Seller Finance on Commercial Property: Good or Bad?

Question

So here I am, just a lowly metalsmith, hammering away at the anvil and feverishly listening to the Bigger Pockets Podcast (as metalsmiths do). I was introduced to BP only a couple months ago and figured I'd get familiarized with real estate via the podcast before I made any crazy decisions - like buying every house on my street so that I could tell people that I (almost literally) own the block...

Well as I have been learning about real estate, I've been working on narrowing down on what niche I want to get involved in. And to be honest, Commercial real estate was right smack at the bottom of the list... For no other reason than it doesn't make sense to me. And as we all know, things that don't make sense are bad and we should never make any attempt at understanding them... All jokes aside, Commercial just seemed to be way over my head so I figured I'd hold off until I understood more.

Did I mention that I'm a metalsmith? I make things with metal. That's my expertise. But I've been learning real estate because I want to retire some day. Because being 66 years old with stage 4 lymphoma and not having the option to stay home because cancer sucks just doesn't seem like a great life-exit-strategy... I'm not 66, of course (I'm 26 and beautiful). Nor do I have stage 4 lymphoma. That trophy goes to my mentor. A great man who dedicated his life to his work and has found himself stuck in his very own creation, with little opportunity to get out besides working to death.

Until recently, that is. As I was describing my dreams of owning my own metalsmithing business and real estate business, as well as running for President of the United States (2028. Watch out world). It was during this conversation that led to the topic of buying his business from him... I know, talk about escalating quickly...

Well after some lengthy conversation, discussing roughly estimated numbers, we got to the real estate part of it. Three buildings, two properties. I don't know the specifics on them just yet, as that information is still unfolding (rougly 5,000sqft each). He gave me a shot in the dark price of about $1.1m to $1.2m.

Now, why on earth would I drag you through all that back story, when I don't even have any meat to give you about the deal? Well because I don't even know where to start (look back to paragraph 2). That and I just really like writing stories. With that out of the way, I'll get to the point. My mentor, aka the seller, would prefer to sell the properties via Owner Finance. I have read and heard on the BP podcast that many investors prefer Owner Finance deals, but I don't know how that translates to commercial property. One benefit I am aware of is that I don't need to worry my pretty little head about adjustable mortgage rates. But I don't know really anything beyond that.

TLDR; Is buying commercial real estate through Owner Financing better than finding a Commercial loan? Also, what factors should I look at when buying commercial property?

**Side note** One day I am certain I will look back at this post through my fingers as I apply my palm to my face. One day.

David Cruice · Answer

@Zac Gavin, to quote Warren Buffet, "Don't invest in what you don't understand". At this point, the question of seller financing is irrelevant until you know whether the price the guy is asking for his buildings is fair, a bargain, or over-priced. I would suggest you start out by asking a commercial realtor to give you a BPO (brokers price opinion) from which to start. Yes, seller financing would be an ideal situation - nearly always better than traditional - but know what you're getting in to beforehand.P.S. Don't want to come across as too blunt, but does yourself a favor and save the backstory on future posts. I"m sure you'll get a lot more responses. There are a lot of people on BP only too willing to help out but most would pass on your post so they can move on to something shorter than can easily digest. All the best.

Faye R. · Answer

If you close with a title company, you don't have to worry about the 7k. It's their job to clear that and anything else that the seller might not know about from the funds that you bring to the table. Be aware that purchasing his business and "absorbing" it into yours carries its own risks that should be addressed by a business attorney so that you don't end up being liable for things that happened before the purchase date. For example, even if you keep his employees and vendors, you'll likely be advised to start their payroll from scratch and also to open new vendor accounts, instead of assuming his. My understanding (I'm not an attorney or accountant) is that the IRS considers single member LLCs to be disregarded entities, so there is no financial tax-related benefit to having two different LLCs. That being said, I suspect it will be beneficial for the following reasons:1) If done properly, it can reduce your liability so that if one LLC is sued, the other is somewhat protected. 2) If you treat them like two individual businesses, it will be easier sell just one off in the future, should you choose to do so. Also, if you mix the books, your future buyer pool will be limited to people who understand both metalsmithing and real estate.

Ellie Perlman · Answer

The main benefit of seller financing is that it's many times easier than a bank loan or a loan from a professional lender (where your experience in RE is crucial for an approval). However, many time a conventional loan can have more favorable terms (3-5 years of interest only, 10-12 years term, etc). It's not always the case, so it makes sense to get quotes from lenders and compare them to the seller's terms.

