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On Tuesday, the average 30-year fixed mortgage rate was at 7.26%. It’s a steep increase from where rates were in 2021 after plunging below 3%. Loans on commercial properties followed closely behind, also near 7%, according to Commloan, a commercial lender.
Higher interest rates means higher monthly payments — and that’s not alluring, especially to real-estate investors like Matthew Tortoriello, who is looking for properties with good cash flow.
Luckily, there are ways around the bank, one of which is seller financing, a process that makes the seller also the lender. It’s what Tortoriello turned to in early November when he secured the purchase of a fully occupied, five-tenant medical office building in Holyoke, Massachusetts, for $1.9 million, according to documents viewed by Insider. The property had monthly rent revenue of $24,469 from long-term leases.
It was an opportunity to add another cash-flowing asset to the more than 700 rental units he and his business partner own.
But if he had to turn to the bank, it would have decreased the property’s net profit because of high interest rates. So instead, Tortoriello was able to convince the seller to finance the sale of the property. According to the terms of the agreement, upon his putting 40% down, the seller agreed to finance 60% of the loan to value of the total purchase price at a 5% interest rate for a term of 15 years with an amortization schedule based on 30 years, according to documents viewed by Insider.
At 5%, he determined that after debt servicing, which is a monthly payment of $6,119, plus additional expenses including taxes, insurance, heat, electricity, capital improvement, and management fees, his net profit would be $9,978. If he turned to a bank, at a 7.5% interest rate, his debt service would be $11,479; after expenses, that net profit would have been closer to about $4,618.
It wasn’t the first time he secured a rate below the market. In August 2022, he closed on a $1 million loan for a commercial property in Chicopee, Massachusetts. He secured an interest rate of 2% for the first five years and then 3% for the following seven years, amortized over 30 years, according to documents viewed by Insider. That month, the average mortgage rate was as high as 5.7%.
Seller financing isn’t common, though it is a more alluring choice when interest rates rise.
Securing seller financing
Seller financing isn’t an advertised option or something a property owner is likely to offer a buyer. Most people on both sides of a deal aren’t even aware this exists. But it’s something that can be initiated by the buyer.
“People don’t think of the strategy because so many people have been used to the low interest rates. They’ve been using banks for years,” Tortoriello said.
But there are other reasons why seller financing isn’t more popular: most sellers do not want or cannot handle the risks banks take on.
Chris Gerbig, an investor who’s been on both sides of a seller-financing deal, said that while it has benefits, buyers who plan to rely on a property’s cash flow to cover their monthly payments better be sure their math is correct: If they default, they’ll lose the property.
Seller financing can help buyers land terms that are more favorable than a bank would offer, said Shmuel Shayowitz, the president and chief lending officer at Approved Funding, a licensed mortgage bank.
However, most sellers are reluctant to agree on long-term funding, such as 30 years, and are more likely to lean towards two to five years. So, if the purpose is to save on interest, it’s a good option for a buyer to ride out higher rates. But if it’s because the buyer didn’t qualify for a mortgage from the bank, then there is a risk because once that term ends, they may not be able to secure financing to pay the lender in full.
“So if you can’t finance, then I would say don’t just go into that just because it’s an option and then kick the can down the road and worry about it in a year or two or three from now,” Shayowitz said. “But if a person is in a position to finance and refinance and get a mortgage, then here it’s an arbitrage, it’s a way to save on the interest rate. And then they could refinance at any point in time, even if it’s higher.”
There are two key steps that can increase the chances of scoring a deal, according to Tortoriello.
First, it’s about finding a seller who is motivated to cooperate. A few things can help narrow down a good candidate, one of which is finding a property that has an old loan or no loan. The less the owner owes on the property, the more interest payments they can pocket.
Tortoriello checks the registry of deeds in the state or county the property is located to see if there is a mortgage or loan on it. If the loan is more than 15 years old or there isn’t one, it increases the likelihood that a property owner will accept a seller-financing deal, he said. But if the loan is more recent, then the remaining balance on it is likely too high, and it wouldn’t make sense for the seller because they wouldn’t get enough equity out of it.
The medical building Tortoriello secured had an 18-year-old mortgage. When he viewed the property with his agent, the owner was on site, and he could meet him and understand his needs. This helped determine what the limits may be during negotiations.
For example, upon realizing that the seller was a Certified Public Accountant and a real-estate investor, Tortoriello knew it would be an easier conversation because a CPA can more readily understand the benefits of this type of deal.
This brings him to the second step: demonstrating how this option would allow the seller to walk away with more cash.
The obvious benefit is that they will receive interest payments over the life of the loan. But the less obvious benefits are the tax implications. The seller won’t need to pay a chunk of capital-gains taxes within the year the property is sold. By accepting smaller payments spread out over a number of years, it could offset some of that, he noted.
“They also have other things that they can depreciate or offset their gain with, but they might not have enough in year one to offset the full million,” Tortoriello said. “But over 10 years, they can use other depreciation from other properties or whatever to help offset their gain. So, therefore, they’re minimizing their gain over those 10 years.”
The key is to be a good negotiator and present a deal that is a win-win situation for both sides, he said. When offering an interest rate, start low because it’s likely the seller will counter but not low enough that it insults them.
“I put myself in their head,” Tortoriello said. “So if they’re looking to basically cash out tons of money and just sit on it, put it into a CD or something like that, I think, well, what is the current rate of CDs or money market accounts? It’s quite liquid, but right now, many money markets are paying 3.75%, so I might start there.”