Todays Market: Thinking through Capital Stack
I’m looking at a 12 unit (Multifamily) deal in the $2M range.
I’ve heard that many of the sellers aren’t giving up much on price so many people have been doing part seller financing.
How would that be beneficial to me (buyer)?
I still have a large debt service? Since I’m paying ~6.5% on ~1.5M (~70% of $2M)
Then 5% on $100,000 of the seller financing portion.
And still putting in $500k (25% of $2M) for equity. Where is the benefit besides having slightly lower rate for the $100k?
Is the argument that I’m blending the rate so I can bring down cost of debt which then allows me to service the debt easier?
What happens if I can’t make a payment of seller financing note? Do they typically work with you or is it much more that they will snap back the property fast?
When thinking about how much equity/debt/ seller financing I should be doing to optimize capital stack, what exactly should I be thinking about?
Seller financing can indeed offer several benefits in a real estate transaction, particularly in a market where sellers are not willing to lower prices significantly. Here’s how it could be beneficial for you as a buyer:
Improved Cash Flow Management: By securing a portion of the financing from the seller at a potentially lower interest rate, you're effectively reducing your overall cost of capital. In your case, paying 5% on $100,000 instead of the higher market rate can decrease your average cost of debt, which can improve your cash flow.
Increased Leverage: Seller financing can allow you to leverage more of the purchase price than traditional financing alone would permit. This can be particularly useful if you're trying to preserve cash for renovations or other investments.
Easier Qualification: Seller financing might come with less stringent qualifying criteria compared to traditional bank loans. This can be advantageous if there are particular challenges or unique circumstances with your financial situation or with the property that might make bank financing more difficult to obtain.
Negotiable Terms: Often, the terms of seller financing can be more flexible than those of traditional loans. You might be able to negotiate not just the interest rate, but also the repayment schedule, and possibly even a period of interest-only payments.
Regarding the risk of default, the consequences can vary widely and depend heavily on the terms negotiated with the seller. Typically, if you default on a seller-financed note, the seller does have the right to foreclose on the property. However, many sellers might be willing to work out a modified payment plan rather than taking back the property, especially if maintaining cash flow from the sale is preferable to managing the property again.
When optimizing your capital stack, consider the following:
Balancing these factors will help you determine the optimal mix of equity, debt, and seller financing for your specific situation and investment goals.
Sources: Investment Sales Vs. Debt/Equity Brokerage, https://www.wallstreetoasis.com/forum/private-equity/thinking-like-an-investor-the-key-financial-metrics?customgpt=1, https://www.wallstreetoasis.com/forum/real-estate/investment-in-rental-property-should-you-leverage-if-you-have-ability-to-100?customgpt=1, https://www.wallstreetoasis.com/forum/real-estate/using-100-equity-for-a-project-does-it-ever-make-sense?customgpt=1, Thinking like an Investor: The key financial metrics
Can you make it more clear, confusing how much is seller financing vs the bank. Use the below format, I wouldn't consider $100k seller financing, that's nothing on a deal like this.
Purchase: $2mm
Equity
Debt:
- Bank (with rate)
- Seller
Ok I’ll slightly change the example.
Purchase price= $2M
Equity= $400k (20% of PP$)
Debt:
Bank= $1.4M @ 6.5% rate
Seller=$200k @ 4.0% rate
Thanks, ask the seller to come up? At $200k that's nothing of the $1.6mm. Ask him if he will give seller financing at that rate for the whole $1.6mm loan or what the max will be.
Seller financing is helpful when the bank isn't willing to lend you more money. It allows you to close with less equity down. That's literally the main/only benefit. There can also be other things like an "earn-out" where there are provisions put in place so the seller basically earns part of the purchase price.
In most cases, the interest rate on seller financing should actually be higher than the bank, because they are usually subordinate to the bank.
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