What Is Seller Financing in Commercial Real Estate?

Your buyer has the down payment but can’t get a bank loan on the terms they need. Or the bank says no entirely.

One option: you become the bank.

That’s seller financing. It can close deals that would otherwise die, and it can earn you interest along the way. It also puts your money at risk in a way a normal sale doesn’t.

The Short Answer

Seller financing means you, the seller, lend part of the purchase price to the buyer. Instead of getting all your money at closing, you get:

• A down payment at closing
• Monthly payments with interest over time
• Often, a large final “balloon” payment after a few years

The buyer gets the building. You hold a note secured by the property, much like a bank would. If the buyer stops paying, you can foreclose.

It works best when financing is hard to get, when the buyer is strong but nontraditional, or when you’d rather collect income over time than take a lump sum.

How Seller Financing Works

Most seller-financed deals include the same pieces:

• Down payment: the cash the buyer puts in at closing, often a meaningful share of the price
• Promissory note: the buyer’s written promise to repay you, with an interest rate and payment schedule
• Mortgage or deed of trust: recorded against the property, so it secures your loan
• Amortization: how long the payments are calculated over
• Balloon date: when the remaining balance comes due, usually forcing the buyer to refinance

You set the terms with the buyer, and your attorney papers it. Nothing about it is informal.

Run the Numbers

Here’s an illustrative deal on the building from Article 2. Your terms will differ.

• Sale price: $2,120,000
• Down payment at 30%: $636,000
• Seller note: $1,484,000
• Interest rate (assumed): 7%
• Amortization: 25 years
• Balloon: due after 5 years

What you collect:

• Monthly payment: about $10,489
• Payments over 5 years: about $629,300
• Interest earned over those 5 years: about $498,000
• Balloon payment at year 5: about $1,353,000

So you get $636,000 at closing, about $10,500 a month for five years, and roughly $1.35 million when the buyer refinances or sells.

The interest is real income. But it’s only worth it if the buyer actually pays.

The Risks You’re Taking On

Seller financing changes your role from seller to lender. Know the risks before you agree:

• Default: if the buyer stops paying, you may have to foreclose, which costs time and legal fees
• Property condition: if the buyer neglects the building, your collateral loses value
• Balloon risk: if the buyer can’t refinance when the balloon comes due, you may have to extend the loan or foreclose
• Your own mortgage: if you still owe on the property, your loan likely has a due-on-sale clause. Seller financing usually works only if you own the building free and clear, or your lender agrees

Protect yourself:

• Require a substantial down payment, so the buyer has real money at stake
• Check the buyer’s credit, financials, and experience like a lender would
• Require insurance naming you as the lender
• Use a real estate attorney to draft the note and security documents

The Tax Angle

Seller financing can change when you pay tax on your gain.

According to the IRS’s guidance on installment sales, an installment sale is a sale where you receive at least one payment after the tax year of the sale. Under the installment method, you report only the part of the gain you receive each year, rather than all of it up front.

The interest you collect is taxed differently. The same IRS guidance says interest on an installment sale is generally reported as ordinary income. It also warns that if the contract doesn’t include adequate stated interest, part of the principal may be treated as interest for tax purposes.

The specifics depend on your situation, so work through them with your CPA before you agree to terms.

Recap

• Seller financing means you lend part of the purchase price to the buyer
• You get a down payment, monthly payments with interest, and usually a balloon payment
• It can close deals that bank financing can’t
• You take on lender risks: default, balloon risk, and your own mortgage’s due-on-sale clause
• Installment sale rules can spread your taxable gain over time, so talk to your CPA

Final Word

Seller financing can turn a stalled deal into a closed one and give you income over time. But you’re not just selling a building anymore. You’re lending against it. Underwrite the buyer like a bank would, and get the paperwork right.

See what buyers are browsing in your market. Browse commercial listings at hutfin.com.