Seller Financing- Pay more than FMV?

2 Replies

My goal is to purchase a $3 million office building. In my market, the cap rate seems to be around 4.5-5%, but lets just say 5% for easier math. That means an NOI of $150,000. For purposes of this discussion, lets also assume that the building is turnkey.

Because a $600k down payment is a massive hurdle, I would prefer to negotiate seller financing.  My hope is that my partners and I can get a down payment of $200-$300k and an interest-only loan for 5 years at 4% (if not below).  That would leave net cash flow of $30,000.

Ideally, the seller would agree to another 5-year note when the original note matures. I would like to keep that going until forced appreciation brings the LTV to 65% at which point we could refi with a bank, and hopefully start pulling out cash through refis.

Obviously I would negotiate the best deal I could, but as a hypothetical lets assume that the seller will not sell at a discount. In order to get the terms I want, would it make sense to offer a premium on the purchase price ($3.1 million instead of the $3 million FMV)? That would mean a net cash flow in the initial year of $26,000.

The simple answer to that is if the numbers make sense, and it facilitates your purchase; then it makes sense for your situation. $26K cash flow sounds promising!

You said the property is turn-key, but is there any value ad opportunity in this situation? If so, and you can push the value over the $3.1M purchase price without a huge investment, then it makes even more sense. 

The part that seems a little scary to me in the scenario is whether the seller would continue to hold the note for you. Make sure that part of the contract is rock solid, else you risk losing everything here. 

Hi Johnny,

Thank you for the feedback. 

At this point everything is hypothetical.  I want to solidify an idea of what I am looking for in a property, and what I am willing to offer/give up in terms before I start looking seriously.  However, I would be looking for ways to increase value.  Even if its adding a vending machine, in a 5 cap market that can add value.  Also, from what I have seen a 3% raise in rents annually seems common in my market (built into most leases).

I agree with you that the scariest part of the deal is what would happen in 5 years if the seller decided not to hold the note anymore. I would be negotiating for a 10 year note, but I think 5 is more realistic. I would start negotiations for the seller to continue to hold the note well in advance of it maturing. I believe the worst case scenario (outside of acts of God or a major market meltdown affecting commercial real estate) would be that the seller would not renew, and after owning the property for 5 years my partners and I would have to pony up the additional funds to refinance with a bank at an 80% LTV amortizable loan.