As interest rates climbed in 2023 and Central PA rents appeared to hit a ceiling in June 2023, we observed that what buyers could pay for a property and still achieve returns similar to the last several years has decreased.
Sales Volume Is Down Across Central PA
With seller price expectations remaining the same, deal volume has compressed significantly, with sales at about a third of the five-year average in the Harrisburg region. Annual sales volume in the Harrisburg region has averaged $78.9 million over the past five years, but the recorded volume over the past year totaled just $24.9 million — the lowest sum over that five-year stretch.
Lancaster’s annual sales volume has averaged $47.1 million over the past five years, and in the past 12 months specifically, $12.4 million worth of multifamily assets sold — about a quarter lower. York’s annual sales volume has averaged $33.4 million over the past five years, and in the past 12 months, $6.4 million worth of multifamily assets sold — about a fifth lower.
To resolve this issue, the market has turned to two solutions: assumable mortgages and seller financing. Seller financing is becoming an increasingly popular option for those looking to create movement in this volatile market. Although there are some risks associated with this type of loan, it can be greatly beneficial for both buyers and sellers.
What Is Seller Financing?
Seller financing is a type of loan in which the seller of a property acts as the lender. Owners can potentially sell at a higher price, and they can also continue to receive similar cash flow, without the risks of maintaining the property or dealing with the day-to-day headaches of tenants.
There are several reasons why seller financing can generate a higher sales price. First, the seller is able to offer more favorable terms to the buyer, which may include a lower interest rate or a longer repayment period. This can make the property more affordable for the buyer, which typically leads to a higher sales price.
We recently closed a seller-finance deal where the seller chose to finance because it provided an attractive income stream — and had they received the cash in hand, there would have been no comparable asset to invest in. With listing levels at a third to a fifth of what they have been on average over the last five years, sellers have even fewer choices, making an income stream the answer to their problem.
Two Ways to Structure Seller Financing
- Sales Installment Agreement: A Sales Installment Agreement is prepared and signed at closing. All traditional closing items are handled, like checking title and prorating property taxes. A deed is prepared and signed by the seller, but the key difference is that the deed is held in escrow by an attorney pending complete payoff of the property. In this scenario, the buyer becomes the “equitable owner” while the seller remains the “deeded owner” — though the equitable owner usually has full rights of ownership, including the right to sell the property in the future. The seller has more protection from buyer default in this setup, since the deed does not record, so they can seek remedy under the agreement to take the property back. For tax treatment, the seller can recognize the gain in part each year, which may help decrease the capital gains tax owed by keeping the gains in a lower tax bracket over time. There’s no difference on the buyer side — they assume all the usual tax treatment, like depreciation and interest write-offs.
- Traditional Sale: The seller sells the property just as they would if a bank were involved, only the seller then records a mortgage for the property, just like a bank would, and the deed transfers at closing. The seller’s remedy in case of buyer default is the same as a bank’s — foreclosure. For tax treatment, the seller recognizes their gain on the sale just as they would with a traditional sale, and the interest they collect on the financing is treated as interest income. There’s no difference on the buyer side.
Generally, the Sales Installment Agreement is preferred by sellers and the Traditional Sale by buyers, but circumstances involving tax or estate planning — as well as the level of trust between the parties — may lead a seller to lean toward a Traditional Sale.
Who Does It Benefit?
Seller financing can be a great way for buyers to purchase a property without having to place the high 40-50% down payment required by many lenders. Although buyers may potentially pay a higher price, a lower down payment requirement and a lower interest rate could make up for it. Sellers benefit because they can get a higher sales price, and they may also receive potential tax benefits.
What Are the Risks?
One of the biggest risks associated with seller financing is the potential for the borrower to default on their loan. To mitigate this risk, it’s important to carefully screen buyers and only offer financing to those who have an excellent track record as operators in the market and are well capitalized.
If the seller has a mortgage on the property, they can’t finance it to you, and you won’t be able to take possession of the title. If the seller has a mortgage, a Master Lease Option (MLO) may be a better way to go.
Some investors will do what’s called a “wrap” or “subject to” financing, where a seller keeps the existing mortgage in place and the new buyer makes the payments for the old owner. This can violate a “due on sale” clause in the seller’s mortgage, which can leave the buyer legally exposed — and if you’re putting large sums of money into the property, it’s a risk worth avoiding.
In Conclusion
Keep in mind that owner financing isn’t just for buyers who don’t qualify for traditional financing. In fact, many owner-financed deals are done with experienced, well-capitalized multifamily buyers willing to pay a premium for the right property with the right financing.
Seller financing is becoming increasingly popular among both buyers and sellers because of the ease of the transfer and the ability to continue an income stream for the seller when it’s difficult to find replacement assets. If you’re interested in seller financing, reach out to our team — we’d be pleased to help you plan the move that gets you closer to your goal.
