Given the housing crisis, the city has enacted regulations that attempt to force a property owner to legalize an illegal unit, unless the owner can prove certain things to the satisfaction of San Francisco Planning Staff or the San Francisco Planning Commission.

Long gone are the days in which an unhappy tenant or neighbor will report an illegal unit to the city and the city will fine the owner unless the illegal unit is removed. Now a complaint from a former tenant or a neighbor about an illegal unit will more often than not lead to the requirement that the owner legalize the unit. In my office, we have come across many cases in which previous owners created an illegal unit and a current owner is surprised to learn that he or she has an illegal unit.

The city has no definitive information on the number of dwelling units that have been added to existing residential buildings without a permit, but unofficial estimates indicate that as many as 30,000 to 40,000 such dwelling units existed as of 2013. Many more exist today. Often these illegal units have been built in the basements, garages and attics of existing buildings or in rear-yard structures. While many of these units may not meet existing Planning Code and Building/Fire Code requirements, the Mayor’s Office has decided that they should be kept (and upgraded to comply with applicable codes) since the Mayor’s Office believes they constitute a major supply of affordable housing units.

The mayor’s recent directive on this subject encourages the city’s building and planning departments to be flexible on code interpretation that would inhibit legalization; requests that the building department issue waivers (called equivalences) from code requirements unless waivers create hazards; and requires that an owner seek exceptions from density, open space, and other Planning Code requirements in order for the unit to become legal. The city justifies this position based on an assumption that the property owner has been benefiting from rental income from the illegal unit.

The city adopted Section 207.3 of the Planning Code to require a property owner to legalize illegal units “whenever feasible.” These newly legalized units will be subject to rent control with little relief in passing the upgrade costs onto tenants if the unit is occupied. Section 207.3 applies when an owner has one or more spaces that were constructed prior to January 1, 2013, without benefit of permit, used as residential space, and when the records show no “No-fault Evictions,” meaning no Owner Move-In or Ellis Act evictions. Writers in this column (including this one) have previously discussed the ability to legalize units even when a zoning district does not allow additional units on a lot. That process involves the creation of “Accessory Dwelling Units.”

The requirement that a property owner legalize an illegal unit will sometimes cause the zoning’s maximum number of lots to be exceeded, but the Accessory Dwelling Unit law allows that, as pointed out in previous articles in this column, there is a limit on the number of extra units allowed above the zoning.

Why Remove a Unit?

There may be several reasons why an owner does not want to add a unit when the city wishes an owner do so. It may make much more expensive as to property insurance, or may cause an owner to have to find a new insurance company if coverage is not offered for an additional unit. It may trigger a refinancing, as creating an additional legal unit often means changing the legal description of the property subject to the mortgage. Lenders may not agree to so modify the mortgage, and may ask for loan payoff, or a higher interest rate with the existing loan. Adding a unit to a two-unit building triggers various building and fire code requirements that are extremely costly. Some owners may find that they want to add an illegal unit into an adjacent legal unit, and not create a separate legal unit. Finally, reducing the number of units could make it easier to do a successful two-unit condominium conversion.

This push for legalization of units with code waivers makes some observers wonder if the city is encouraging the legalization of units which cannot be made safe and whether this will lead to another “Ghost Ship” fire—when 36 people were killed in Oakland in December 2016 after that city’s building department officials allegedly looked the other way as to code violations since the artists’ live/work residence housed a number of artists who could not afford regular dwelling units.

San Francisco has tried to avoid such a problem by creating a “safety valve” in which a unit that has no ability to legalize (no matter what the expense) can be removed.

Avoiding the Requirement to Legalize Illegal Units

If one cannot use this safety valve, and if the property owner wants to eliminate the illegal space, the owner must request unit demotion or merger approval at a Planning Commission hearing, with one exception (mentioned below).

At this hearing, the owner must show all of the following:

• whether or not the cost to legalize the illegal unit under all applicable city codes is reasonable is based on how such cost compares to the average cost of legalization according to the Planning Department’s Master List.
• that the cost to legalize these deficiencies exceeds 50% of a cost to build the unit in question as a new unit. For example, if we assume that the contractor’s estimate of the cost to repair specific habitability deficiencies is $230,000 for the smallest unit, and this represents more than 50% of the cost to build the smallest unit as new, then this criterion is satisfied.
• that the gain in the value of the illegal unit when legalized is less than the cost to legalize. The calculation of the gain in the value of the illegal unit must be based on the current value of the property with the illegal unit in its “as is” condition, compared to the value of the property if the illegal unit is legalized. The calculation of the gain in value must be shown by a California licensed property appraiser.
• that there are no city funds available to assist the property owner with the cost of legalization, and whether the cost to legalize would constitute a financial hardship. Generally speaking, unless the unit owner is a moderate- to low-income wage earner, there is no program that would assist an owner with the cost of legalization. If this is the case, or if an owner is not a low-wage earner but is out of a job, it is very possible to meet the financial hardship criteria. If one can show that one is not eligible to obtain a construction loan, perhaps because of poor credit or the fact that there is little equity in the building, this could also meet the financial hardship criteria.

Merging Units

If the illegal unit is to be merged with a legal unit, one must indicate how the Residential Merger Criteria are met. The discussion of the Residential Merger Criteria is not always relevant to the complete removal of a unit. Since this article deals primarily with the removal of a unit and not with the merger of an illegal unit with a legal unit, the findings which must be made to merge an illegal unit with a legal unit (Planning Code Section 317(g)(2)) will not be discussed in this article.

No Path to Legalization

To avoid a planning commission approval altogether (which involves six to seven months of dealing with the staff and spending perhaps $15,000 or more in city fees and consultant costs), one must obtain a letter from the building department to the planning department indicating that no matter the amount of money one spends to legalize code deficiencies, there is “no path to legalization.” To obtain such a letter from DBI, one must retain a building code and/ or fire code consultant to write DBI as to what the code issues are and why they cannot be fixed. Then there must be a meeting among the consultants and DBI, and a site visit by the Building/Fire Department.

Should the Building and Fire Departments agree that no matter what the cost, the illegal unit cannot be legalized, the Building Department will write the Planning Department to say that there is no path to legalization. If the Planning Department receives this, the removal of the unit or units in question can occur by submittal of an alteration permit to remove the kitchen and full bath, without the need to go to the Planning Commission for approval. It is ideal to obtain a “no path to legalization letter” as without one, one must seek approval of the Planning Commission, which has been reluctant in most cases to allow removal of an illegal unit.

Rejected Removal

If a unit removal is not approved, and an owner is forced to legalize, the owner is not of course compelled to rent the legalized unit. In fact, many owners will use all units in the building together, merely by keeping doors open among units. Or an owner may use a legalized unit as a home office space, family recreational space or space for guests. This will not assist in ameliorating the housing crisis. As the expression goes, one can lead a horse to water, but one cannot make him drink.

The information contained in this article is general in nature. Consult the advice of an attorney for any specific problem. M. Brett Gladstone is a San Francisco attorney with over thirty years’ experience in real estate development, acquisition and financing. Gladstone serves as Chair of the Land Use Group at the San Francisco firm of Hanson Bridgett.