Unprecedented interest rates still have the real estate market reeling, and as a result, many are hesitant to buy or invest.
“The resurgence of 8% mortgage rates has triggered the lowest mortgage demand in three decades… Potential buyers have been hesitant to accept such high rates,” reports Private Market Labs.
However, the situation isn’t so bleak, depending on how the deal is structured. Sellers and buyers have gotten more creative with financing options, with many turning to seller financing to close the deal.
What is Seller Financing?
Seller financing, sometimes called owner financing, is when the seller agrees to finance a portion of the purchase of the property for the buyer. With seller financing, the buyer and seller can either bypass the bank or a third-party lender entirely, if 100% of the purchase price is financed, or the amount that is financed by the seller can be counted as equity in the transaction. The buyer repays the loan to the seller over time following an agreed-upon contract.
When buyers can avoid using a loan through a third party, the seller and buyer enjoy more flexibility on the structure of the loan, including (potentially) a lower interest rate. This opens the door for more commercial real estate opportunities for both buyer and seller, when interests rate are a barrier to getting deals done.
Seller financing offers a welcome alternative to bridge the gap in such a high-interest-rate environment. According to the IBBA Q3 report, there has been a “significant rise in alternative financing methods like seller financing… often at rates more favorable than those offered by banks.”
We’re seeing seller financing with recent purchases of big-name hotels like the Kimpton Muse in New York, the Sheraton Boston, and the Sheraton New York Times Square. All used seller financing to move forward with the deal, negotiating lower interest rates.
The Advantages
Seller financing offers advantages for both the seller and buyer. In addition to the negotiable, lower interest rates, the process is typically faster and more straightforward than going through a bank or other lending institution. Both parties can enjoy more flexible terms surrounding the down payment and the repayment schedule.
For example, seller financing is commonly set up as a short-term loan with a longer-term amortization schedule and balloon payment at the end. The loan and payment schedule can be curated to allow the buyer some breathing room to ensure they can cover costs and find suitable financing via a more traditional lender during the property’s transition period. Within the loan terms, the buyer’s monthly payments can be adjusted to an amount that the buyer can afford, allowing the seller to enjoy a steady cash flow and lower taxes as they will only be taxed on the lower payment amount.
Another advantage of seller financing is sellers can attract a wider pool of buyers. In a high-interest rate environment, the number of buyers may be limited when going the traditional loan route, not to mention the current climate can make it more challenging for owners to sell a difficult property quickly. With the flexibility of seller financing leading to more buyers and quicker sales, sellers can capitalize on their investment.
Flexibility
The versatility of seller financing is a huge draw, and while you can draw up customized agreements, it’s good to know the basic seller financing models.
Seller financing sale agreements can look a few different ways, including an installment sale agreement in which the buyer makes installment payments with interest, a lease-purchase agreement in which the buyer leases the property from the seller for a set period with an option to purchase the property at the end of the lease, and a land contract in which the seller finances the purchase but retains the title until the loan is repaid in full.
You can also set up an earnest money contract in which the buyer pays a non-refundable deposit and makes installment payments to the seller. Or, you can enter into a seller carry-back mortgage where the seller provides the buyer with a mortgage, and the buyer makes regular mortgage payments until it is fully paid off.
While many are optimistic that interest rates will eventually see a downshift, seller financing is a great solution to incentivize buyers and sellers to move forward with a purchase, allowing both parties to reap the benefits of investing in commercial properties.
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