Prepayment Penalties & Seller Financing Structures
Moving into Q3 of 2023, seller financing in Multifamily continues to be a viable option that we recommend to our clients, but we have become aware of some common concerns and misconceptions owners may have, and want to address them.
Prepayment Penalties: We recommend this to our clients to protect themselves on seller financing transactions.
Scenario: We are currently working with an owner who doesn’t want a buyer to pay their loan off early because he doesn’t want to be hit with a huge capital gains tax all at once.
How can we help him prevent this? Prepayment penalties. If a buyer has to pay an additional 25% of the remaining loan balance in a prepayment penalty fee in year 5, this will incentivize the buyer to continue with the loan payments rather than paying it off early.
Seller Financing Options: There are several different options for seller financing that you can offer depending on your goals as an owner:
- Principal and Interest Payments Long Term: Protects owners against capital gains tax and keeps their cash flow consistent for a long period of time.
- Interest Only: Allows an owner to receive monthly cash flow and receive a lump sum at the end of the loan term. A seller could then either 1031 exchange into another property or take the cash and pay the capital gains tax.
- A Variable Interest Rate: Owning a multifamily property is all about cash flow. This can be a great option if a property is currently rented below market rate or needs extensive renovations. It allows the owner to still get a maximum sale price while also giving the buyer the opportunity to raise rents or renovate the property.
Example: The buyer would have a lower interest rate for the first 1-2 years (around 3%), while they improve the property or raise rents. Then the interest rate would climb to a higher rate during the remaining years.
With seller financing being utilized often in today’s market, it is important for owners to figure out the best way to structure financing in the best interest of both parties. It is also important for owners to protect themselves as they are essentially operating as a bank and lending money to the buyer. Please reach out to discuss how seller financing can benefit you as an owner.
SVN Cornerstone Multifamily Team
Nate Gant is an Advisor with SVN Cornerstone. Nate has been an active member of the Eastern Washington real estate community since 2010. He has brokered more than $100 Million in real estate transactions, specializing in land development, REO and investment properties. To get in touch with Nate, email nate.gant@svn.com or call 509.993.4440.
Jordan Lester is an Associate Advisor with SVN Cornerstone. Jordan served as a brokers assistant for 3 years with SVN Cornerstone before becoming a full time broker. Jordan specializes in the multifamily sector of commercial real estate. To get in touch with Jordan, email jordan.lester@svn.com or call 509.496.6922