New Trend in the Market: Seller Financing

Brian Platt, Michael Urquhart and Ben Douglas | Paragon Real Estate Advisors | Vendor Member

As active multifamily brokers in the Puget Sound area, we have seen and been involved in more and more seller-financed transactions. Deals requiring a buyer to get a market-rate loan are falling short of sellers pricing expectations due to the increase in interest rates, the uncertainty of where they will go next, and the high down payment requirement from lenders. Seller financing has bridged the financing gap and carved a path for both the buyer and seller to meet their financial goals.

Seller financing is a viable alternative to traditional financing if you, the owner, own the building free and clear or have a very small loan amount left. This form of financing allows a buyer to purchase the property with a higher amount of leverage and a lower interest rate, allowing them to pay an otherwise above-market price.

In this current market with interest rates 2.75% higher than they were 12 months ago, seller financing allows for you to provide the buyer with the opportunity for a smaller down payment and a lower interest rate. What we see most often is an interest-only loan which requires 20-30% down and an interest rate of 0.5%-1.5% below current rates. The loan duration tends to be 3-10 years and has a balloon payment that is due at the end of the loan term. The great aspect of seller financing is you can create a loan with terms that work best for you based on your investment horizon and goals. Here are some of the pros and cons of seller financing:

PROS:

Aggressive Pricing: Since the buyer can get more favorable loan pricing and terms you would be able to price your property more aggressively. It would allow your property to trade at a price higher than the otherwise current market value.

No Management Cash Flow: You would be able to continue receiving cash flow from the property without the hassle of having to manage the building yourself or with a property manager. The buyer would make their monthly interest payments to you through a third-party facilitator that is set up with escrow at closing. We see owners receive equal or greater monthly cash flow without having to answer any more running toilet calls.

Tax Benefits: An owner would only have to pay capital gains tax on the initial down payment and could defer the tax burden of the balloon payment. Since the monthly payments are interest-only, they are treated as ordinary income and are taxed at a lower rate.

CONS:

Continued Involvement: As opposed to cashing out with the sale of the property and moving on to your next endeavor, you would still be loosely tied to the property. If the buyer stopped performing on their loan payments, then you would regain the rights to the property and go through the sales process again. If handled correctly during the original sale, this should never happen as it is important to properly vet the buyer’s financials and real estate track record.

To give a real-world example of how this plays out, here is a case study of one of our recent sales:

SALE DETAILS:

• Sale price: $3,200,000

• Financing terms: 5 years interest-only with interest rates of 4%, 4.25%, and 4.5% for years 1, 2, and 3 through 5 respectively

• 75% Loan-to-Value

SELLERS POSITION BEFORE SALE:

• Current Net Operating Income from the property was $102,000.

• Exhausted from management responsibilities.

• Had a big capital gains tax liability.

• Relied on the passive income from the property.

• Owned the property free and clear.

• Moving towards retirement.

SELLER’S POSITION AFTER SALE:

• Received $800,000 at closing.

• Interest payments for years 1, 2, and 3-5: $96,000 - $102,000 - $108,000 respectively

• $2,400,000 balloon payment at the end of year 5.

• Zero headaches from management responsibilities.

• Freedom to pursue hobbies, travel, etc.

• Sold at an above-market price (3.8% CAP rate).

• Deferred Capital gains for 5 years.

• Received a personal guaranty on the loan from the Buyer.

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