Buying Teardown Properties and Condemned Buildings

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Dear Mr. Melson:

My husband and I are great fans of your Searchlight Crusade essays. Excellent work!

In today's mortgage-mess market, will lenders reject loan applications from average buyers (not investors) wanting to purchase acreage with a teardown outside the city limits, with the intent of building a new home? Obviously, preservationists and neighborhood associations who might object to interference with the "character" of the area wouldn't be a major factor in this kind of decision.

Would the mortgage needed for such a purchase have to be a combo "jumbo" loan, or what? We are in DELETED and would be using a VA loan.

Okay, let's deal with the peripheral stuff quickly. The "jumbo" and "conforming" labels don't apply to VA loans. They're for conventional A paper financing only, and VA loans having a government guarantee attached as well as the ability to go up to 103% of purchase price with no PMI, there's no need to split the loan amount or to pay PMI at all with a VA loan. I know of at least one lender who'll do VA loans up to $1.5 million.

Now as to the main question: Buying teardown property.

All residential real estate loans require two things: 1) an interest in land, and 2) a permanently attached residence where people can live. Condos and PUDs qualify, because they do have an interest in land held in common, as well as the residence itself. But bare land does not qualify for standard residential financing, because it has no residence.

So the essential question here is: Is the building actually condemned? If it is, what you have isn't a residence at all, but bare land that it's going to cost you money to scrape clean. If you hear an agent talking about "land less demolition and haul away", this is the type of situation you're in. You can't get a residential loan on it because you can't live there. You have to go to one of the other loan types, which means higher down payment and usually higher rates, as well. You've still got the utility hook ups, and you might be able to use the original foundation, so you're not starting from nothing, but property with a condemned building on it is generally less valuable than bare land, because you've got the expense of getting rid of the condemned building. Condemned buildings also have the virtue of short-circuiting most concerns of historical preservation - not always, but most of the time. If the City of Philadelphia were to condemn Liberty Hall as unsafe, I'm pretty certain that wouldn't be the end of the matter. On the other end of the scale, there's a house on the same block I grew up designated historical because it was built in 1895 and by the time anyone in the City of La Mesa looked around, it was one of the oldest buildings remaining in the City. But it wasn't really anything special at the time, so if it was ever certified unsafe, I imagine there wouldn't be much fuss about actually tearing it down.

If the building is not actually condemned, however, you do have the ability to get a residential loan on the property, but you also have to be careful it's not designated historical in any way, shape or form - and that there's no one with any interest in designating it so. Once designated historical, it's like the labors of Sisyphus to try and get permission to get rid of it, and even the attempt to designate it as historical (whatever that attempt may be motivated by) can cost years and many thousands of dollars in expenses. Just because it's outside city limits doesn't mean that nobody has an axe to grind.

People do want to tear down existing buildings for other reasons than condemnation. They want to do something else with the land, or they just don't like what's there. In the meantime, they can still buy with a regular residential loan, until they're actually ready to tear it down. In such a situation, your lender would probably have the right to call the loan, so your destruction and construction financing should take cognizance of this fact. Even if your state law and loan contract do not give the lender the right to call the loan, one should be very careful that you're not misrepresenting your intentions in any way. In other words, if you're buying with intent to demolish, don't hide it from the lender. That's FRAUD. If you refinance out of the loan before destruction begins, it shouldn't be a problem. But if you sign loan documents today, and tomorrow the bulldozers start flattening, a reasonable person is going to see it as deception.

There are also the permits to consider. No matter where it is or what you want to do, it's going to require building permits. This is often a paper trail for preservationists of whatever stripe, as well as for the lender who wants to show fraud. You told the lender by signing the loan documents that everything was hunky-dory on the 15th, but you had applied for demolition and construction permits on the 14th. That's what is called a "smoking gun." Permits for single residence construction are both costly and byzantine, and often so contorted that the only practical way to get them is to commit an illegality. Poor civil servants, how else are they going to live in ten bedroom mansions and take a dozen foreign trips yearly?

There are a couple of commonly used alternatives. The first is to leave one or more walls standing. When you do that, it's not new construction, it's reconstruction - the same as after a fire or earthquake - and the permit process is far more streamlined, but you're still going to watch it as far as the original financing goes. Check with experts in your particular area as to the ins and outs. The other is to retain the old residence while you build a new one, then demolish the original structure after you've moved into the new. The advantage there is you can definitely keep the original financing in place during construction and only worry about the money you need for actual construction, but the disadvantage is that you've got to deal with zoning issues, as well as being unable to use the original site for the replacement residence - so you have to pour a new foundation and clone the utility hookups, and quite often, the lot is just too small to have a second site available that meets setback requirements, etcetera.

Destruction of an existing building and construction of a new one are both difficult tasks, fraught with landmines, if you want to do it legally. One of the things many folks just never quite understand is that those costly hurdles and roadblocks they want to throw in the way of "commercial developers" apply just as strongly to the individual property owner as they do to that corporation. In fact, what the corporation may accept as a cost of doing business, thereby passing that cost along to its customers, as well as economies of scale and everything else, that corporation is much more likely to be able to afford to navigate the process than any but the wealthiest of individual homeowners. Furthermore, by artificially limiting the supply of housing, this has the effect of raising the point at which supply and demand are in equilibrium (i.e. market price) quite significantly. I've seen recent estimates for San Diego County that this cost of getting permits raises the cost of single family detached housing by anywhere from $130,000 to $200,000 over what it would otherwise be. Incidentally, for the developer who goes through the process for several hundred units, the economies of scale reduce the price of the permits to roughly $20,000 per unit. They make a profit off the situation, while the poor guy who wants to build their own property may end up spending hundreds of thousands of dollars just to get the little pieces of paper that say it's okay for them to actually start construction. So be careful, and plan ahead, and make certain that it's going to be possible within your means in the area you want to buy before you sign on any dotted lines.

Caveat Emptor

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About this Entry

This page contains a single entry by Dan Melson published on March 18, 2013 7:00 AM.

Real Estate: Getting From Where You Are To Where You Want To Be was the previous entry in this blog.

What Does It Mean To Fall Out Of Escrow? is the next entry in this blog.

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