Conforming vs. Nonconforming – Making Your Property Lending Decisions Is the subject property conforming, legal nonconforming, or illegal nonconforming? As a lender it is necessary to determine the property’s conforming status.
A conforming use is one where the subject property is in compliance with local zoning laws and the use of the property is legally permitted. Conformity is a byproduct of zoning laws and municipal ordinances which may change over a period.
“A legal nonconforming use is a use of lands or structure which was legally established according to the applicable zoning and municipal building laws at the time, but which does not meet current zoning and building regulations. A use or structure can become legal nonconforming because of rezoning, annexation, or revisions to the Zoning Code.”* As long as a nonconforming property’s use status does not change, a municipality or regulatory agency may protect its legal nonconforming designation. A legal nonconforming designation usually requires the property to be in continuous use. If it is vacant for a period, its legal nonconforming status may be lost. In some communities special or conditional use permits, variances, or site development permits may be obtained to extend or even modify legal nonconforming use.
Communities vary in the way they treat legal nonconforming properties which are destroyed. Most will allow the rebuilding of the property to its prior condition only if 50% or less of the structure is destroyed. If, however, the entire structure is destroyed, most often the owner would be required to rebuild to current zoning standards. A lender in such a case may experience a serious loss in collateral value but may mitigate such a risk by getting the correct property and casualty insurance coverage. Endorsements to hazard policies may be available that would allow insurance is used to build a different structure because of changes to building laws and ordinances. For example, a retail strip center situated on a small lot may not have enough parking spaces to comply with current zoning requirements. If zoning changes regarding parking requirements have increased from requiring 3 spaces per thousand square feet of a building to 4 spaces per thousand, the owner may be required to reconfigure the retail center’s footprint. The owner should seek knowledgeable insurance counsel to obtain this special protection. The lender should verify the coverage and require that they be named as mortgagee and loss payee and an additional insured.
Lenders are most at risk with a property which is nonconforming and has been illegally modified or is operating without proper conditional use permits. For economic reasons, owners may elect to illegally modify a property to a use that falls outside current zoning standards or the use permit framework. For example, a 4 unit building of 2 bedroom/2 baths units is converted into an 8 unit building of 1 bedroom/1 bath units. If done covertly, without approvals or permits, it becomes illegal nonconforming. This process is sometimes called 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.
Conditional Use Permits
Issuing a conditional use permit must be in adherence to, and consistent with, the hierarchy of land use laws. The use permit results from zoning laws which must comply with an adopted general plan which must comply with state laws. “A Conditional Use Permit (CUP) allows a city or county to consider special uses which may be essential or desirable to a particular community, but which are not allowed as a matter of right within a zoning district, through a public hearing process. A conditional use permit can provide flexibility within a zoning ordinance. Another traditional purpose of the conditional use permit is to enable a municipality to control certain uses which could have detrimental effects on the community”**
A CUP is generally required for certain land uses which are an exception to a community’s general plan. Land suitability, environmental impacts, project design, traffic and noise impact, and availability of public services are conditions which may call for a CUP. Mobile Home Park, “granny” units and second dwellings on single family lots are typical cases where a CUP might be required. Conditional use permits run with the land, not the applicant, and may be passed on to future owners of the property, however, they may also be revoked for several reasons. Relying on a CUP as the major factor in a credit decision could cause reduction of value should the permit be revoked.
The intent of zoning variances is to provide a form of equitable relief when the owner or representative of a property can show that the variance would not conflict with the public interest and that undue hardship or loss of financial return would occur should the variance not be granted. Building code variances may include exceptions to height restrictions, setbacks, or moving demising walls, etc. As with the conditional use permit, an applicant for a variance must submit a set of plans and a statement of purpose to the proper municipal authorities. Once granted, the variance runs with the land, may be transferred, and is not subject to revocation.
Some properties, such as a senior care facility in an R1 single family, zoned neighborhood, may require both a state license for the operator and a use permit by the municipality to run the facility. The state licensing of the operator may be required for special training and competency. If the property is sold, or a lender is underwriting the property to make a loan, there will be four concerns of, property conformity; permitting; licensing of the operator; and the impact on a going concern. It may be problematic when doing a cap rate analysis if there is a deviation that makes a property significantly different from other comparable properties. The assumption of an increased value may be fraudulent or false at best.
As a lender, or agent of the lender, it is necessary to determine which of these classifications the subject property falls under. Each lender will have a different standard of tolerance and/or requirements for legal nonconforming properties, but would most likely not want to be in a position of loaning on a bootlegged property. While an appraisal might pick up this fact, it should not be depended upon nor should the representations of the realtor who might be involved in the transaction be depended upon. Lenders can be sued by a multitude of parties for failing to identify the true legal conformity of the property. Calling or visiting the city planning departments to verify zoning and conforming vs. nonconforming status is highly recommended. Verifying the terms and conditions of a conditional use permit and under what circumstances it may be revoked is also recommended. If possible, get a copy of the approved permits or variances from the city or answers from the governing authority in writing. If a loan has been secured by an illegal nonconforming property or on a property with a revoked permit, getting paid back may be at risk.
** Neighborhood Action Group v. County of Calaveras (1984) 156 Cal. App.3d 1176
Business and Private Money Finance Consultant
Bus. 949 521 7115
Cell 949 533 8315