Buying my first commercial building from an owner offering terms several years ago made me an instant fan.
I was reminded that the technique is still alive and well.
Just a few months ago, 5828 Temple City Blvd. sold for near asking in less than 60 days. The listing description went something like this:
“Commercial building for sale. Large lot with approx. 2500 sq. ft. building plus more parking. Currently chiropractic offices. OWNER IS RETIRING & WILL FINANCE 1ST TRUST DEED WITH APPROVED CREDIT & TERMS.”
So why does someone who is retiring think of doing this? Most likely his first objective was to defer capital gains and create a dependable monthly income. His money is probably growing somewhere between 6-8%, and is secured by a property he’s very comfortable with.
I’m thinking he’s glad he hasn’t been exposed to the stock market or to low- yielding CD’s from banks who may, or may not, be in business next year.
Secondarily, it probably helped him sell quickly for top dollar. When conventional financing isn’t required, there are more potential buyers for a property. But that doesn’t mean there isn’t any underwriting involved.
You notice that even though the seller was providing the financing, his ad said,
“with approved credit and terms.”
He’s still looking at the strength of the buyer . . . down payment, credit score, and probably financial statement.
When a seller carries, it’s important that the transaction be structured properly for maximum safety of the investment itself (the trust deed), as well as the marketability of the note if he ever needs to sell it for cash.
The first items usually negotiated between the buyer and seller are:
- purchase price,
- down payment,
- interest rate,
- monthly payment, and
- term or due date (or balloon payment, if any).
A seller should require no less than 10% of the purchase price as a down payment, with 20% being ideal (25%+ for commercial). There is no substitute for protective equity.
The interest rate on a note, in most instances, should at least be the going rate in the market at the time. It can often be a point or two higher. Even with a higher interest rate, the buyer is saving cash at closing by not having to pay points or loan origination fees.
The sellers carrying back a note would want:
- A due-on-sale provision.
- A balloon payment due on the note 5-7 years from closing.
- A late charge of 6% of the payment if it is not made within 10 days of its due date.
- A prepayment penalty (if early pay-off would generate adverse tax consequences).
- The buyer to pay all closing costs.
A buyer would want:
- No due-on-sale provision.
- No balloon payment. Where will they get the money in 5 years?
- No late charge.
- No prepayment penalty.
- The seller to pay all closing costs.
A compromise would look something like this:
- A due-on-sale provision will give the sellers some control in the event the buyers sell. They will be able to approve the new buyer.
- A balloon payment in 10 years, not 5.
- A late charge of 6% of the payment if not paid within 15 days.
- A prepayment penalty only if the buyers make additional payments that reduce the principal balance by more than 10% in any given year.
- Buyers and sellers agree to share closing costs equally.
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