Strategies

KPS V – SELLER FINANCE

Continuing my series on little-known and creative killer property strategies, I now look at seller finance. You’re the buyer and the seller gives you the money to buy their property. How good is that?

Killer Property Strategy V – Seller Finance

Seller finance is the property strategy where the seller of a property helps the buyer to purchase it by providing financial assistance in the form of a loan or mortgage.

THE BIG POSITIVE FOR THE SELLER IS THAT THEY SECURE A BUYER; THE BIG PLUS FOR THE BUYER IS THAT THEY SECURE A MORTGAGE WHICH MAY BE EASIER TO OBTAIN THAN ONE FROM A REGULAR LENDER.

1. Features of the strategy

The seller may provide: (1) a mortgage for the full amount, (2) a mortgage for the balance of the purchase price or (3) a loan for the deposit – with the buyer securing a mortgage for the balance from a regular mortgage company.

The strategy typically involves the first two alternatives.

The seller may get security in the form of a first charge or a second charge – depending on the circumstances.

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A typical situation is where the seller or owner is a builder, developer or investor of a new development or block; has a few units left to sell, which are proving hard to shift; and needs or wants to sell them promptly in market conditions which are not ideal for a sale.

Further, the seller has the financial resources – directly or indirectly – to help potential purchasers to buy.

Although the usual situation will involve a new property, there is no reason why in principle the seller of a second-hand property cannot offer seller finance.

HOWEVER, THE STRATEGY IS MORE LIKELY TO BE PRACTICAL AND VIABLE IN THE CASE OF SELLERS HAVING A FEW NEW PROPERTIES TO SELL.

The strategy may be especially appealing to a builder, developer or investor wanting to sell out a development, get their profit out and move on to another project.

The loan from the seller may be short term or long-term – with long-term being as long as 25 years – the term of a regular mortgage.

Because of its non-standard nature and features the strategy is more likely to appeal to investors rather than mainstream buyers.

Short term funding may be appropriate where the seller does not want to tie up their loan capital for a long period and the buyer seems able to secure more conventional long-term funding in the near future. 

The strategy is likely to be most appropriate in a situation where the market is slow and new properties are proving hard to sell. A seller with spare capital, or linked to another person or business with spare capital, can use those funds to ensure that the development is fully sold – which may have a range of business advantages.

2. Advantages of the strategy

The strategy offers a range of advantages for sellers and buyers.  Advantages for sellers include:

  • A way to expedite or gain a sale where beneficial for practical, strategic, financial, fiscal or accounting reasons
  • A method to secure a sale in market conditions (such as after the 2007-8 credit crisis) where mortgages are extremely difficult to obtain
  • A way to get a better price in a falling market    the buyer may be tempted to purchase nearer the asking price because of the availability of a mortgage, thereby enabling the seller to secure a price better than otherwise.

There are also several advantages for a buyer in a seller finance situation, including:

  • The seller’s mortgage or loan may be simpler, easier, quicker and cheaper than a mainstream loan or mortgage.
  • The buyer may be able to secure a mortgage or loan in circumstances where they would ordinarily be refused by a mainstream lender operating more stringent credit scoring.
  • If the seller is distressed and has to sell quickly, the buyer may be able to bag a genuine bargain.
3. Risks and dangers

The strategy does have a range of risks or dangers for both sellers and buyers. The risks or dangers for the seller include:

  • The seller is not usually a professional underwriter and cannot be sure that they have conducted an accurate credit risk assessment for the buyers they accept.
  • A decision to accept, on pragmatic grounds, a buyer not meeting their credit criteria may be a false economy if the buyer fails to keep up payments and turns out to be a problem borrower going forward.
  • Transferring available capital to a buyer may not be the best investment or financial use for such funds, especially in a low interest environment. The seller needs to calculate whether lending to a buyer is the best use for their capital.
  • If a long loan is provided – for instance a mortgage for 25 years – the seller cannot be sure when the buyer will pay back the loan and may need the capital in the future at a time when it is not available. 

The risks for the buyer include:

  • Unwittingly paying over the odds for the property by reason of being enticed by the relatively easy availability of finance, perhaps on favourable terms. Paying over the odds could occur in relation to the purchase price and/or the level of interest being charged on the loan. A prudent buyer will ensure that they obtain an independent valuation of the property prior to purchase and do not pay above that valuation in any circumstances. 
  • The willingness of the seller to provide finance may conceal negatives with the property or the developer. For instance, the property may be in a poor location or may be poorly built or finished.
  • The buyer will be at the mercy of the future financial health of the seller. Not being a mainstream lender, their financial future will be less predictable and may be less secure. Financial difficulties, liquidation or bankruptcy on the part of the seller, could have serious adverse financial consequences for the buyer. 

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4. Minimising risks

To minimise the drawbacks of having their capital tied up for a long period with uncertainty as to when it will be paid back by the buyer/borrower, sellers can minimise their risk by favouring shorter loans – say up to 7 years.

HOWEVER, SUCH A FACILITY MAY NOT BE VERY ATTRACTIVE TO REGULAR BUYERS – AS OPPOSED TO INVESTORS.

If the seller is only offering short term funding, a buyer/borrower should ensure that they will be able to obtain longer term funding if/when required at a later date.

That may not seem important to a buyer planning to sell the property at the end of the short-term loan.

However, even if that is the plan, it is prudent to have the capability to remortgage to another lender at the end of the short-term loan if necessary for financial or practical reasons. 

5. Opportunities for buyers

Seller finance is especially appealing to a buyer if there is an opportunity to add value to the property.

With a new property, opportunity to add value may be limited, but may still exist – for instance, by adding an extension to a house or converting a garage into a granny flat or studio.

WITH A SECOND-HAND PROPERTY THERE MAY BE MANY MORE WAYS TO ADD VALUE.

If carefully thought through and skilfully structured, a seller finance deal could enable a buyer to refurbish or develop a property during the loan period, disposing it for a profit on completion of works.

The strategy may also be a way for a buyer to obtain a no-money-down-deal – if the seller is willing to provide 100% funding. Normally such a loan, with its higher level of risk, would not be appealing to a seller.

However, out of necessity or on pragmatic grounds – for example, in the case of a buyer with an impeccable credit record or a proven reputation for reliability – it may be something a seller can be persuaded to offer. 

Seller finance may also appeal to family members. It may be a good way for one family member to transfer property to another. 

As seller finance is a non-standard property strategy, it is important to engage an independent solicitor with experience of that strategy if you are planning on embarking on it. 

It is also advisable to link up with someone – a joint venture partner, mentor or the like – with knowledge and experience of the strategy, and the ability to identify and analyse its pros and cons, having regard to your own specific circumstances.

Read about Killer Property Strategy IV – “Delayed Completion” HERE

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Dalton Barrett
Rebel Property Coach

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