Understanding Owner-Financed Real Estate Deals
The standard scenario for buying commercial real estate properties plays out like this: the buyer finds a property they like; the seller agrees to sell; and a financial institution provides the financing.
However, there are some instances where the traditional process isn't feasible. In such cases, another potential option is seller financing of the commercial property.
What is Seller Financing in Commercial Real Estate?
It's a transaction in which the seller provides financing to the buyer rather than a financial institution.
The Basics of an Owner-Financed Real Estate Transaction
Essentially, seller financing of a commercial property (sometimes called owner financing) means that the seller acts as the lender, offering a loan directly to the buyer instead of going through a bank.
In these instances, the seller also sets up the terms of the loan. Typically, the agreement will come in the form of a promissory note, which details the loan amount, interest rate, and repayment period.
Unlike CRE in finance, where banks provide structured loans, seller financing offers a flexible and personal approach. While many buyers turn to seller-financed deals because they might struggle to get a traditional mortgage, that's not always the case. There are a variety of opportunities where seller financing can make sense for both parties.
"A misconception is that [owner-financed transactions] are only for situations in which there is no other choice. That is, the buyer can't secure third-party financing, or the property has attributes or challenges that make bank financing difficult," explained Lee Roberts, managing partner of Sharpvue Capital, a Raleigh, North Carolina-based asset management firm that operates private real estate and private credit and equity funds. "The truth is that seller financing can make sense in a broad range of situations, including institutional transactions."
Buyer Benefits of Seller Financing
Seller-financed transactions offer several advantages for buyers, particularly those who may struggle with traditional financing.
- Faster Closing Process - Without the involvement of a bank, deals can close significantly faster, often saving weeks or months typically spent on loan approvals, underwriting, and document processing.
- Lower Upfront Costs - Buyers may avoid expenses like loan origination fees, bank appraisal fees, and other closing costs associated with traditional financing.
- Flexible Loan Terms - Sellers often have more room to negotiate interest rates, repayment schedules, and down payments, making it easier for buyers to structure a deal that fits their financial situation.
- Accessibility for Non-Traditional Buyers - Investors with limited credit history or those looking to finance niche properties (such as marinas, mobile home communities, or even land) may find seller financing a more feasible alternative to bank loans. For land transactions, traditional options like commercial land loans are available, but seller financing can offer greater flexibility.
While a swift transaction can be an advantage, it's also important not to let due diligence slip through the cracks in favor of speed, especially when it comes to environmental or appraisal assessments.
"Buyers complain about the time and money spent getting environmental reports, tax return documents (to prove income from the asset), and having to get an appraisal completed," said Tyler Saldutti, CEO of Prime Realty, a Jacksonville, Florida-based commercial brokerage and property management firm. "But these steps are there to protect the buyer as well as the lender."
Seller Benefits of Seller Financing
Sellers who offer financing can benefit from increased deal flexibility and ongoing financial returns.
- Faster Property Sales - Seller-financed deals may attract more buyers, especially those unable to secure traditional loans, leading to quicker sales.
- Ongoing Income Stream - Instead of receiving a lump sum at closing, sellers can generate steady monthly income through structured loan payments. To better gauge a property's cash flow, buyers and sellers can use a NOI calculator to assess its income potential.
- Higher Potential Returns - By charging interest on the loan, sellers can increase their total earnings over time, often exceeding what they would have received in an all cash deal. Measuring these returns using metrics such as capitalization rate can help evaluate the performance of the investment.
- Accurate Valuation - Leveraging commercial property valuation tools helps sellers assess the property's fair market value. This ensures they set a competitive price for a seller-financed deal.
- Potential Tax Advantages - Seller financing may allow sellers to spread out capital gains tax over multiple years rather than paying it all upfront. For more strategies on deferring taxes, consider a 1031 Exchange. Consulting a tax professional can help determine if this strategy is beneficial.
However, if the buyer misses payments or cannot keep up with the loan, then the seller may have to reclaim the property. If that does happen, the loan income goes away and there are often costs associated with the foreclosure.
"Any use in which the buyer is permanently altering the nature of the asset is not a good candidate for seller financing for this reason," noted Lee Roberts, managing partner of Sharpvue Capital, a Raleigh, North Carolina-based asset management firm.
Both Saldutti and Roberts also cited additional tax advantages for the seller as another potential benefit. However, it's important to review your tax situation with a professional to determine the specifics, especially if you're new to these types of deals.
Contract Terms for Owner-Financed Real Estate Transactions
Jessica T. Zolotorofe, a lawyer with expertise in commercial real estate at the New Jersey-based Ansell Grimm & Aaron, PC, highlighted why it's essential to consult a lawyer before finalizing any owner-financed deal.
"Seller financing is often a whirlwind of a transaction. There is no long underwriting or document review process like there would be with a bank mortgage, so a lawyer should be retained to make sure nothing slips through the cracks considering the speed of the transaction."
It's not uncommon for an owner-financed deal to have a structure that's different from a conventional mortgage. In many cases, the seller will amortize the payment over a longer term, typically anywhere from 15 to 30 years. However, they will often ask for a balloon payment much sooner, often within five to seven years. In order to fulfill the requirements of the balloon payment, it may be necessary for the purchaser to refinance the property.
Understanding debt yield is important because it shows how a property's income compares to its debt. Lenders often ask, "what is a good debt yield?" to gauge a loan's risk and viability.
Accordingly, it's essential for buyers to pay close attention to these terms, Zolotorofe noted. "In entering into seller financing, buyers must be confident they will be able to refinance the property within that period of time prescribed by the note."
Obtaining beneficial contract terms is also crucial for sellers. Zolotorofe cited one example: retaining the option to sell the loan to a third party. That option can provide the seller with a lump sum or regular monthly income before the maturity date on the deal.
While seller financing of commercial properties can provide flexibility for both buyers and sellers, it's essential to fully understand the contract terms, potential risks, and legal implications before entering into an agreement.
What is important, Saldutti said, is understanding that "your investment is going to succeed or fail due to the income and appreciation of the project. Don't make a bad investment because it has good financing terms."
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LIZ FROMENT
CONTRIBUTOR
Liz Froment is a finance, insurance and real estate writer based in Portland, Oregon. She previously worked in corporate finance and has in-depth experience writing about B2C and B2B finance and insurance, as well as both residential and commercial real estate topics.
This article was updated on 2/4/2025
