Seller Financing Making a Come Back?

Our market is shifting, and sellers are beginning to want to make a deal. Most sellers want to hold tight to their sales price. Many, however, are willing to get creative to make that happen. If you can make the numbers work for everyone, getting creative can be a great way to purchase real estate.

The keys to being creative in real estate is to ask and explain! First, the ask. Most people don’t get seller financing because they are afraid to ask. Stop fearing that you’ll look bad, or they will never go for it and ask. The second is to explain. You will often look like an idiot if you ask, but don’t explain the reason and advantages to your offer. Having a well thought out explanation, detailing the benefits to the seller, including their financial gain and tax saving, will lead to many conversations and a few deals.

There are many ways to get creative when buying real estate. Here are 3 of my favorites:

Seller financing through a land contract (contract for deed) or lease with the option to purchase.

This strategy is difficult in a hot market and even more difficult if you try to buy the really nice properties in nice neighborhoods. As the market cools and interest rates continue to rise, this could be a great strategy. This is perfect for something that needs some work, and you find an owner that is retiring or doesn’t need the money. This strategy also, typically will not get you no money down, but could allow you to get in for less money.

Here is an example of a deal that I bought. It was a 22-unit apartment building with seller financing at 10% down (he was ok with 5%, but I wanted to have more equity down). This seller rejected my traditional offer because of the price, but liked my seller financed offer at a lower price - yes lower price! This was because it would give him a good return based on the interest payments and allowed him to differ the capital gains tax hit. When I presented the seller financed offer, I showed him the monthly payments he would be getting and how much additional interest he would make over a 5-year time period. He loved the idea of passive income and took the lower offer, talk about win-win!

Get creative on this. I purchased a 120-unit apartment building through a Contract for Deed and only had to put in an 8% down payment. This property was 75% occupied, so getting a loan would have been required a bridge loan, which is an expensive loan. I agreed that I would pay the seller close to his asking price, if he would finance the deal like a construction loan. Here is how it looked: I gave the seller a $300,000 down payment on a $4,170,000 purchase price. The renovation was scheduled to be $725,000, so I put $600,000 into an escrow account that was held by my attorney. As we completed the renovation, we could then draw upon the $600,000 to pay for the work. If I would have defaulted on paying the seller, he could then access the $600,000 and foreclose on the property.

Seller carry back (2nd mortgage). This is also hard to do, as a lot of banks want you to have 20%-25% down. My suggestion is to make a lot of phone calls to banks to find out which ones are going to be ok with you doing this. Most will still require 10% down or greater. Many sellers are willing to carry a note for you at 10% of the purchase. They get most of their money from the sale and can defer some of the taxes until a later date. This is also a great strategy for sellers that are retiring or not in the business.

Seller Equity Shares. Here is my favorite - have the seller keep 10-25% of the sales price in the deal in exchange for an equity share of the deal. This will take trust and creativity but will allow for less money down. In this scenario the seller will sell you a property for $10,000,000 and they will keep $2,000,000 into the deal for your down payment. You set up a syndication (please consult a securities attorney) and they get an A share. This will in turn give them equity in the deal. Now, we usually set this up as a preferred return, with no or limited equity upside. The seller gets an A share, which gives them a 5-8% preferred return and no upside or maybe a 20/80 split (20% of the upside to them). The rest of the money you need to raise gets a B share with your typical returns. You could also just make them investors in the same share class as all of the other investors.

The great thing about this, is that if you’re giving a return based on performance, the lender will not count that as debt, so it will not affect your debt service coverage ratio. Of course check with your lender first, to be sure that they are ok with you doing this. 

Here's how I ask. "I am going to be raising money through a syndication for the down payment and the seller may end up putting in X%. My company will be the general partner with control of the asset and the investors will be limited partners. The general partner(s) will be signing on the loan, not the limited partners. Are you ok with that set up? 

With any of these options be sure to consult with your attorneys and make full disclosures. The last thing you want to do is assume you’re being creative, when in fact you’re just breaking the law.

There are a number of additional ways to get a deal done creatively. Sellers don’t always need the cash up front. The key is to ask and explain. There are many people that will tell you no or it can’t be done, but I would guess that they do not try. Nearly every offer I submit has 2-3 options that will give the seller the option of getting creative or just cashing out.

Take action, get creative and get it done!

Todd Dexheimer