top bar
Bobblehead Gallery
Developing residential land vs. suburban sprawl: Developers talk about expansion in central PA

Loan to Own

Seller financing attracts potential buyers in a constrained market.

By Jeffrey A. Usow, JD, and Jade Earl Newburn, JD

"Reprinted with permission from Commercial Investment Real Estate, The Magazine of the CCIM Institute, Jan/Feb 2010, Vol. XXIX No. 1.”

Given the current credit-market constraints, seller financing may be a way to bridge the financing gap facing buyers and sellers in today’s commercial real estate market. Seller financing is a transaction in which the seller makes a secured loan to the buyer to finance a portion of a property’s purchase price. The two most common forms are traditional mortgage loans, which are secured by a lien on the underlying real estate asset, and mezzanine loans, which are secured by a pledge of the borrowing entity’s ownership interests. Property owners should carefully examine their ability and preparedness to be lenders, their  economic  motivations for selling particular assets, and the potential seller-financing capital structures.  

Lender Requirements

Sellers must satisfy a number of threshold requirements before becoming lenders. They first must review their organizational documents; joint venture, fund, and  upper-tier  debt agreements; and statutory and regulatory obligations. If they find they are not authorized to make  loans, sellers  must  amend  or modify organizational  documents or  meet any applicable statutory or regulatory obligations.
In addition, sellers must consider if they have the underwriting and monitoring capabilities necessary to effectively service individual loans or a lending portfolio. If not, they must either  build internal systems or outsource to appropriate loan servicing agents. In the context of such activities, sellers also must know the laws, regulations, and other legal restrictions that apply to lenders. These include lender licensing requirements and potential lender liability that may arise from real estate loan originations or servicing.
Seller Motivations
Sellers authorized and otherwise prepared to be lenders also should consider their motivations for entering into seller-financing transactions. The key economic questions in any seller-financing transaction are how much cash the seller needs to receive at closing either to pay off existing property-level debt or generate liquidity, how much cash the buyer can pay at the closing, and the assets that the seller may choose to sell.
Assets  that  are  encumbered   by little  if  any  property  debt  have the greatest potential to be sold in seller-financing transactions. However, seller financing is likely to be more challenging if the existing property-level debt is a significant percentage of the property’s current value. In theory, the seller could sell a portion of the seller-financed loan at closing or convince the senior lender to accept partial lien payment, allowing the buyer to assume the remaining debt and junior liens to attach at closing. However, these solutions will be challenging to implement in practice. Fortunately, the choice of capital structure may solve these problems.
Capital Structures
The difference between the amount of closing cash that  the seller needs to receive and the buyer is able to pay forms the basis  for  two  primary  capital  structures in seller-financing transactions. Sellers may  be able to  serve as either senior  lenders or  junior lenders to facilitate such transactions.
Accordingly, in one possible capital structure, the buyer pays a portion of the purchase price — for example 40 percent — with its own equity, and the seller lends the remaining 60 percent of the purchase price to the buyer as the first priority lender. This structure works best when the existing property-level debt is relatively small in comparison to the asset’s sale price. The seller has greater flexibility in determining the amount of cash it is willing to accept at the closing; however, the usefulness of this structure is dependent upon the extent to which a buyer is able and willing to contribute cash at the closing.
Alternatively, suppose a buyer can only contribute 20 percent of the purchase in cash and the seller needs more cash at closing. Then the buyer may be able to borrow a  portion of  the purchase price from  a  first  position  third-party  lender  and borrow  another  portion  of the purchase price from the seller. The seller becomes a junior lender, either through a second priority  lien on  the  underlying asset or by a pledge of the ownership interests in the title-holding entity in a mezzanine loan.
In such a transaction, the third-party senior lender might loan 50 percent of the purchase price in first position, the seller might loan 30 percent of the purchase price as a junior lender, and the buyer might pay equity at closing of 20 percent. Accordingly, the seller would receive 70 percent of the purchase price at closing and the buyer would obtain an aggregate loan-to-value ratio of 80 percent.
With the cumulative leverage of both a senior loan and a junior loan, potential buyers also may be able to maintain a relatively high debt-to-equity ratio and have the potential to earn greater yields on their equity investment. Thus, they may be more likely to enter into commercial real estate transactions in the near term. Also, sellers may be able to charge higher interest rates than the senior lenders but would be in a first loss position relative to the senior lender.
Sellers looking to sell multiple assets should consider setting up a program with other lenders that are willing to lend in first position in relation to the seller’s junior loan. By doing so, sellers may be able to pre-negotiate the intercreditor agreement and subordination agreement and present prospective buyers with complete financing solutions during the purchase agreement negotiations.
 About the Author:
Jeffrey A. Usow, JD, is a   partner   and Jade E. Newburn, JD, is an associate at Mayer Brown LLP. Contact them at  and

Harrisburg Real Estate  |  Mechanicsburg Real Estate  |  Carlisle Real Estate  |  Harrisburg Realtor  |  Commercial Lease Properties
Site Map
Copyright © 2015-2016 Gladstone Group. All rights reserved.

Commercial-Industrial Realty Co. | 1015 Mumma Road, Wormleysburg, PA 17043 | PA License #RB024320A