In our business, we talk with a lot of people about a lot of things, but the most common conversation we find ourselves having is: “What happens when I sell”?
For a novice investor that likes to hold real estate, that’s an easy answer. Buy more real estate. These folks will typically leverage a 1031 Exchange to roll their equity into a larger property, or something that has more upside than their current asset.
For a house flipper, that’s even easier. Take the profit, pay your taxes, buy the next one, and repeat. These folks are typically doing this for what we call “now money”, or to grow a bit of reserve to start investing in holding properties.
But what about an investor who is more mature in their career, doesn’t have the time or desire to self-manage, can’t keep a good property manager, and has a genuine need for their recurring income through retirement? That’s a bit different of a scenario. Selling might cause a tax event that you’d like to avoid. Holding the property may continue the headache, especially if you’re anticipating major maintenance, turnover, etc. Similarly, you could hold the property until the time to pass down the property to your heirs; you’ll just need to make sure that you’ve set it up in a way that spells out, clearly, who gets what and how. All of these options still leave you with a headache or eliminate your income.
What about Seller financing?
Referred to as an “owner-carry”, “seller-carry” or “selling on contract”, this–– in essence–– makes the Seller the bank. In other words, a Buyer approaches a property owner and hopes to buy their asset. The Buyer sees some potential in managing the property differently, or maybe even wants to redevelop the project which would give them some upside. The Buyer offers a 25% down payment and requests that the Seller “carry” the remaining 75% on a contract. The Seller (tired of managing, but still in need of recurring income) entertains Seller financing and the transaction could look like this:
Sales Price : $1,000,000.00
Down Payment : $250,000.00
Seller Loan : $750,000.00
Interest Rate : 4%
Amortization : 30 Years
Term : 10 Years
The Buyer holds the Deed and the Seller has a lien on the property. Keep in mind, the Seller and Buyer can agree on any terms that fit for both parties, the example above is just used as a reference.
Here are some of the benefits that the Seller will see…
In the scenario above, the Seller has generated $250,000 in immediate income. Though this is taxable, it’s a smaller portion than a full sale and we often see this money used to pay off other liabilities. The remaining $750,000.00 is made into a loan collecting 4% interest and generating a $3,581.00 stream of income from the loan payment. No more calls about a broken dishwasher. No more calls from tenants. No more wondering how you’ll pay for that roof; just $3,581.00 of monthly income.
It’s important to have a conversation with your Certified Public Accountant before entering into an agreement like this. In our experience, we have seen a huge benefit to our clients by spreading out their tax exposure over several years.
If your property has had any maintenance that you’ve deferred, it may be hard for a new Buyer to finance the property until improvements are made. That said, there are a lot of buyers who are willing to take on these types of projects. Your willingness to carry a contract on the property might make or break your ability to sell the asset.
Just like anything, there is an inherent risk. It’s crucial, that you vet your Buyer. What is their experience? Have they done this type of transaction before? Frankly… What does your gut tell you? This is why it’s important to speak with a trusted attorney when drafting the contracts. Given that you’ve made yourself the bank in this transaction, you reserve the ability to foreclose on your loan and take the property back. Making these contingency plans is crucial for a successful transaction.
If any of what you’ve read here resonates with you or you’re interested in discussing further options beyond what’s written here, I’d love to connect with you. For now, happy investing and we’re wishing you prosperity.