How to Protect Yourself from a Seller’s Unpermitted Rental Unit During a Sale

Unpermitted rental unit

Unpermitted rental units and their tenants can pose a risk to real estate agents and brokers. If a buyer can prove that they thought they were purchasing a property that could generate rental income when, in fact, it was an unpermitted rental unit, they can bring a claim against the seller and their agents or brokers. In addition, tenants and property managers can become entangled in the real estate transaction, further complicating matters. When you understand how to sell an unpermitted rental property, you reduce your risk of a real estate lawsuit for you and your seller client.

When dealing with a tenant who is occupying the property

In a situation where a tenant is living in an unpermitted rental unit, the rental agreement becomes void and unenforceable. The result is that a landlord is barred from collecting any additional rent, and the tenant is entitled to a refund of all rent paid plus accrued interest.

For the selling agent, this means that you will need to advise your client on the need to bring the property up to code prior to the sale, insist on a third party inspection of the property, and then memorialize all of this in writing. The agent should also advise the seller to consult an attorney regarding the potential need to refund the tenant the rent paid during the time the unit was unpermitted.The financial settlement of funds will need to be completed prior to the sale, or disclosed to potential buyers if the property is already listed for sale.

When dealing with an unoccupied, unpermitted rental unit

There is a duty of full and complete disclosure in all real estate transactions in most states between the buyer and seller and their respective real estate agents, preferably in writing.

In California, for example, where the seller knows of facts that may affect the value or desirability of the property and also knows these facts are not known to, or within the reach of the diligent attention and observation of the buyer, the seller is under a duty to disclose them to the buyer.

A seller also has a common law duty to disclose defects materially affecting the market value of real property, when the seller is aware of the defects, and knows the buyer is unaware of them and would not discover them in the exercise of reasonable diligence.

Undisclosed facts are grounds for a real estate lawsuit if they would have a significant and measurable effect on market value. As a matter of law, a structure that has unpermitted additions that could affect price or desirability must be disclosed to all potential buyers in writing before the close of escrow. If any of the real estate agents involved in the transaction know that a component of the structure is not permitted, they need to disclose that in writing to all parties, with a request that all parties consult with appropriate third party experts to remedy the issue before close. The buyer may still agree to the purchase after disclosure of the unpermitted rental unit, and acceptance of the condition must be noted in all final sales agreements.

Clarity, transparency, and documentation:

There is no penalty for over-disclosing a perceived problem with a listed property in writing and then asking that all potential buyers date, sign and return a copy of any such disclosure. One is not penalized under the law by over-disclosing a possible issue. Always recommend that the seller or buyer consult with appropriate third party experts. Save a copy of all of your disclosures and recommendations in the transaction file and electronically for future need.

You will also want to keep your broker updated in writing on a weekly basis regarding all transactions, especially those with unpermitted rental units. You can further reduce your risk of a real estate lawsuit by calling the CRES ClaimPrevent® Legal Advice Hotline whenever you have a question or concern about a real estate transaction.

This blog/website is made available by CRES Insurance Services for educational purposes to give you general information and understanding of legal risks and insurance options, not to provide specific legal advice. This blog/website should not be used as a substitute for competent legal advice from a licensed professional attorney in your state. Claims examples are for illustrative purposes only. Read your policy for a complete description of what is covered and excluded.

Originally Published May 3, 2017

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