Purchasing Property with Seller Carry Back as Equity Instead of Debt

[Mike Lowery]

Hello BP Community! 

I am sure it has done before and I am not thinking too outside of the box, but in starting to structure syndication deals, it dawned on me that if you could find a seller willing to carry back some capital, you could provide equity instead of debt?

For clarification, I will use an example:

Purchase Price: $1M

Seller Carry Back: $300K

Loan: $700K

Instead of a traditional seller financing deal, where the seller would take a second position to the bank, why not offer them equity stake in the asset?

I understand this is not ideal as most sellers are looking for cash and would not keep equity in an asset just to relinquish operation?

But in the long run, the owner is more than likely cashing out the equity they have built in the property while also continuing to earn cash flow from the asset. Not to mention the equitable position that could be passed down or capitalized upon at disposition. 

Has anyone has experience with this? Pros and Cons? Things to watch out for? Am I crazy?

Thank you for your anticipated input!

[Don Konipol]

Quote from @Mike Lowery:

Hello BP Community! 

I am sure it has done before and I am not thinking too outside of the box, but in starting to structure syndication deals, it dawned on me that if you could find a seller willing to carry back some capital, you could provide equity instead of debt?

For clarification, I will use an example:

Purchase Price: $1M

Seller Carry Back: $300K

Loan: $700K

Instead of a traditional seller financing deal, where the seller would take a second position to the bank, why not offer them equity stake in the asset?

I understand this is not ideal as most sellers are looking for cash and would not keep equity in an asset just to relinquish operation?

But in the long run, the owner is more than likely cashing out the equity they have built in the property while also continuing to earn cash flow from the asset. Not to mention the equitable position that could be passed down or capitalized upon at disposition. 

Has anyone has experience with this? Pros and Cons? Things to watch out for? Am I crazy?

Thank you for your anticipated input!

Why wouldn’t the seller get his own loan for $700k and maintain 100% ownership instead?
Here’s the holes in the program you presented
1. Almost all lenders want borrowers to have personal capital invested in the deal - if there are any that would finance 70% and allow seller carry of 30% in a subordinated note they’d be charging interest rates of 15% +
2. As mentioned above why would the seller hand equity to a buyer when the buyer brings no investment?
3. For a seller to agree to provide a second with no buyer capital contribution the property would probably be priced significantly over market value and hence unsellable conventionally at that price.
4. Unless the seller is going to accept a note with deferred payments the property is going to have a negative cash flow

There are many scenarios that can be drawn up and theoretically look good, but the reality of sales price, rental income, and property expenses don’t fall into the narrow window that makes sense.  Yet, once in a while a deal like this can be put together.  What’s required is a combination of some of the following

1. Seller agreeing to sell a property at discount of 20%  less than market value
2. A property being operated inefficiently where income can be quickly increased or expenses quickly reduced
3. An event outside of the property itself that results in rapid price appreciation
4. A property that can be repositioned for greater income and or value
5. The ability of the buyer to qualify for lowest interest rate loans available
6. Seller highly motivated to sell 

 

[Mike Lowery]

@Don Konipol

Thank you for your input! The example was just that, an example. I know it would be tough for lenders to not require the buyer to have some ‘skin in the game’. Also, the properties that are most sought after in this scenario would be value add properties where the seller is older, maybe wants to retire, or has other circumstances that make them unable to maintain, operate, etc the property as they have in the past.

I understand it’s not an easy method to deploy, however, I was merely looking for someone who may have done something similar.

[Don Konipol]

Quote from @Mike Lowery:

@Don Konipol

Thank you for your input! The example was just that, an example. I know it would be tough for lenders to not require the buyer to have some ‘skin in the game’. Also, the properties that are most sought after in this scenario would be value add properties where the seller is older, maybe wants to retire, or has other circumstances that make them unable to maintain, operate, etc the property as they have in the past.

I understand it’s not an easy method to deploy, however, I was merely looking for someone who may have done something similar.

I’m sure that there are many successful experiences of putting together a 100% financed deal with owner carry seconds - however these are much tougher to do now than they were when I started investing in 1978 because lenders are more adamant about borrowers bringing personal capital with a purchase.  The fact that all residential loans contain a due on sale clause is a large factor in the decline in subject to deals.
while I did do some subject to deals in the old days, most of my home runs were the result of being able to close fast and pay cash without waiting for financing, and to make offers without the usual financing contingencies.  I’ve know many people who put together subject to deals and owner financing subordinate financing deals - but hardly ever at a below market purchase price.  

[Bill Brandt]

I assume you’re talking deals with no realtors and zero government fees? You’re not expecting the seller to bring $100k in closing costs to the table to give you the property are you?

What if this $1m property needs a $50k roof. Does the seller have to kick in $15k? What if the 70% owner decides they should invest in $100k Tesla with an advertisement on the side they’ll drive around, does the seller kick in for that?

Does the seller have to pay closing costs again to get his equity out? Can he ever force the sale or is he stuck as your partner forever? What if there’s negative cashflow because of the financing the 70% owner takes out. Do they have to kick in monthly?

I can see how this is basically a zero percent risk deal for the “buyer” who can walk at anytime and lose nothing. But what’s the upside for the seller who loses 10-20% financially, and 100% decision-wise day one. 

[Mike Lowery]

@Bill Brandt No I am not expecting the seller to bring $100K in closing costs to give me the property. No, the seller would not have to kick in $15K for a roof, just as I would not have a capital raise for a new roof. If I perform adequate due diligence, this should have already been thought of. The whole Tesla comment, yeah, I will not even bother with that.

In this scenario, the seller would not be stuck as my partner forever, the 70% owner would not take cash out, etc. Obviously I understand that a zero risk is impossible for the 'buyer' and said buyer would not just walk away from the deal. 

All that said, you made a lot of assumptions thinking you understand how I operate based on post merely looking to see if there were ways to get creative about purchasing properties. I simply made a suggestion. I do not believe in free lunch and this suggestion was far from that. 

Thank you for your response!

[Jay Hinrichs]

Quote from @Mike Lowery:

@Bill Brandt No I am not expecting the seller to bring $100K in closing costs to give me the property. No, the seller would not have to kick in $15K for a roof, just as I would not have a capital raise for a new roof. If I perform adequate due diligence, this should have already been thought of. The whole Tesla comment, yeah, I will not even bother with that.

In this scenario, the seller would not be stuck as my partner forever, the 70% owner would not take cash out, etc. Obviously I understand that a zero risk is impossible for the 'buyer' and said buyer would not just walk away from the deal. 

All that said, you made a lot of assumptions thinking you understand how I operate based on post merely looking to see if there were ways to get creative about purchasing properties. I simply made a suggestion. I do not believe in free lunch and this suggestion was far from that. 

Thank you for your response!

this may work in D class assets or Bad C class areas.. were sellers are desperate

[Rick Pozos]

Hey @Mike Lowery Keeping the seller as equity limited partner does come into play in the value add game. Older folks trying to get more for their property than you want to pay for it. Maybe your property COULD be worth 2mil, but because of deferred maintenance you want to pay 900k and he wants 1mil. Bring him along for the ride as a limited partner. He will get some cash from the sale, but more importantly for him, his equity value should increase because you are going to improve the property. Maybe he does not have the cash to do the repairs for the roof or plumbing or whatever, but he knows that he has a great property. He may want to stay in the deal so that he gets some cash AND his small equity should grow AND it can be someone else's headache.

I have asked several times for the seller to become my limited partner to no avail. It never hurts to ask. I have a buddy who has been successful in asking for that extra that they are asking for to become equity.