Understanding Owner-Financed Real Estate Deals 

This article was updated on 6/03/2024

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, for myriad reasons, the traditional process isn't feasible. In such instances, another potential option is an owner-financed real estate transaction.

What is an owner-financed real estate deal? 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, owner financing (also referred to as seller financing - the terms are interchangeable) means that the owner of the property is willing to finance the purchase for the buyer.

In these instances, the seller also acts as the lender and sets up the terms of the loan. Typically, the agreement will come in the form of a promissory note, which will detail the loan amount, interest rate and repayment period.

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 owner financing makes 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."

The Advantages and Disadvantages of an Owner-Financed Real Estate Transaction

As with any commercial real estate deal, there are attributes and challenges to an owner-financed transaction for both parties involved.

One of the most often cited benefits of seller-financed deals is that they move quickly. Since you're not getting a bank involved, it's reasonable to save weeks (if not months) on reports, searching for lenders, dealing with underwriters and completing bank required documents before closing. It can also often mean that buyers save on some of those traditional bank-related costs and fees upfront.

While a swift transaction can be an advantage, it's also important not to let due diligence slip through the cracks in favor of alacrity, 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-financed transactions can offer purchasers the opportunity to complete transactions that they would have difficulty financing through traditional means. For investors with less than stellar credit; for those purchasers seeking to acquire more esoteric assets - mobile home communities, marinas, etc.; or for investors interested in certain value-add scenarios, this approach can make otherwise challenging transactions feasible.

A common benefit for sellers is that owner-financed deals can provide ongoing income. If the exiting seller has no debt on the property, a promissory note structured for payment terms over a set period represents a predictable stream of passive income.

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.

It can also be a concern if the property needs extensive updates or repairs to get it ready to go back on the market. Roberts noted, "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."

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.

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 it might seem relatively straightforward on the surface, there are many factors to take into account before exploring any owner-financed real estate transaction.

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."

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.