Unknowingly purchased a rental home with a deed restriction

by Guy
(Tri state )

Visitor Question: I purchased a home that I was using as a rental with cash. Everyone knew I was an investor and how this house was going to be used.

I used an attorney and title company for the cash purchase and for the delayed financing shortly afterward. The home was built by Habitat for Humanity, and I asked my realtor, attorney, and basically everyone involved if there were restrictions before I purchased. The seller and their attorney said there were none, and the title search uncovered nothing (at least nothing was disclosed to me as I would have walked away).

Fast forward to a year later, and I go to do another refinance and the new title company uncovers a deed restriction. It says the property can’t be used as a rental, Habitat for Humanity has the first right to purchase the property, and the purchaser has to be low income. (I should have never been able to purchase.)

As the buyer, I knew nothing, asked everyone the right questions and everyone else screwed up (title company, realtors, sellers, both attorneys etc). What happens now? Who can I go after? Am I able to sue for damages for the legal costs I incur, opportunity cost since I can’t rent the house for x amount of years and if I sell, can I sue for the difference in the sale price and what an unrestricted sale would have been?

Editors Respond: It certainly seems as if you did your due diligence. To answer your direct question first, the best course of action if you want to sue is to discuss the facts with an attorney licensed in the state where the home is located. We are not attorneys, but in a situation such as this, we would suggest thinking about suing "all of the above" to try to discover all of the culprits. As usual, we would advise discussing likely total fees and probability of recovering legal costs before making a definite decision.

Even if you ultimately recover your legal costs, you will probably have some associated out of pocket costs and opportunity costs for other productive activities you will have to sacrifice to tend to the suit. We thought we would offer some suggestions short of suing all involved parties. These may be less emotionally satisfying, but they might be financially wise.

Some people would merely give up on refinancing and proceed as if the deed restrictions had not been uncovered, since no one is challenging you because of the restrictions. However, as you know, these restrictions should be disclosed when you ultimately sell the property, so that is a terrible solution.

Ultimately your best course of action would be trying to get the deed restrictions lifted. Often we advise people that this is a difficult undertaking, but in your case someone clearly had Habitat for Humanity in mind when imposing the restrictions. Talk with your local Habitat affiliate if you haven't. Explain your dilemma just as you have relayed it to us. See if they know or can find out who imposed the restrictions in the first place. (You can learn this at your local courthouse, but asking Habitat has the advantage of letting you gauge the degree of relationship between the person who imposed the deed restrictions and the current Habitat for Humanity staff and board members.) If these restrictions are quite old, the staff might have to do a little digging to find information about the person who imposed the restrictions, but if you are charming, you can probably persuade them to do this.

If you develop a good rapport with Habitat for Humanity, there are some possible good outcomes. They might want to buy the house, since they were supposed to have a first right of refusal and apparently did not receive any notice that the house was for sale. Importantly, if they have no interest in the property for the foreseeable future, they might help you by meeting with the person who imposed the restrictions to urge that they be lifted.

You no doubt have noticed that the restrictions themselves are a bit muddled. (But we point that out because others will be reading this.) Habitat for Humanity typically requires the future homeowner to put sweat equity into the construction or substantial rehabilitation of the home, but in your case, that amount of work may not be necessary. It seems that the person who authored the restrictions wanted to see it ultimately owned by a low-income person, which again may or may not be feasible in your particular market. We point out these potential flaws in the current application of the deed restrictions only to help you find potential arguments in favor of dropping the deed restrictions.

Of course, the person who originated the deed restrictions may now be deceased, in which case you would need to deal with heirs. Potential complications include not being able to get the heirs to agree with one another, not being able to entice the heirs to act promptly since they have no incentive to do so, and even not being able to locate all heirs. The result of conversation with heirs is unpredictable. You could expect a reaction that the heirs want to honor the memory of their loved ones by leaving things just as their ancestor wished, but it is equally likely that they will say that we don't care about mom or dad's passion for low-income housing.

The bottom line for us is that we would go ahead and consult an attorney about this matter, while contacting Habitat during the same time frame. Ultimately if you decide to sue, which seems well justified, you will need a good real estate attorney, and if you decide to pursue having the restrictions lifted, resulting in a higher rent and better resale value, you will want to make sure of exactly what your state laws and case law require for changing deed restrictions. For example, sometimes unanimous agreement of heirs or other stakeholders (such as current owners in a subdivision) is required, and sometimes not.

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