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The legal status of a property may be affected as cities and counties change their zoning ordinances.  Factors such as density, height restrictions, floor area ratios and parking requirements are often down-zoned (meaning more restrictive). Buildings that were at one time built legally according to applicable zoning codes and building standards and were once considered conforming may now fall under the classification of non-conforming (illegal) or legal non-conforming.

Sometimes owners, for economic reasons, will elect to illegally modify a property to a use that falls outside current zoning standards. For example, a 4-unit building of 2 bedroom/2 bath units located in Laguna Beach may be converted into an 8-unit building of 1 bedroom/1 bath units. If done covertly without approvals or permits it is non-conforming (illegal) and referred to as bootlegging.  

This example of bootlegging may be perceived as subjecting the surrounding community to unnecessary burdens. Negative impacts could include traffic, ingress and egress, inadequate parking, more transient occupancy, and a lack of approved (and possibly dangerous) electrical, plumbing and general construction

The municipality may designate the non-conformance of certain properties as legal non-conforming. If the building were destroyed, the current zoning regulations would apply. The owner may only be able to rebuild a much smaller building therefore losing significant value. Watch out…. your value may just go up in smoke…no pun intended.  In some communities, the rebuilding of a structure may be “grandfathered” where the city or county will allow the exact footprint to be rebuilt as it was prior to the loss. In other instances, deviations may be allowed with a conditional-use permit. Some jurisdictions disallow the rebuilding of non-conforming structures if there is a partial destruction of only 40% – 60% and require the new building to conform to current zoning standards.

You may be able to mitigate the risk by obtaining the correct property & casualty insurance coverage. Endorsements to hazard policies may be available that would allow insurance proceeds to be used to build a different structure as a result of changes to building laws and ordinances. The borrower should have sought knowledgeable insurance counsel to obtain this protection. The lender will need to verify coverage and will require to be added as an additional insured.

As a commercial loan broker it is absolutely necessary to determine which of these classifications the subject property falls under before submitting a loan request to a lender. Each lender will have different standards of tolerance and/or requirements for non-conforming properties. Additionally, you would not want to find yourself in the position of processing and underwriting a 4-unit bootlegged building and referring to it as an 8-unit when indeed it is considered illegal. Perhaps the appraiser would pick this up but you cannot rely on that. You also would not want to find yourself defending against a lawsuit by the borrower or for defrauding a federally insured lender because you failed to identify the true legal use of the property. Do your homework by contacting the local building department sooner rather than later.