Seller Financing: Another Option for Commercial Real Estate
Credit markets are forecasted to continue to be tight through 2010. As a result, financing commercial and industrial real estate deals will be tough.
We likely will not see what were considered to be conventional terms for real estate deals for some time, so why not consider seller financing if waiting out the market is not feasible?
Why do a Seller-financed deal? Even credit-worthy buyers are unable to get financing in this market, so Seller financing makes sense if you have a Buyer that can give you satisfactory security and acceptable rate of return. Seller-financed deals are more flexible because you are not dealing with a financial institution's standards for interest rates, maturity dates, and so forth, although the deal will still have to comply with applicable laws regarding caps on interest rates, unconscionable provisions and so forth. In addition, because a lending institution is not involved, a Seller-financed deal may move more quickly.
Who does Seller financing? A variety of Sellers use this mechanism, including:
- Property owners needing to discharge a debt, but cannot get financing or re-financing.
- Property owners needing the capital for another business venture.
- Property owners desiring to liquidate their portfolio.
How are the deals structured? A Seller should consult with their tax advisors and legal counsel to determine how best to proceed. A personal guaranty from the individuals who own the business entity that is the Buyer is highly recommended to lower the Seller's risk. Seller financed transactions typically fall into the following categories:
- Seller receives a mortgage lien on the underlying real estate;
- Seller makes a mezzanine loan secured by a pledge of the ownership interests in the business entity purchasing the property (this carries a higher risk, but a higher rate of return should be part of the deal); or
- Seller and Buyer enter into a traditional land sale contract.
What are the risks of a Seller-financed deal? The biggest risk by far is not having a credit-worthy Buyer or one that will deal with you honestly. As a result, it is essential to do financial due diligence and business reputation due diligence on your Buyer. Review financial statements, tax returns, and the credit history of your Buyer. Ask for bank and business references. If the Buyer balks at giving you references, proceed with caution. Try to get an accurate picture of how the Buyer conducts its financial affairs so you may make an informed decision as to the likelihood of the Buyer performing under the deal.
Many Taft attorneys have experience in Seller-financed transactions and would be happy to assist you with evaluating the economics of a deal and prepare the necessary documents to make it work.
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