Theo Hicks · Answer

Hi Zac,One of the main benefits of seller financing is that the purchase price and purchase terms are completely negotiable. And, you don't have to worry about meeting the net worth, liquidity, and experience requirments to qualify for a commercial loan. High level, to determine a fair offer price, first, you need to know the current profit and losses and the profit and loss projections after you take over the property (which means you need to have a business plan for what you will do after you take over the portfolio, like renovate and raise rents, keep the same, etc.). That will give you the net operating income (NOI) projections. Next, you need to determine how much cash flow you want to make each year. Then, you can create the purchase terms such that the NOI minus the annual payments to the seller is equal to or greater than your desired cash flow.

Ronald Rohde · Answer

If the price is reasonable for the cashflow (i.e. the rent you'll pay yourself + possible rent from other tenants) then you have a lawyer draft a Purchase Agreement with a note for the financing, close at a title company.

Damon Pendleton · Answer

Like anything else, it’s all about the terms of the deal. How much in gross rents? Expenses? NOI? What do the leases look like? What opportunities do you have to reposition and raise rents? Generally speaking, owner financings is ideal if the terms make sense. Also I didn’t quite understand how you painted your mentor as having to work to his grave and then said he offered to sell you his million dollar commercial RE portfolio?? Is it just not cashflowing sufficiently for him to chill?Good luck either way. Sounds like it could be an opportunity in there somewhere.

Mason Clark · Answer

@Zac Gavin if you’re looking at buying his business, owner financing will definitely be a major benefit. It will be more difficult going through traditional financing where you need to provide all details related to the business you will be operating and still potentially being denied. He knows you, you know him so the trust level is already there whereas a bank needs to figure out if they trust you to be able to pay them back. You will probably want to get a commercial agent to see if they can get a better idea of price based on comps in the area and how your market is. Or you can do this on your own without an agent. You probably want to go through an inspection as well to make sure there are no major issues just to protect yourself. Get everything in writing and i always ask for a low rate because you never know If you dont ask. It just needs to be mutually beneficial for you both

Jeff Filali · Answer

You make money in real estate by BUYING at the best price, regardless of terms. First step is to have the buildings appraised to make sure the purchase price is a good deal (preferably below appraisal). Next, seller financing is great for both parties as long as the terms are fair to both. Its beneficial to him because he or his heirs would have cash flow coming in and it would also spread out the taxes for him. Its beneficial to you because its easier to get then a commercial loan, especially at the point you're currently at. But you shouldn't have to pay him interest rates that are much higher then the bank would charge, maybe 1-2 points higher, but nothing more then that really. Otherwise, seeking out a bank loan may be better option. Also, even though he's a friend and colleague, its BUSINESS, you need your own attorney reviewing contracts for you. You need to make sure there's no pre-payment penalty, in case you decide to refinance through the bank for a lower payment in the future. Also, I would prefer myself to make it where my other assets are not on the line in the event of a default. Again, this is why you need your own attorney.Good luck!

Zac Gavin · Answer

Thanks @Ronald Rohde. He talked with his CPA today to start putting things together with the properties and the company assets. Hopefully we'll see back on that in the next couple days. The discussion so far is that we would have his lawyer put this deal in his trust. I'm not savvy on how that works, so I have some studying to do there. @Theo Hicks, once he gets his information back from his CPA, I intend on laying everything on the table so that I can determine those facts. As of now, the idea is that I will be buying a turn-key blacksmith business. Properties, tools, material, etc. Of course I can't make any actual decisions on exactly what I plan to do until I see how his business is performing on the books. But assuming it's a profiting business that allows me to survive, my priority would be to do some much needed rehab on the properties. The long term idea is similar to what he and I are working on now. Sell the business and/or its assets, then rent the properties out.Which leads to a question, maybe best suited for a different forum (if so, maybe someone can point me in the right direction). I'm curious to find out if it might be financially beneficial to buy out the company and its assets via my metalsmithing business, then with a separate entity like an LLC, buy the properties. With the end result being that my metalsmithing business would rent the properties from my LLC. Any ideas on whether that would be a good move or if I should just buy it all under one business. A small update: He told me today that he has a $7,000 line of credit against the properties, but it is otherwise free and clear. I'm assuming he would need to pay that off before I should make any moves on purchasing.

Zac Gavin · Answer

@David Cruice, duly noted. I'll keep future posts a little more on the light side. Still new to the forum world.I understand that the whole thing is at a stand still until there are legitimate numbers. The deal lies in the numbers afterall. I do like the idea of getting a BPO.I guess, that's really where the big question is. Where can I start on my end to be prepared for him when he comes back with his numbers? A BPO is a good start I think. I'll start my research there.Thanks David!