Thoughts on owner financing as the seller

11 Replies

I was approached by the renter of a commercial property I own about my willingness to sell the property.  It's a nice commercial building that I bought for $80,000. I put about $40,000 in it.  I was originally going to use it as a business venture and when I decided not to do that I kept it as an investment property.  She's renting it from me for $1650 a month currently with 2 years left on the lease.  I told her it's not "for sale" but that I would sell anything for the right price.  I shot a number out of $290,000 and she didn't freak out.  The one catch is that she would only be interested in owner financing.  Curious what people think about doing deals that way and whether it would be worth it.  She indicated 5% down would be the best she could do.  To me that would indicate I need a higher interest rate but I don't have a good gut feel for whether owner financing something is a good strategy.  Any general thoughts?

At least from my experience in residential properties, I think seller financing can be just as valuable for the seller as for the buyer.  As the seller, you can get a big chunk of cash up front, monthly cash flow, high interest, and none of the work of a landlord. 

Here's a few thoughts off the top of my head regarding your specific situation...

Why can't your buyer get traditional financing and does that make her a risky borrower? I'd dig deep into the reasons behind her being unable to get a relatively small commercial loan.

I'd push for more than 5% down... On a $290k loan, I would want my buyer to have more skin in the game than $15k.

What would the tax implications be if she refinances or pays off the loan early? Depending on the terms it's probably a safe bet that she's going to make every effort to find cheaper money and pay you off as soon as she can. Unless there's something in the terms that prohibits her from doing so, there could be some significant tax implications when you get a $290k check that you weren't necessarily expecting.

Sounds like a messy deal. 5% down is not enough for giving away control of the property. You would likely go through that quickly trying to foreclose is she didn't pay. The fact that she is pushing it to scrape up 5% down would concern me greatly. 

Why not suggest she go SBA loan putting 10% down?? That way you get your money and are off to 1031 into something else.

For owner finance the question is WHY is she dependent on that?? If she has good liquidity and new worth then that is a plus. If she is barely getting by then the purchase price is irrelevant as it is theoretical money until you get paid off.

I don't have a ton of info yet.  Haven't probed for her financial info.  She just asked if I'd consider it.  @Joel, not familiar with SBA.  How does that help?

Justin some thoughts, if I may.  

The point the others have brought out are valid.  But think about how the terms would  be set up vis a vis her financials.  The note can be structured in many ways to either make it affordable, or not.  You could have her pay some amount over and above her rental as an amount to go towards down (to address @Corey's Point)  for the remainder of the  lease, and then pull the trigger on the sale.  As you know, the note can be sold but you'll get a better discount if it has been seasoned a bit ( say one year).  and Yes I like the 1031 approach  Why pay taxes before you need to?

Seller financing is great if it works out. We did one deal so far, and it has not. We sold a 65K house, the lady put 25k down, and we held 40k. She was late with first payment, didn't leave herself enough to pay her mortgage, got behind on taxes and insurance, we had to insure like a bank would do, now we're in foreclosure which may take up to a year. I will never do seller financing again, unless we get 50% or more down and decent credit. To be honest, much of this was my fault. I did a bg check and their credit wasn't great but it was mostly medical and cell phone. 

Justin the SBA is the small business loan administration. Business owners in some cases can buy a building with as little as 10% down.

Your tenant could apply for an SBA loan and then cash you out and you sell and 1031 into something else and not do any owner finance.

Owner financing doesn't mean that you can't also do a 1031 exchange if you've got access to some other cash.  The IRS requires that you use all of your proceeds in the next purchase.  In your case, the proceeds would be like 15K in cash and 275K in a note. 

The way to combine with the complete tax deferral of a 1031 is to start the 1031 with both the 15K and the 275K note in your exchange account.  Then prior to your next purchase you "buy" the note from your exchange account for 275K in cash.  This cash can come from anywhere - savings, other equity, another loan on another property etc... At this time you now have 290K of cash in your exchange acct and can buy a new property and complete defer the tax on all of that 150K in gain.  Meanwhile you also have a note for 275K that you paid 275K for so there no gain in it and the only tax you will pay will be on the interest that comes in.  

Just saying you don't have to choose one or the other.

Seller Carry Back Financing can be tricky in regards to your 1031 Exchange.  We advise our clients to plan carefully if they intend to sell a relinquished property with a seller carry-back note when completing a 1031 Exchange transaction. You must decide whether you want to include or exclude the seller carry-back note inside your 1031 Exchange before the close of sale of your relinquished property. The installment note and deed of trust or mortgage will be drafted differently depending on which strategy you select.

We have more detailed information on our website, or we are happy to chat with you offline for more personalized information.

@Justin W.   The only way your buyer could go SBA is if your buyer uses 51% or more the commercial building for her business.  

@Justin W.  

I personally like the seller carry but my seller carry % was typically in second position at 10% to 25% of the purchase price. Also my seller carry's were in states like Arizona and Alabama. Carrying 95% of the note can be tough. You would need to make sure she is not living in property as her home.   Is the property in Texas?  If she is living in the property in Texas, foreclosing on the property can be very difficult with Texas's Homestead Act. 

It is completely commercial property.  She is using it for here business (it's a tax prep company).  The property is in Texas.

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