Why, How and When (Not) to use seller concessions or rate buy downs for acquisitions

[AJ Wong]

Seller concession, or no seller concession? That is a question. 

What is a seller's concession, some may ask? 

A seller's concession is a portion of the transaction that the buyer finances, with permission from the seller. 

Usually, it is structured as a percentage or fixed proportion of the proposed sales price or transaction. 

For example: A client closed on a $500k Triplex with a 3% seller concession towards closings costs. Effectively the seller contributed 3% of the sales price ($15k) towards the buyers costs. 

- Sellers proceed are $485k minus RE costs and any loan balance

- Buyers funds to close are (in this example) 10% down (of $500K) = $50k and finances or absorbs $15k of proposed closing costs into the loan. 

This reduces the buyers total necessary cash to close by roughly 25% ($50k vs $65k) and increases their monthly installment marginally. (Think of it like rolling the premium features of a vehicle into a car note.)

Seller concessions are best negotiated with the initial offer and acceptance but can (at least in Oregon) also be utilized or useful during inspection or contingency periods to promote compromise. 

Depending on the property type and transaction, lenders also have limitations and restrictions as to the quantity or percentage concession permissible. 

Additionally, concessions are not limited to only covering the costs of a transaction. In addition some lenders will permit a concession to be towards pre paid interest. In other words, an interest rate buy down. Usually in the form of a 1, 2-1 or 3-2-1 rate buy down. 

This is interest paid upfront and at closing that essentially reduces the buyers initial interest rate by 1% (below the qualifying rate) for 1 year. 2% for the 1st year, and 1% for the second year. Or in the case of a 3-2-1, by 3% the first year, 2% the second year and 1% the third year, before  resetting to the fixed qualifying rate. 

Without diving too deeply into interest rate buy downs, these can be effective tools for improving cash flow, but there is a limitation to their benefit that is best analyzed with your mortgage broker/banker. 

Some common lender guidelines specific to seller concessions include:

- Up to 6% seller concession on Primary/Second Homes

- 2% seller concession maximum on investment properties 

- Interest rate buy downs must be seller paid (usually entirely) 

So when is a good time to utilize a seller concession? In today's rate environment, I feel it should always be a consideration but certain conditions won't generally provide transactional or offer enhancement. 

In highly competitive markets or on competitive offerings, a seller concession likely isn't going to be an option. Why?

Sellers have no obligation to or inherent benefit of offering a concession. It's actually an increased risk factor to any transaction for the simple fact that the asset needs to appraise for higher. In our previous $500k example, what did the seller yield? ($485k) Sellers are conceding, buyers are leveraging. In multi offer situations, typically the offer that includes the concession is less assured to close as proposed due to the appraisal variable. 

So why would a seller accept a concession? Because by offering more attractive terms they expand their potential buyer pool. 

To re-example: $475k offer with 20% down vs $500k with 10% and 3% concession. Initially (in this actual case) the seller chose the first, we accepted a back up position, that eventually moved into primary position. 

In this example, one can see from a buyer perspective, how a seller concession could expand the buyer pool. 

Buyer A would need to come up with $110k+ with closing costs. 

Buyer B had to come up with $50k total. 

Seller had to do an appraisal and underwriting dance for a couple weeks, but with a serious buyer. 

Seller concessions are best but not always negotiated prior or at offer acceptance. They can also be an effective tool for inspection or contingency negotiations. For example on a $1.5M purchase of an oceanfront STR, the inspection had notable concerns. As there were multiple offers initially and a back up consideration, the compromise was a 1% concession for the anticipated $10-12k in repairs. Negotiated as a concession this reduced the hard cash to close, instead of a reduction in sales price.

Real Estate Professionals should be accurately aware of market analysis and market conditions and as best as possible to ensure there is room for a concession to be incorporated into the sale price. 

Seller concessions should be closely coordinated with lender/broker and real estate representatives, as there are nuances to property types, loan amounts and income qualifications. 

It does not go without saying that the 'right' lender or at least one with options and experience utilizing concessions and familiarity with your specific investment goals is essential. I always say lenders are the most under appreciated and yet arguably most essential element to a financed transaction. They bear the brunt of the responsibility and none of the glory. lol Seriously though, the right lender, makes and breaks deals for all parties. Lean on your Real Estate network for a go to mortgage master. They are my best contacts on Bigger Pockets and beyond :) 

In coordination with several of my recommended local mortgage brokers we've effectively executed concessions on at least half of our transactions during the past 24 months.