Repair Credit vs. Price Reduction When Buying an Apartment Building
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When due diligence turns up problems, a buyer of an apartment building usually asks for one of three things: a lower purchase price, a credit from the seller at closing, or a seller-funded repair escrow held until the work is done. They are not the same. A price reduction lowers the loan (when the lender sizes it on price), the transfer tax and often the property tax reassessment. A credit keeps the contract price but puts cash in the buyer's hands at closing, if the lender allows it, which reduces the equity you need to raise. An escrow ties the money to specific repairs. Choose based on what the lender permits, how much equity you can raise and who should control the work, and show the result in the deal's sources and uses.
This guide compares the three with an example and the questions to ask. It follows from property inspections and feeds into sources and uses.
How do the three options compare?
| Topic | Price reduction | Credit at closing | Seller-funded repair escrow |
|---|---|---|---|
| Contract price | Lower | Same | Same |
| Loan proceeds (loan sized on price) | Lower | Same, if lender accepts the credit | Same |
| Cash the buyer brings | Lower by the loan-to-price share of the cut | Lower by the credit | Same, with money held for repairs |
| Transfer tax and reassessment | Usually lower | Usually unchanged | Usually unchanged |
| Lender approval | Simple | Often capped or restricted | Often required anyway for critical repairs |
| Who controls repairs | Buyer, after closing | Buyer, after closing | Buyer, under escrow terms |
A worked example (made up)
The numbers below are invented. The contract price is $6,000,000 and the lender lends 70% of price. Inspections find $300,000 of roof and plumbing work.
- Price reduction to $5,700,000: loan $3,990,000 (was $4,200,000). Equity needed before costs: $1,710,000 (was $1,800,000). Saving in equity: $90,000. The $300,000 of repairs must still be funded, usually by raising more equity.
- $300,000 credit at $6,000,000, if the lender accepts it: loan stays $4,200,000. Equity before costs: $1,800,000 minus the $300,000 credit, so $1,500,000. Saving in equity: $300,000. The repairs are then funded from the raise.
- $300,000 seller-funded repair escrow: loan stays $4,200,000, the equity stays $1,800,000, and $300,000 of the seller's proceeds sits in escrow for the repairs.
In this example the credit lowers the equity you raise the most, but only if the lender allows it. Many lenders size loans on the lower of price or appraised value, and limit credits that reduce the borrower's cash in the deal.
What about taxes and property taxes?
- Income tax basis. A credit from the seller is generally treated as an adjustment to the purchase price, so the building's depreciable basis is about the same as with a price cut. IRS Publication 551 lists rebates treated as adjustments to the sales price among items that decrease basis. Your CPA decides the treatment.
- Transfer and recording taxes are usually based on the price on the deed. A price reduction lowers them; a credit usually does not.
- Property tax reassessment. Where a sale resets the assessed value, the recorded price matters. See property tax reassessment.
How to negotiate it
- Price the work. Get contractor bids, not guesses, for every item you ask for.
- Ask the lender first. Find out whether it caps seller credits, requires a repair escrow for life safety items, and sizes the loan on price or appraisal.
- Pick the form, then the amount. A seller may agree to a credit more easily than a price cut because the recorded price looks better for them.
- Write it down. Sign an amendment to the purchase contract with the new price, the credit or the escrow terms (amount, release conditions, deadline, what happens to leftover money).
- Update your numbers. Change the sources and uses, the renovation budget and the financial projections before you finalize the raise.
What should investors see?
Show the original price, what inspections found, what you negotiated and how it changes the equity raised and the renovation budget. Investors reading the offering documents want to see that the problems found are paid for, not just discovered.
How DoorRaise fits in
DoorRaise helps sponsors raise equity for apartment buildings with 5+ units from their friends and followers under Rule 506(b) or 506(c). It prepares the standard offering documents, forms the LLC, files Form D and state notices, and verifies accredited investors for 506(c) deals. Escrow for investor funds is at Enterprise Bank & Trust, an FDIC-insured bank, and investors fund by wire only. See pricing. DoorRaise is not a law firm, broker-dealer, investment adviser, funding portal or bank.
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FAQ
Is a credit always better than a price reduction?
No. A credit lowers the cash you bring only if the lender accepts it, and it keeps transfer tax and the reassessed value higher. Compare both with your lender's rules.
Can the seller do the repairs before closing instead?
Yes, but you control less: the seller chooses the contractor and the quality. If you go this way, require permits, invoices and a re-inspection before closing.
Does a repair escrow at closing come out of investor money?
A seller-funded repair escrow comes out of the seller's proceeds. A lender-required repair escrow funded by the buyer comes out of the money raised. Read the settlement statement to see which it is.
Does the change affect Form D or the offering?
If the price or the raise amount changes after the offering documents are out, update investors and the documents before you close. See Form D amendments for when a filing changes.
Next step: see how the money moves on the day in closing day funds flow.
Sources
This article is general information, not legal, tax or investment advice. The example is made up to show the math. Talk to your lender, a real estate attorney and a CPA about your deal. DoorRaise is not a law firm, broker-dealer, investment adviser or funding portal.