In a transaction environment that has largely crawled on its hands and knees over the past two years, dealmakers pushing sales across the finish line are still getting increasingly crafty about how to finance them.
Enter an old tactic that is newly back in vogue.
Seller financing is on a steep rise despite recent interest rate cuts. The creative financing mechanism, which allows property owners to function as lenders, can help buyers acquire properties at below-market interest rates and sellers to maintain cash flow once they have sold an asset.
Bisnow/created with assistance from OpenAI's DALL-E
Seller financing has seen a resurgence in a tight lending market.
The financing mechanism resurfaced and caught fire over the past couple of years in a high-rate, tight-capital-market environment.
“Seller financing is not a new idea. It's been around for as long as I've been doing business,” said Scott Sherman, founder and principal of Miami-based Torose Equities. “Today, just given where rates are and the challenges of bank financing, it's probably a little bit more valuable than it was when debt was more readily available and cheap.”
In 2023, the most recent year comprehensive full-year data is available, commercial loan dollar volume for seller financing increased nearly 60% over 2022 and 30% over 2021 levels, according to research from Noteinvestor.com. The average commercial loan note size for these types of transactions was about $613K, up from about $433K in 2022 and $495K in 2021.
Stakeholders who utilized seller financing last year indicate that the trend continued to pick up steam through 2024. Those speaking to Bisnow cited a traditional lending environment that has remained stubborn even after three Federal Reserve rate cuts at the end of last year.
“In 2021, in 2022, when rates were really low, there was no reason to explore seller financing,” said Paul Waterloo, managing director at Chicago-based Interra Realty. “But as rates have climbed over the last, call it 24 months, maybe even a bit longer … it's become a tool that we've kept in our back pocket to help use as a catalyst to keep deals flowing.”
CRE debt is unlikely to get less expensive in 2025, due partially to rising inflationary expectations under the incoming Trump administration. The yield on 10-year Treasury bonds, used to benchmark all sorts of real estate debt, went up by about 100 basis points since the Federal Reserve began a cutting cycle in September, something experts don't think will change without significant economic distress.
Generally, the seller financing market favors mom-and-pop owners across a variety of asset types, those with little to no debt on their properties, Waterloo said. The financing mechanism allows sellers to spread out a tax hit and maintain cashflow without having to continue managing the property, he said.
In the back end of last year, Waterloo brokered two deals that included seller financing: a pair of 12-unit courtyard buildings at 8524-8528 and 8532-8536 W. Gregory St. in Chicago and 1128 Des Plaines Ave., a 34-unit rental building in the Chicago suburb of Forest Park.
Waterloo said that many times, smaller sellers live off the steady stream of income the deal generates.
“Everybody loves cash flow,” he said.
While the average size of seller-financed loans is relatively small and favors smaller owners, that isn't always the case.
A pair of big players took advantage of the tool last summer. Blackstone Real Estate Income Trust offered seller financing on a portion of the $1B student housing portfolio it sold to KKR last June, the only instance of this kind of mechanism being used in BREIT’s history, according to Bloomberg.
Oak Row Equities paid $38.5M for a Downtown Miami development site in June on a deal through “structured attractive seller financing supported by in-place income,” it said in a release. Oak Row is planning a luxury 500-unit, transit-oriented development on the site.
For buyers, seller financing can provide a degree of relative certainty that a deal will make it to the closing table, and it sometimes offers faster contract timelines, said Michael Williams, managing director of investment sales at Miami-based Current Real Estate Advisors, who has had several seller financing deals in his pipeline in the past 18 months.
It also helps to close the bid-ask spread between buyers facing the reality of the embattled postpandemic market and sellers still expecting the high prices from a few years prior, he said.
“A lot of these sellers that we're working with still say, ‘Hey, look, maybe two years ago, three years ago, I could have received X from my property during a sale,’” Williams said. “We're educating and saying, ‘Well, that's not really the case today,’ but they might be able to close in a little bit on that gap … when values were so high, because they can give more favorable terms than what the traditional lending environment would.”
Some lenders are also engaging in seller financing, Sherman said. He said he is evaluating several opportunities, and a few are “effectively short sales.”
Sherman said he could see this trend continuing in 2025 if the market remains tight.
“The lender wants to get [the asset] off the books, but they also don't want to take as big of a loss, so we're basically going to them and saying, ‘Well, look, you want to maximize your value here, or maybe reframe it as minimize your loss. I need you to take back paper. I need you to take back financing,’” Sherman said. “Technically it's seller financing, but it's actually a lender doing it at X, Y and Z terms.”
The length of these deals can often be short-term in nature, said Sandy Jacobson, an operating partner and co-chair of the New York Real Estate Group who has worked on seller financing deals dating back 30 years. This allows for buyers to reset loan terms in a better rate environment, she said.
“It's sort of like a short-term bridge loan,” Jacobson said. “Meaning a year or two term to allow for buyers to see what's going to happen in the marketplace in the short term, with the hope, obviously, that interest rates are going to go down and they can refinance and get into a typical loan structure.”
The biggest risk in a deal completed with seller financing is that because the property is collateral, if the borrower can’t repay the loan, the seller will have to take back a property it may not be interested in owning anymore, Waterloo said. Seller resistance to the idea largely centers on not wanting to take over a big project where a buyer started to try to increase the property’s value, he said.
Still, Jacobson said the risk for the seller is relatively minimal.
“From my perspective, it's a low risk for the seller,” Jacobson said. “They're getting some cash capital influx into their pocket. They're getting security on a piece of property that they already own. So they know it. Their biggest downside is their borrower, you know, defaults, and they get the property that they already own back but with some capital in their pocket.”
The continued popularity of seller financing depends on the direction of interest rates and whether more lenders become active in financing deals, Williams said. He expects to see a more significant dip in interest rates toward the end of 2025, which would change the landscape for seller financing.
“If those lenders come into the market to play and they want to start putting the dollars out again, that'll reduce the need for more seller financing in the market that we have been seeing,” Williams said. “If, alternatively, things continue in the same direction, I think that seller financing will still be a very important element and topic of conversation during transactions.”
