Seller Financing in High Cost Areas

[Rick Albert]

Hello All,

I keep thinking about Seller financing as it comes up a lot in discussions here in Los Angeles. Here are my initial thoughts:

1. When looking at high cost areas, it's so risky for a Seller to finance a large loan.

2. Even with interest rates in the 5%, it's still very risky for a Seller because in the event of foreclosure, they now have to cover the cost of the foreclosure plus property taxes, insurance, maintenance, etc. 

3. I would imagine most Seller financing requires 20%+ down. So for owner user who wants to put less down I would imagine it is a pass for a Seller.

4. From a tax perspective, assuming there are some levels of capital gains, it might make sense, but again, the perceived risk is so high.

What am I missing? When would it make sense for a Seller to consider financing in this market with low rates.

Thanks!

[Marco Bario]

@Rick Albert -

In a state like California (I live in Los Angeles as well), a moderate earner who realizes a significant capital gain in a single year due to the sale of real estate could be faced with 40% or more in state and federal taxes on the profit. For that reason, installment sales are attractive.

The reason you don't see as many seller-financed transactions in our market now is that interest rates have been so low. 

Ideally, seller-financed interest rates are at least 4% above institutional, and the ideal terms are closer to 15 years. Given the size of loans here, the difference in payment vs. a 30-year institutional loan is significant. 

As interest rates rise, and credit tightens, I believe there will be an uptick in seller financing, even in markets like Los Angeles.

The best question to ask a seller who is on the fence about seller financing is to ask what they're going to do with the money. Goldman Sachs' Marcus money market accounts are currently paying 6/10 of a percent. A seller might be motivated to seek monthly income and a fair interest rate rather than hand 40% to the government and watch the rest shrivel and die in a money market account.