Clearly there are benefits for both the buyer and the seller when a flexible seller is willing to provide owner financing to you as the buyer of their property. Let us take a look at a few examples:
The property seller may prefer to have the steady predictable income a seller-financed note will provide them without having to manage their property any longer.
He no longer owns the property or is responsible to maintain it, repair it, pay the taxes on it, keep up the insurance, and deal with the dreaded “T & T, ” tenants and toilets. These responsibilities will fall on the shoulders of the new owner. By becoming a creditor and financing the sale, the seller simply collect checks as paid.
By converting their existing equity in a property they own to a seller-financed instrument, they often can earn higher rates of return on that equity than if they cashed out that equity and placed the funds into a bank certificate of deposit (CD) that pays them little interest.
For example, Peter property seller has $300,000 in equity in his rental triplex. If Peter sells the triplex and places all $300,000 into a bank CD he might earn 3% to 4% interest on those funds. However, Peter has been approached by a younger investor who is looking to build his estate and acquire rentals.
He has offered Peter 6% interest, if Peter will seller finance part of the sale and hold $300,000 in the form of a purchase money mortgage to be secured by the property. This is double the interest of what the bank CD would pay.
The property seller may face some tax consequences that will take place if he were to sell the property to a cash buyer. Assuming this seller has owned their rental investment property for a long period of time, there will be probably be some decent equity growth in the property that was generated by the loan amortization, appreciation of the property’s market value, and depreciation taken, which will have to be recaptured.
A buyer paying all cash to such a seller under these circumstances will trigger a large potential tax liability to the seller. Often sellers can elect to do a tax-deferred property exchange in order to defer the taxes, but many sellers do not want to acquire another rental investment property.
An installment sale where the property seller sells and also finances the sale may allow them to spread out the taxes that would be due over a longer period of time as opposed to owning them in the year of the sale.
When you are contemplating the purchase of income-producing property it might make sense to consider your objectives down the road in holding that property for the long haul. We recently helped a buyer of a free and clear mini storage facility who had negotiated the following deal with the property sellers:
$700,000 Sales Price
-$100,000 Cash down payment
$600,000 Balance to be seller-financed over 240 months @ 6%
Naturally the seller would be in a position to carry this $600,000 purchase money mortgage and note and collect the $xxxx installment payment each month. However, the buyer felt that in the future he would be coming into some large cash reserves and might like to pay down some of the principal that would be due on the $600,000 that would be seller financed.
The problem with this arrangement for the buyer is that if he did pay a large sum towards principal reduction, he would still owe the seller next month the same $xxxxx installment payment until the entire $600,000 note instrument is paid off in full.
To alleviate this concern, the buyer requested that the seller finance the $600,000 balance by agreeing to carry back three separate mortgages and three separate notes in the amounts of $100,000, $200,000, and $300,000 all to be financed under the same repayment terms @ 6% and amortized over 240 months.
Now in the future if the buyer were to pay off one of the notes, let’s say the $100,000 note, their debt service payments that would remain would go down and their overall cash flow that the property generates would improve.
So, think through some of the issues sellers may be facing when you are attempting to negotiate favorable seller-financed terms and also consider the needs or objectives of the property buyer.