Can You Use Seller Financing in an Apartment Syndication?
Yes, you can use seller financing in an apartment syndication: the seller either carries the whole loan or takes a smaller note behind a bank loan, and your raise covers the rest. The catch is the senior lender. Fannie Mae and Freddie Mac offer their own supplemental loans for added debt, and their loan documents generally limit other debt on the property, so a seller second usually needs the senior lender's written consent or a different senior loan. Whatever you agree, the note's terms go in the offering documents so investors see them.
How does seller financing work in a syndication?
In seller financing, the seller lends part of the purchase price instead of receiving it all in cash at closing. Your deal's LLC signs a promissory note to the seller and usually a mortgage or deed of trust on the building. The note sets the rate, payment schedule, maturity and what happens on default.
Three structures come up:
| Structure | How it works | Main thing to check |
|---|---|---|
| Seller-held first loan | The seller is the only lender, often for a few years, with a balloon at the end | How you will refinance before the balloon |
| Seller second behind a bank loan | A bank makes the first loan; the seller takes a smaller second note | Whether the bank allows it, and the intercreditor terms |
| Unsecured or separately secured note | The seller takes a note not secured by the building | Whether the senior lender counts it as debt, and the seller's remedies |
Can you add a seller second to an agency loan?
Generally, plan on no. Fannie Mae's and Freddie Mac's term sheets point borrowers to their own supplemental loans for added debt (Fannie Mae conventional term sheet, Freddie Mac supplemental term sheet), and agency loan documents typically restrict other liens on the property. Ask the lender directly and get the answer in writing before you count on a seller note.
HUD-insured loans are different. HUD's MAP Guide says it "permits secured secondary financing on Section 223(f) loans up to total debt of 92.5% Loan-to-Value," with details in its own chapters (HUD MAP Guide). Bank and credit union loans vary by lender. See bridge loan vs agency loan for how the senior loan choice shapes the rest.
A made-up example
A sponsor buys a 24-unit building for $4,000,000. A local bank lends 65%, or $2,600,000, and agrees in writing to allow a seller second. The seller carries $400,000, or 10% of the price, interest-only at 6% for five years with a balloon.
| Topic | With seller note | Without seller note |
|---|---|---|
| Bank loan | $2,600,000 | $2,600,000 |
| Seller note | $400,000 | $0 |
| Equity for the price | $1,000,000 | $1,400,000 |
| Seller note interest per year | $24,000 | $0 |
The seller note cuts the equity needed for the price by $400,000, before closing costs and reserves. In return, the deal pays $24,000 a year in interest and owes $400,000 at year five. The model should show where that $400,000 comes from: a refinance, a sale or cash reserves. See sources and uses.
What do you have to tell investors?
Seller financing is a material term of the deal, and the antifraud rule bars untrue statements or omissions of material facts in connection with selling a security (Rule 10b-5). In the offering documents, include:
- The note amount, interest rate, payments and maturity date, including any balloon.
- What secures the note, and its priority against the senior loan.
- Default terms and the seller's remedies, including whether the seller can foreclose.
- Any personal guaranty by the sponsor.
- Any relationship between the sponsor and the seller.
- How the plan pays the balloon, and what happens if it cannot.
Combined debt also raises risk. Investors should see the debt service coverage with both loans, not only the first. See multifamily underwriting basics.
Why would a seller agree?
Some sellers want income over time instead of a lump sum. Tax can be part of it. Under 26 U.S.C. 453, an installment sale is a sale where at least one payment is received after the year of the sale, and the seller can generally report the gain as payments come in. The rules have exceptions, including for depreciation recapture. The seller should ask their own tax professional; you should not give them tax advice.
Do consumer lending rules apply?
Generally not to a deal like this. Regulation Z, the federal consumer lending rule, exempts credit extended primarily for a business, commercial or agricultural purpose, and credit extended to someone other than a natural person (12 CFR 1026.3(a)). A loan to your LLC to buy a 5+ unit rental building usually falls in that exemption. State usury and licensing rules still apply, so have your attorney review the note.
How DoorRaise fits in
DoorRaise helps sponsors raise equity for apartment buildings with 5 or more units from their friends and followers under Rule 506(b) or 506(c). It forms the deal's LLC, prepares the standard offering documents, files Form D and state notices, and holds investor funds in escrow at Enterprise Bank & Trust, an FDIC-insured bank. Fees are $1,500 at setup (non-refundable), $5,000 at closing (only if the deal closes) and $3,500 a year. DoorRaise does not negotiate or draft seller notes.
Raise your apartment deal from the people who already follow you.
DoorRaise is built for apartment buildings with 5 or more units: one link for the deal, escrow until closing and a standard fee card.
See pricing for the full fee list.
FAQ
Is seller financing common in apartment deals?
It depends on the seller's goals and the senior lender's rules. A seller who owns the building free and clear has more room to carry a note.
Can the seller also invest in the syndication?
Sometimes a seller rolls part of the price into equity instead of a note. That makes the seller an investor, so the offering rules and disclosures apply to them too.
What rate should a seller note carry?
There is no standard. It is negotiated, and it should be realistic against what a bank would charge for similar debt.
What happens if the deal cannot pay the balloon?
It depends on the note. The seller may be able to foreclose or take other remedies. That risk belongs in the offering documents.
Next step: read can a syndication assume the seller's loan for another way the seller's financing can help your deal.
Sources
- Fannie Mae Multifamily, Conventional Properties term sheet
- Freddie Mac Multifamily, Optigo Supplemental Loan term sheet
- HUD, Multifamily Accelerated Processing (MAP) Guide
- 17 CFR 240.10b-5
- 26 U.S.C. 453, Installment method
- 12 CFR 1026.3, Exempt transactions
This article is general information, not legal, tax or investment advice. Talk to a securities attorney about your deal. DoorRaise is not a law firm, broker-dealer, investment adviser or funding portal.