Getting creative | Unconventional financing can make real estate deals happen in a challenging market
With the holidays fast approaching, I am preparing for my annual family get-togethers like everyone else. During these festivities, I am sure to be asked two questions: “How’s the baby?” shortly followed up with, “How’s the market?” The latter is a question I get everywhere and one I really enjoy discussing (for baby updates, see my wife’s Facebook page).
The conversation inevitably leads to a question about financing. What’s the lending environment like and what do buyers have to do to close a sale? The answer: Financing is complicated, but there are a few creative ways we are getting deals done.
Most bankers I talk to explain they have plenty of money to loan and are eager to find good deals. Interest rates are at historically low numbers. In fact, last week I heard of a commercial quote dipping below 5% on a 20-year amortization schedule. However, the equity (down payment) required is in the 25%-30% range. That’s big bucks when you’re talking about commercial properties that are often $500,000 plus (and, of course, can be several million dollars). So if a conventional bank loan simply isn’t feasible for you, let’s examine a few alternative options.
IRAs, the SBA and seller-financing
I was recently having lunch with a friend who is a tax attorney. We got to talking about the market (what else?). As I described the challenge some buyers have coming up with the kind of capital necessary to secure a loan, he offered a very interesting solution: your IRA. Yes, you can apply the money you have saved and invested into your IRA to an investment real estate acquisition. It’s called a self-directed IRA and, if applied carefully and strategically, can bridge the gap between a buyer being forced to give up on a property and getting to the closing table.
An important caveat of a real estate IRA is that the property must be exclusively used for investment. Per IRS regulation, your IRA-purchased property cannot be for personal use, even for a short time (a vacation home that you rent out for most of the year would not be allowed). The most straightforward way to invest your IRA into real estate is to purchase an investment property with all cash directly from your account. Any non-leveraged income and capital gains flow directly back to the IRA tax-deferred (or tax-free if you have a Roth IRA). With the volatility in the stock market, this is also an excellent opportunity to diversify your investment portfolio.
For owner/users, on the other hand, there is an attractive financing tool called the CDC/504 loan program. This program typically includes a loan secured by a private sector lender (a bank) for up to 50% of the project cost and, additionally, a loan secured from a Certified Development Company (CDC) for up to 40%, which is guaranteed by the Small Business Administration. So, in most cases, the buyer only has to put down 10% of the project cost. There are a number of qualifications a buyer must meet. The business must be for-profit and fall within specific size standards as defined by the SBA. The borrower also has to use more than 50% of the building; CDC/504 loans cannot be applied to speculative or investment properties. There is typically more paperwork and time involved with securing a CDC/504 loan but the effort is worth it. Several banks specialize in putting together these deals and can navigate the process.
Another creative option I recently implemented actually involved the sellers. Owner-financing can be a great vehicle to help close a sale if the sellers are comfortable with the idea and terms, they have enough equity to hold a note, and the buyers are well qualified. For the deal I worked on, the sellers were particularly motivated to move on from the property. So they agreed to finance 10% of the purchase price at a higher interest rate, 8%, and shorter amortization period, five years. This allowed the buyer to put down 15% of the total price and the bank covered the remaining 75%. We fully vetted the buyer’s financials and credit history and determined that the sellers could comfortably count on the buyer making his second mortgage payments directly to the seller.
The bank’s primary concern is that the cash flow still works for the buyer and that the seller’s note is subordinate to the bank’s. It’s not an ideal scenario (obviously getting one check at closing is preferred), but we were able to get the property sold and the sellers will ultimately make an extra $12,000 in interest payments over the five-year term.
So when my Uncle Phil asks me in a few weeks, “How’s the market?” I will be honest. It’s challenging but manageable when the right strategies and approaches are implemented. Each deal is different and there is no single answer on how to sell a property. Consult a real estate professional to see which creative financing vehicle is best suited for your next transaction. Have a happy and safe holiday season!
Justin Lamontagne, broker at NAI The Dunham Group in Portland, can be reached at justin@dunham-group.com. Read more of Justin’s columns here.
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