Seller financing, also known as owner financing, is an alternative financing arrangement where the seller of a commercial property acts as the lender for the buyer. Instead of relying on traditional financing from a bank or financial institution, the seller finances a portion of the purchase price for the buyer, who then makes regular payments with interest over a set period.
This article by board-certified real estate attorneys at Texas Horizons Law Group will explore the intricacies of seller financing in commercial real estate transactions.
What Is Seller Financing in Commercial Real Estate?
Commercial real estate transactions often involve significant sums of money. While traditional financing from a commercial lender remains the most common option, seller financing can provide a viable alternative for both buyers and sellers under certain circumstances.
For buyers who may struggle to secure traditional financing due to factors like creditworthiness or property type, seller financing can offer a path to acquiring a desired commercial property. Sellers, on the other hand, can benefit from potentially faster sales, increased returns through interest payments, and potentially spreading capital gains tax liability over a longer period.
Types of Seller Financing Agreements
There are several ways to structure a seller financing agreement, each with its own advantages and considerations. Let's delve into the five most common types:
Promissory Note for Installment Payments
In this arrangement, the buyer signs a promissory note, outlining the repayment terms, including the principal amount, interest rate, and repayment schedule.
Lease Purchase Agreement
This structure combines elements of a lease and a purchase agreement. The buyer makes lease payments with a portion credited toward the eventual purchase of the property at a predetermined price.
Wrap-Around Mortgage
This is a more complex structure where the seller takes over an existing mortgage on the property and adds their own financing terms for the remaining purchase price. The buyer makes a single monthly payment to the seller, who then uses that amount to cover the existing mortgage and their own financing.
Why You Need a Real Estate Attorney for a Seller Financing Agreement
Regardless of the chosen structure, a well-drafted seller financing agreement is crucial. Its intricacies can vary depending on the structure, property type, and the presence of a balloon payment. Here's why a real estate attorney is crucial for both buyers and sellers:
Benefits for Sellers
A real estate attorney will draft the financing documents to protect your interests. This includes ensuring the documents are recorded correctly by securing the loan with a deed of trust against the real property.
Benefits for Buyers
An attorney will review the agreement to ensure the financing terms don't unreasonably restrict your intended use of the property and that the documents are drafted to reflect your understanding of the payment structure including amount and frequency of payments, interest rate, and length of loan. This safeguards your ability to use the property as planned after the purchase and your rights in ownership and usage of the property that is subject to the Seller’s lien.
Property Ownership in Seller-Financed Deals
In a seller financing arrangement, the buyer acquires title to the property subject to the seller’s lien on the property as security for the amount of the purchase price financed by the seller. Once the full amount is paid off, the seller releases the lien.
Advantages of Seller Financing
Seller financing offers several advantages for both parties. The seller can enjoy:
- Quicker Sales: Eliminating the need for lender approval can expedite the sale process.
- Higher Selling Prices: Sellers may be able to command a higher price for the property, as the buyer’s options may be limited.
- Stable Returns: The seller can earn a consistent income through installment payments, often at an interest rate higher than traditional investment options.
For the buyer, seller financing offers:
- Easier Qualification: Seller financing may be available even if the buyer has a less-than-ideal credit history.
- Flexibility: The terms can be negotiated between the buyer and seller, offering room for creative structuring.
- Lower Closing Costs: Without a traditional lender involved, some of the typical fees associated with conventional loans may be avoided
If traditional financing is not an option or is not advantageous in a particular situation, seller financing may be a better method. Consulting a real estate attorney can help you determine which form of financing is right for you.
Disadvantages of Seller Financing
While seller financing offers advantages, it also comes with potential drawbacks.
For the seller, a lack of liquidity could be an issue. The seller won’t receive the full sale price upfront, which can be a drawback if immediate cash is needed.
Additionally, there is the risk of default to consider. If the buyer defaults, the seller must go through the legal process to foreclose on the seller’s deed of trust lien, incurring additional costs and time delays. The condition of the property could deteriorate during the life of the loan.
For the buyer, interest rates are a potential drawback, as the interest rates in a seller-financed deal are often higher than those offered by third-party lenders. Some seller financing arrangements may also require large balloon payments, making it crucial for the buyer to refinance or sell before the loan comes due.
Legal Documents in a Seller Financing Agreement
Several legal documents solidify a seller financing agreement, protecting both buyer and seller:
Promissory Note
This is the core document outlining the loan terms, including the interest rate, repayment schedule, and default consequences.
Deed of Trust
A deed of trust (i.e., “mortgage”) is signed by the buyer to secure the loan. The property being sold is the collateral for the loan. If the buyer defaults on the loan, the seller can foreclose on the deed of trust lien.
Guaranty
If the buyer is an entity, such as a limited liability company or corporation, as is often the case in commercial real estate transactions, typically, the owners of the buyer execute a guaranty. As the guaranty makes the owners personally liable for the loan, it serves as additional assurance that the loan will be repaid.
