#6 Keep an eye out for illegal suites in apartment buildings!Dec 07, 2018
In today’s post, I would like to talk about illegal suites in apartment buildings as something you need to watch out for, especially in older properties, when you are considering purchasing an apartment building.
By illegal suites, I mean apartment units that were often added after the time of the initial construction of the building and for which the property owner may not have obtained a building permit from the municipality to add these new units.
This can have negative consequences from a financing point of view as the income from these illegal suites will not be taken into account by the bank and in the calculation of the net operating income (NOI). This means the bank will reduce the loan amount accordingly.
You see, in the world of multifamily investing, the value of the property is mainly derived from the property’s income, called NET OPERATING INCOMEor NOI. When the NOI is lower, so is the value of the property. Therefore, banks and CMHC want to see an income that is reliable and recurring.
To be considered legal suites, all units must be accounted for by proof of a building permit obtained from the municipality. If no building permit was issued for the correct number of units, the city could shut down these units at any time, which means you’d be left without the income streams from those illegal suites and the property’s net cash flow would decrease accordingly along with the property’s value.
What to do when conducting your due diligence?
I teach my students in my multifamily investing blueprint workshops (see: https://www.multifamilyinvestingcanada.com/p/cmib-training-enrolment) that the first thing they should do when they get an accepted offer on an apartment building is to start their due diligence by doing a walkthrough of the property on their own first before even hiring a professional building inspector. If you don’t like the property at first glance and you decide to walk away from this deal, there’s no need to hire a professional inspector. It would be wasted money.
However, when you do your walkthrough of the property, make sure to go to the electrical room and count the number of electrical meters.
If the property is said to be, for example, a ten-unit building, there should be eleven electrical meters, that is one for each suite plus one for common areas such as the hallways. This eleventh meter is called the ‘house meter.'
If units were added after the original construction date of the building, it is possible that these new units were added to the house meter and as such, they would not have their own electrical meters. This would mean that the property owner pays the cost of electricity for each unit and accordingly this should be reflected in the amount of rent paid by each tenant. In other words, the tenant's rental charge should be higher to reflect that and include the cost of electricity.
However, you need to confirm this by conducting a search at the municipality and obtaining a copy of all construction permits that were granted by the city for this property including the original one. The construction permit will indicate how many units were built initially. If more units were added, later on, there should be a newer construction permit confirming this too.
In the example below, the City of Edmonton sent me a copy of the original building permit for a 20-unit apartment building.
Below is a copy of the more recent construction permit from the City authorizing the addition of two units to the property.
What If Some Suites are Illegal?
If you happen to discover some suites are illegal, don’t panic!
The deal is not necessarily dead yet! You have to switch to problem-solving mode!
I always tell this to my students:
‘When there is a problem, there is always a solution! If you cannot find the solution, you’re part of the problem!
Let that sink for a minute. Apartment building owners are business people, and business people are problem-solvers…
So if you discover some suites are illegal, you have a few options:
- Go back to the municipality and check whether or not it would be possible to make the illegal suites legal. If they can be made legal, next find out what’s required to make them legal and what the cost of doing so would be. At this point, I suggest you try to get a price reduction from the vendor if the purchase price is based on a valuation which includes the income from the illegal suites as the value of their building is inflated;
- Still proceed with the deal if, on the whole, you feel strongly the deal is worth saving based on the numbers and the rest of your analysis, or;
- Walk away from the deal! You always have this option.
Now, if you ever come across a multi-family property which only has one meter for the whole building, don’t freak out either. There’s also a solution for that too!
I have bought two properties where the individual units were not separately metered for electricity, and that did not stop me from purchasing those properties. It's a happy story, and I still own both of those properties to this day. But I’ll leave this story for another blog post.
To your life fulfillment.
P.S.As you may know, my training programs, live or online, have been rated 9 out of 10 by my students in the last two years since I've completely overhauled my curriculum with the help of a professional consultant.
I’ll be announcing the new dates for my 2019 workshops in Edmonton and Hamilton in the coming month. The online course is already available for purchase (click here: https://www.multifamilyinvestingcanada.com/p/cmib-training-enrolment - training-options).
If you choose to come to the live training workshops after purchasing the online course, the amount you paid for the online course will be credited towards the cost of the live training. However, there is limited seating at my live training events, so I would suggest you sign up on my website to have your name put on the waiting list if you wish to secure your spot.