

Converting non-conforming units

Landlords who make the decision not to come forward and register their rental property open themselves to liability and informing tenants about the unit’s illegality will not be enough for them to avoid this.

Several other disadvantages for landlords managing illegal units include:

  • Lower rent pries
  • Decreased resale value of the property
  • Potential for fines in case they’re discovered
  • Lost rents upon discovery

While this certainly puts landlords at a disadvantage, choosing to convert an illegal unit can be costly as well.  First, they will need to get the services of an attorney who is  experienced with land use regulations.  Next, they’ll need to work with a contractor to bring the property up to local codes.  Finally, they will need to obtain the required certificate of occupancy.

As you can imagine, this can turn out to be a costly and time-consuming process, especially when you factor in all the red tape, but the end result is a significantly higher property value for landlords.

With demand for rentals surpassing available units, it’s easy to see why many are taking this opportunity to cash in.  Additional multi-family conversions will help deal with the increasing rental population.  This will benefit both property owners and tenants but time and money required as an upfront investment will still discourage landlords to take necessary procedures.