Seller carry second mortgage with variable terms

[Tyler Derickson]

I'm looking into a commercial retail deal where I would have the seller carry back a portion of the property as a second mortgage. I like the property as it's in a good area, however with the lack of national tenants (mostly mom and pop tenants with decent lease lengths) and the maturing business cycle I want to protect my downside as much as possible, but still get deals done. 

With that said, I would bank finance 60% of the project and the seller and I would come up with the remaining 40%. If I don't include the seller second or my down payment portion, the DSCR for the bank debt would be 1.82 DSCR. I understand this portion well.

Now getting to my question. Has anyone ever structured the seller's second to be a percentage of the remaining cash flow after the banks mortgage payment? Because the property is setup as a MTNL, it's fairly easy to calculate the remaining cash flow after bank debt service. Example: NOI is $300k/yr, bank mortgage payments would be $165k/yr, remaining cash flow would be $135k/yr. Could you structure a seller second so the seller gets 65% of the remaining cashflow? In this example the seller would get $87,750 and I would get the remaining 35% or $47,250.

The appeal to me is that the cost is a percentage of the cashflow, so if the economy tanks and cashflow is reduced, both the seller and I get a smaller payout, but I'm still able to weather the downturn with the bank (keeping both my money and the seller's money more secure). On the flip side, if the economy continues to do well and I can actually increase the NOI (currently a few vacant units) the seller would also share in the upside potential as well, increasing his return!

Has anyone structured a deal similar to this? If so, were there any major concerns with the bank? Would this blend lines for the sellers between debt and equity? Thanks in advance for all your advise and suggestions!