Commercial Real Estate: About Seller Carry-Backs and Creative Financing

Not everyone can get financing on a commercial building for one reason or another. Maybe the buyer’s credit isn’t where the banks require for their lending programs, or maybe the desired real estate won’t appraise for the published asking price; this is where asking the seller to carry the note becomes a viable purchase strategy.

Sellers who agree to finance all or part of the purchase price receive or create documents, such as a Deed of Trust, that evidence the terms and conditions of the loan. The seller carry-back documents are typically recorded in the public records just like a standard mortgage would be.

Seller carry-backs can be in the form of mortgage, trust deed, land contract or possibly a lease purchase. Most carry-backs are secured by a promissory note.

If there is an existing loan secured to the commercial real estate, alternatively, sellers might let buyers take over the existing loan payments, provided the loan is assumable. If it’s not assumable, the loan will remain in the seller’s name. The difference between the sales price, minus the down payment and the existing loan, is the “assumed” equity the seller would carry as a loan.

Sellers agree to carry part or all of the financing; here are some of the reasons:

  • It’s a soft or depressed real estate market — owner-carried financing will attract a greater pool of buyers.
  • The buyers cannot qualify for a commercial or SBA loan.
  • The seller is facing capital gains on the sale of the property and can defer that portion which is financed.
  • The financing gives the seller a better rate of return than a money market account making the commercial building or land a great investment and income-producing property without the hassle of ownership.
  • Sellers sometimes want a monthly income.
  • The property is non-conforming and lenders won’t touch it.
  • Often sellers can receive a higher sales price in exchange for offering owner financing.

Drawbacks to the carry-backs:

  • The buyer might default on the payments, causing the seller to initiate foreclosure proceedings
  • After foreclosure, making up back payments to the existing lender, if there is an existing loan, paying closings costs and real estate commissions, the seller might not be left with any equity.
  • Sellers who carry back mortgages have tied up cash by securing it to the property.
  • If the buyer files bankruptcy after a period of non-payment, the property could be tied up for months, if not years, in bankruptcy proceedings.

Converting the note to cash

There is a large pool of private investors in the marketplace who regularly buy seller carry-backs. However, they do not pay face value. Investors look at the yield they will receive over the term of the investment, and this yield can be increased if the investor pays less than the outstanding balance due, therefore buying the note at a significant discount.

The discounts vary across the board, but sellers can expect to lose 10 to 30 percent of the unpaid balance, depending on the following:

  • Seasoning: This is how long the seller has been receiving payments on the carry-back financing. A seller who has received timely payments over a 12-month period will receive more cash than a seller holding a brand new mortgage.
  • Interest rate: The higher the interest rate, the lower the discount. A lower interest rate will attract investors who want a higher discount.
  • Mortgage term: Long-term mortgages such as a 30-year mortgage are not as attractive to an investor as a short-term mortgage; therefore, long-term mortgages are typically sold at higher discounts than short-term. Most carry-back mortgages are five- or 10-year balloons.
  • Prepayment penalties and late charges: Carry-back mortgages that contain a prepayment penalty and a late charge are also more attractive to investors, which affect the discount rate.
  • Loan-to-Value Ratio: Lower loan-to-value ratios receive more favorable discounts. Higher ratios are considered greater risk and the discounts are steeper.
Investors also consider the type of security, its appraised value, location, amenities, condition and the credit-worthiness, if known, of the buyers. All of these factors come into play and make a difference when selling the note. Savvy sellers create attractive notes just for this reason.

The investor/buyer may ask the seller of a carry-back mortgage to pick up all costs associated with the sale of the note and mortgage such as: the title insurance policy, escrow fees, document fees, appraisal fees, real estate commissions, courier fees and, of course, the final recording fee.

[stextbox id=”grey”]These tips are provided by Pete Baldwin, designated broker and owner of Platinum Realty Network with offices in Scottsdale and Flagstaff, Ariz. With over 25 years of experience in business and real estate, Pete specializes in country club communities and second home investments, including large commercial portfolios. He also owns an Arizona branch of a family-owned, Montana-based company Baldwin Log Homes – Arizona Territory and has become the area leader in full- custom, handcrafted log homes in Northern Arizona.

To learn more about seller carry-backs and commercial real estate, please visit[/stextbox]