Seller financing for Retail Building- is that possible??

Question

Good Morning!!

I scanned the vast corners of the Forums to find a discussion on this topic to no success, however, I am fully aware it may be my fault for missing it, or looking in the wrong places. That said, my question is this:

Does anyone have experience with seller financing of a retail strip center?

My situation is this: There may be an opportunity to buy a true NNN retail building that is owned outright by my in-laws. It is 100% full, and they may be looking to sell as it was passed onto the kids a few years ago as a Ltd Family Partnership. The 4 kids want to sell it now since the father just passed a few weeks ago. My thought is this- Rather than sell if for what I am guessing is around $6-8M and taking a huge chunk out for taxes both Fed and state, and then divide the leftover pie 4 ways, ($1m each??) is rather to sell it to us, and we provide each of them (4 Adults total) a monthly payment, almost like an annuity. I know you can do this with other types of properties such as SFH, or Multi's and my thought is, is there any reason you cannot do something like this on a retail building?

Has anyone done this type of thing with a retail center? If so, is this more/less complicated to do than other types of real estate as mentioned above? I would like to know how to structure this, and how to present this to the family in a professional way. I would be very interested in talking to someone and "Pick their brain" on how to go about something like this. Thanks!

Douglass Belt · Answer

Hey all,

I apologize for the lack of response to your feedback as  have been traveling quite a bit for work lately. Thank you everyone for the input and you gave me a lot to think about. i thought I would update you on this situation for those that are interested.

In short, i am passing on the deal and here is why. The deferred maintenance, selling price ($6+M), a lawsuit, and logistics all make this not worth it.  It is a 40 year old building and as I did a lot of inspecting of the property, there is quite a bit of repairs needed. (New roof on one section, HVAC, mold, illegal utility hook ups, sewer replacement, and elevator issues. Also, I found out that there is a lawsuit being filed from one of the tenants regarding mold issues, among other things. Also, with a full time job now, I think getting this deal up and running would be a full time job in itself and I just can't do that at this stage in my life with my family. I would like to in the future own a small retail building but do not feel that this would be a good "First Deal" in that arena!

Again, thanks to those who provided input and expertise in this area. I really appreciate it and my takeaway was that this was a deal where, on the surface looked like a creative and doable deal, in reality, it was much more complicated for a "first timer" and should be for a more experienced investor.

Daniel Chang · Answer

I agree with Joel Owens.  This is unlikely to work.  From a logistics standpoint, getting this done is not complicated.  In fact it's quite simple.  They essentially seller finance the property to you and whatever terms you agree to.

In order to sell this idea to them, you would have to come up the finances that makes sense to them.  All they pay in terms of taxes given the pass through taxation of partnerships, is 15% federal + state, on the capital gains.  Given how the partnership was set up, you mentioned it was just passed on to them a few years ago.  Then there might even be a step-up basis given the father's death, which means even less taxes.

But let's say they agree to even hear out the concept.  I ran some rough numbers.  Assuming $6MM purchase price, 8% cap, and loan terms of 20 years fully amortized at 7% interest at 1.25 DCR, you would need to come up with $1.9MM in down payment.

Assuming you have $1.9MM in down payment, you would have to convince that earning 7% interest on their money is better opportunity then whatever else they can invest in.

If you don't have $1.9MM in down payment, then you would have to convince them to seller finance with higher LTV (bad), lower interest (bad), interest only loan (bad), or lower DCR (bad).   Especially since there's no upside for them in terms of future capital gains or future rent income increases.  And they stay "tied" to this property.

(Since you didn't provide the actual numbers, the above is just to give you an idea.)

Granted, it doesn't hurt to ask.  Please post their answer if you decide to pursue this.

Jeff B. · Answer

Triple Net Lease:  Insurance, Taxes, & Maintenance.

3xNet is a highly  leveraged transaction with max profit to the leasee

and you'll never know the condition of these until  you take  possession and have to  catch up.

AND you're doing  business with family?   Think it over carefully

Mark Creason · Answer

Douglass,

I do not think they would be taxed twice on this transaction.  If the FLP sells the property, the profit would be distributed to the 4 partners, and they would potentially receive a K-1 showing income, which would then be taxed at their current rates.

If you structured the deal with them carrying the financing, I believe that they would pay taxes on the repaid principal at the cap gains rate, and the interest income would be taxed as ordinary income.  But I would recommend contacting a tax attorney if you move forward.

Mark

Douglass Belt · Answer

Thank you for your responses and input @Joel Owens, @Dan Wallace, @Jessica Wilson. I did wonder if the current set up as a Family Limited Partnership would pose a problem. It sounds like it just makes this more tricky and perhaps not worth the expense. My point I was trying to describe regarding taxes was that instead of the family selling the property outright, and paying tax on say, $6M, then tax again on each partners share, they could sell to me, act as the bank, where I pay the partners a share monthly (e.g. $10K/month/partner)  and get taxed on the smaller portion over a 20 year timeframe (for instance). Again, no idea if this would/is feasible but trying to be "Creative". I do agree with you Dan that I will contact an accountant to run the scenario by them and go from there.

I am very interested in commercial real estate, retail to be specific. I have watched this property for many years and learned a great deal about tenants, managing, etc over that time and feel like this would be a once-in-a-lifetime opportunity to capitalize on somehow. Perhaps my almost "emotional" attachment and excitement about this property is clouding my judgment. I suspect it is somewhat like homes....."there will always be another....."

Joel Owens · Answer

A lot of times family does not want to be beholden or connected to other members for any reason.

Only you understand the family dynamic and getting all of them on the same page might be really tough.

I wouldn't spend a lot of money trying to make this work. Long shots are like gambling. The chances of winning big are low and the chances of losing all your investment are high. Again if you can try a strategy on the cheap it might make sense to see if something could work.

Dan Wallace · Answer

Owner financing of a commercial property like any other type of financing is possible. You indicate that one of the primary reasons would be to avoid taxes. While I am not an accountant or tax attorney I would think the only taxes on this type of project would be long-term capital gains. Furthermore it would seem that any transfer of ownership would trigger a taxable event and the IRS would be very interested in any non-market-value transfer structured to avoid taxes whether inside a family partnership or an arms-length sale. I would engage a tax accountant first to know the taxable consequences then worry about how to finance the property second.

Jessica Wilson · Answer

To answer your specific question: Yes, I have seen this type of thing done.  It can be win win for both parties if it is structured right as the taxes are offset and private lending being easier, etc. BUT it is family and that can be tricky and can lead to issues.  Decisions to be made.

Also, the structure of the Family LTD partnership is going to play a BIG role in how this gets done.  I agree with Bill that it could be done inside the business entity if it is strutted appropriately, but sometimes Family Partnerships are VERY complicated and again, this could be tricky.  The question to you is; is it worth the legal / accountant fees upfront that may lead to not?  is it worth the family entanglement questions? and if you stand to benefit from the outright sell, could that be a simpler transaction with a quicker yield?

That's my .02.

Bill Gulley · Answer

Might consider refinancing, perhaps at 50% LTV with your local bank, the purpose being to buy out family members. That should give them cash. If the property isn't sold you have no tax issue, but buying out their share of the business entity will depending on the valuation of the entity.

The rest of their business interests can be purchase with a note to them, they will have interest income and taxable principle as it is allocated over their basis in the business.

This transaction is accomplished inside the business entity, you don't need to convey title of the property.

Need to see your accountant and attorney, get the details then present your offer. :)

Joel Owens · Answer

Sounds like they all just want their money and have different things they want to do with it.

Your proposal seems to be a real long shot with no upside to them. You can always try but do not be shocked when they do not go for it.