The Property Management Shop
by Marc Wilson
Q. We have read and admired your column for a long time. Both my husband and I enjoy discussing the issues you raise, finding your responses practical and reasonable. Five years ago, we bought a five-unit building. One of the units is illegal, with an elderly tenant who has been there over 30 years. We are concerned that (1) we are open to liability from our illegal unit, and (2) that our insurance company will deny coverage in the event of a loss because of the illegal unit. How do you recommend we proceed?
A. You have to assume that most insurance companies have only two departments: a premium collections department and a claims denial department. Insurance companies will deny any claim when and if they feel that they have a good chance of prevailing—that is just the nature of the beast. I have not read your insurance policy, but I would be surprised if there were not some verbiage contained within the policy that could be interpreted to call into question an insurance company’s obligation to pay claims on illegal units. My position is, big deal. If your policy looks anything like mine, it has 20 to 50 pages of fine print. A slick insurance executive can justifiably deny just about any claim, legitimate or not, for one reason or another. Insurance companies deny legitimate claims all the time as a normal course of business. There are attorneys that do nothing but specialize in suing insurance companies that do not pay claims pursuant to their policies. In fact, my brother makes a darn good living punishing insurance companies that don’t behave.
The good news is that your insurance company is not more inclined to deny a claim, simply because there is a nonconforming unit at the property. For whatever reason, nonconforming units are not a big deal with insurance companies. Insurance companies never ask about nonconforming units, and they never have specific exclusions within their policies relative to illegal units. From a practical standpoint, the presence of a nonconforming unit does not materially affect your legal exposure. The fact is that the City of San Francisco is not on a witch-hunt to torture owners of nonconforming units. Insurance companies also do not have a documented history of denying nonconforming-unit claims. There are more than 30,000 nonconforming units in San Francisco, and for whatever reason, nobody seems to really care. In fact, some supervisors are actually promoting legalizing in-law apartments. If there were any real risk associated with nonconforming units, the market would react by reducing the sales price for those buildings with nonconforming units. The presence of a nonconforming unit does not in and of itself reduce the sales price of San Francisco apartment buildings. To conclude, you should relax and manage your nonconforming unit as you would manage any other unit. Remember, you are a San Francisco Apartment Association member and always a consummate professional.
As a matter of policy, I always ask both prospective and existing tenants of nonconforming units to sign a disclosure document that outlines the risks associated with renting this type of unit. I want each tenant to understand that there is always the possibility, no matter how remote, that the City might require me to remove any of these units. I do this not because I am concerned about my legal exposure with the tenant, but because I think the tenant has a basic right to know that his unit is a nonconforming one. My experience is that most tenants could care less about the legal status of the apartment. Just give me a call if you want a copy of my standard nonconforming unit disclosure. Please remember that having a nonconforming unit is not a license to be a slumlord. Your nonconforming unit should be as safe, if not safer, than all of your conforming units. Also, don’t go overboard on the total number of nonconforming units at a particular property. One is enough.
The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of the SFAA or the San Francisco Apartment Magazine. Marc Wilson has been managing and selling San Francisco apartment buildings for over 15 years. Please send your questions concerning property management issues to Marc Wilson at 1699 Van Ness Avenue, SF, CA 94109. He can be reached at 415-229-1275. Copyright © 2004.