5 Advantages to Seller Financing Your Property
What Exactly is Seller Financing?
For many individuals seller financing can be an extremely attractive option for numerous reasons. For example, with seller financing, also known as “owner financing” or an “owner contract sale,” the seller of the property effectively provides the loan to the buyer instead of the buyer obtaining a loan from a bank. In general, the loan is secured by the property being sold. The term of the loan is generally much shorter than with a mortgage, typically 1-10 years, at which point the buyer pays the seller the full balance on the loan (a “balloon payment”), typically via a refinance or sale.
Is Seller Financing an Option for Me?
To participate in seller financing, the seller must ensure that they are in a legal position to do so, either because there’s no mortgage on the property or because it will be paid off with the down payment received at closing.
John Smith is a successful businessman who invested heavily in real estate in the 1970’s and early 80’s. He purchased 8 smaller properties, including single-family homes, a four plex, a 10 plex and a 12 unit building. He has self-managed the properties and is approaching retirement. His wife would like to move to Austin, Texas to be near the grandchildren.
- Lose Money: Sell for all cash and pay capital gains: He has met with his CPA and heard his taxes may approach 30% currently, or higher if the federal government makes changes proposed.
- Lose Time: Sell for all cash and do a 1031 exchange: John has researched it, but being at the tail end of his active management and investing career, he would prefer annuities over active management and ongoing “toilet and tenant” headaches.
- Make Money: As John owns all the assets free and clear of mortgages, a seller financing option is attractive. Via an owner contract sale, John will increase his monthly net income from $4,000 a month on one apartment sale to $8,200, more than doubling his income with no ties to tenants or maintenance issues! At the same time, John avoids paying capital gains until the PRINCIPAL is paid. In theory, an owner could sell a million-dollar asset with zero down and have minimal capital gains at sale (depreciation recapture must be paid in year of sale tax filing). John is fully collateralized like a bank would be via a Deed of Trust and promissory note. As the buyer is a seasoned property owner and investor, the seller’s secured position will increase in security daily as the property is improved and the rents increase.
Why Choose Seller Financing?
Seller financing can offer significant advantages to a seller, particularly for those who have no immediate need for most of the funds generated through the sale. These advantages can be summed up as follows:
1. A Contract Sale defers most Capital Gains until the Loan is Paid Off
Loan payoff can be scheduled to occur at a time when the seller’s earnings are lower, such as after retirement. Provided the seller enters a lower tax bracket at the time of loan payoff, their tax burden would be lower on capital gains generated through the balloon payment. For example, because of retirement and thus lower earnings. If the mortgage on the property is fully or largely paid off, the equity in the property may be very substantial, in turn leading to a large tax bill on the gain that results from its sale.
2. A Contract Sale can Generate a Steady and Healthy Income through the Interest Paid by the Buyer
For example, a seller accepts a $1,000,000 offer on their property and agrees to finance 90% ($900,000) through an interest-only loan at 5% for five years. The seller would receive $3,750 per month in interest ($45,000/year) throughout that five-year period, but without the hassles of managing the property. Consequently. this income becomes normal investment income to the note holder.
3. Increased Monthly Cashflow to Seller
Our experience has shown that most owners experience a 150 to 200% increase in their income by selling on contract. Many sellers have not raised rents on their tenants for years, pay all utilities, and their return compared to their equity is very low. By selling on contract, we have seen some owners receive well over 200% of the net operating income (NOI) they had before selling.
4. Seller Financed Transactions can be quicker than Conventional ones
There is no need to wait for the bank loan officer, underwriter, and legal department to analyze the deal. Closing can occur in as little as 10 days or less.
5. The Buyer intends to complete Renovations and Improvements to the Property, which will substantially Increase its Value, and thus Enhance the Seller’s Security
Summit Capital Partners have completed hundreds of owner contract sales.
We welcome the opportunity to meet and discuss the advantages of this type of sale.