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Not a lender, but depending on the municipality and associated millage, avoiding transfer taxes can be a big reason to acquire an entity interest instead of a fee simple interest.
Thank you @Ozymandia, I always appreciate your insights.
Avoiding transfer taxes (as Ozy said) and, theoretically, having the sale hidden from appraisers/tax assessors. In my state, the latter is why some people try their hand at entity sales because it could save them from a bump up in their tax assessment. Now in practice, does it always save you? Not always.
The other time I've personally dealt with it was on a hotel deal where we didn't have to do a PIP if we bought the entity.
I would think this would be more common if it was a way to avoid transfer taxes. I’ve done maybe ~50+ deals at this point and I’ve only come across one seller who was dead set on selling the entity instead of the real estate. I’m assuming there was some logic behind it as they were a pretty sophisticated group but I’ve done business with a lot of sophisticated groups and this doesn’t come up that frequently.
The reason you won't see most groups do it is that in many states, the transfer taxes aren't nearly high enough to warrant the shenanigans involved with an entity sale. From a seller's perspective, it's not as easy as "buy my entity". Some buyers flat out won't go down that rabbit hole, so you'll lose buyers along the way. And usually an entity sale comes along with seller holdbacks / longer liability tails / higher liability caps. In my state, the transfer tax is less than half a point. So on a $20M sale, why would I take on a bunch of post-sale headaches to save less than $100K?
Appreciate the insight @CRESF This is the first time in my state (TX) that I'm seeing a MIPA ... It does seem like a lot of headache. If you have the time, could you explain longer liability tails and higher liability caps?
I've done some research on my own and I know we'll probably have to research the entity (LLC) and get some representation & warranties on the history of the LLC and any of their known/unknown liabilities.
From a lender perspective, it is a risk for them as the LLC might have any known/unknown liabilities. They prefer a new Single-Purpose Entity (SPE).
There could be some complex pricing strategy involved. If the existing property has a mortgage on it and that mortgage was done when terms were very favorable (low fixed rate for long term) then there may actually be some structural advantage to buying the entity interests, assuming the existing debt, and doing some kind of fancy calculation to show the seller how it's beneficial for them to sell entity interests at a net price rather than gross price. Doing the entity route also offers the ability to do some kind of fancy structure that could allow for an overall higher return to the seller but spread over a longer period of time.
There could also be some tax strategy involved. Buying the interests in the current property owner means you are purchasing that entity's basis in the property. If it's been fully or mostly depreciated, then there's going to be higher tax liability for the future owner and that could influence the purchase price. That could also be desirable for some investors who may have a particular kind of gain they are looking to deploy (Opportunity Zone?)
There may be some other weird strategy involved that could involve some kind of "look-back" that applies to the entity rather than the property that the buyers are trying to use (all kinds of stuff that fall into this).
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