Very VERY small commercial deal with seller financing

[Kathleen DeNault-Ridge]

I am considering the purchase of a small commercial mixed-use property.  It is a building with two current multi-year leases (post office, yoga studio...no history of lengthy vacancies), and a very small owner-occupied launderette (coin-op).  The long time owners want to retire.  The property cash flows.  The owners are willing to seller finance.  I'm not sure how to structure the deal.  I spoke with a local commercial banker and he recommends:

bank financing the purchase price for 20 years (5 years fixed and floating after that)

20% down

because sellers are motivated and have agreed to seller finance: he recommended having the sellers carry back a second mortgage which used to supplement our equity to come up with the down payment.

I have read that when seller financing the goal is get the seller to finance between 40-60% of the price.  In previous discussions with the seller, they agreed to seller-finance almost 70% of the deal (they just want their existing small mortgage satisfied so they can retire). Should the deal have a higher percentage of seller financing or is the seller financing a portion of the down payment a reasonable approach (the bank seemed to like that approach more)?   What kind of terms should be used with the seller financing portion?  How does this all work at closing (a double closing??) and how is that coordinated?

Thanks,

Kathleen

[Bill Gulley]

LOL, typical banker! Let me make a loan and reduce my risk while you're at it!

So long as your post office isn't scheduled to be closed, you can't ask for a better tenant than the government! I suggest you check on the status of the P.O.

There is no ideal LTV to shoot for with seller financing, if the project cash flows at 100% then that can certainly be the best amount and I've done many at 100%, some at even more where the seller kicks in cash to a project! So, there isn't some optimum amount.

When you're dealing with older sellers, you may find they owned the property since dirt was invented, it's fully depreciated which means that depreciation will be recaptured for taxes, they don't like paying taxes anymore than anyone else. So, the amount they may want to carry back could be 100%, but their concern will be risk of default where they want a hefty down payment to secure their position, that makes sense.

You said this was very small, in the commercial world it may be, I doubt it's that small with two tenants. When a seller is willing to carry the financing, first thing to address is the amount in relation to the sale price and a buyer needs to ensure the price is not inflated, the seller needs to assess ability to pay and their security.

After a seller like this reviews their tax position, they will have a better idea as to what they may be willing to do.

I won't ask private information in a forum (you can always PM me on this) but you may be a bit more creative and pledge other assets to compensate for the down payment and often a seller is willing to go there to avoid the tax dig.

Another issue is in dealing with older sellers, elderly and you can be the hero in assisting them in protecting their asset (note) according to their needs. If these sellers are not "wealthier" owners, just mom and pop types, they may have issues in their retirement planning, their health concerns and their ability to qualify for health benefits, holding a note can be a blessing or it can cause a chunk to be lost. I won't attempt to address the issues here, but they need to look down the road as this may effect their willingness to accept a longer amortization or hold the note longer than they may initially think. This effects the term of the financing, for you, the longer the better.

I approach interest rates as a buyer from the standpoint of; if they were to receive the full amount at closing and after paying taxes, what alternative investment they have available to them to create an annuity income or to simply invest in, what rate would they be getting? I can assure you, unless this seller is a lender type, the interest will be much lower than what they may ask for. The rate needs to be fair to both parties and the rate is a reflection of the risk they assume, it is not just some arbitrary number pulled out of the air.

A seller financing a property they have owned in an equity funded loan has a lower risk of the unknown than any bank, they know exactly what the property is, they owned it! They will also be getting the property back without matters of collateral equities that banks or a cash lender contends with, so actually, there is little collateral risk, it's pretty much limited to the maintenance and upkeep of the collateral and that can be addressed in the note and security agreement. They have pretty much assumed the same risks by leasing the property.

Their risk then is in the credit risk, your ability and willingness to pay. Much of this can be hedged by the assignment of rents which is a standard measure, that in the event of default they will have the right to collect rents.

Another aspect of reducing risks pertaining to both you and a seller is having the note serviced, administered where the servicer ensures that payments are properly allocated, where you obtain a verifiable credit reference that a private note holder can't offer, where insurance and taxes are accounted for and managed, with the necessary tax filings are accomplished for both parties and that can eliminate any loan collection or compliance matter for both of you.

It may also be possible to obtain a bid to purchase the loan in the future where the seller has an option down the road to acquire cash if required, they may sell part or all of the note and this is another important factor with older/elderly note holders, a servicier may accomplish this, a big benefit to both of you actually, you don't want just any Joe Blow end up with your note, IMO.

You have a banker that appears to be willing to take the collateral and make a loan, unless he dies and bank policies change (unlikely) the bank will probably be available to you to refinance the obligation if that becomes necessary, but if you structure this in a beneficial way for the seller, you may not have this issue, but it's prudent to have the option. A commercial loan will be more expensive to obtain or refinance, I would suggest you shoot for 40% equity at any time a refi might be necessary to allow the costs of the loan to be rolled into the loan amount.

Tell, you what, instead of me typing a book, I'll volunteer to assist you initially to get you and them started, I'll be happy to speak to you, them or any attorney or other advisor in the matter for you. Free suggestions, how's that?

I can tell you, devising a good and compliant seller financed transaction is not a simple matter and you need professional advice. Good luck!  :)