In spite of the Fed’s rate increases and a slowly deteriorating economy, commercial real estate (CRE) transactions are still happening. But in a few cases, we’re seeing and hearing about transactions that seemed on track for closing just three or four months ago that are starting to fall apart.
The overall CRE market is nervous, perhaps less so in the metropolitan-Denver region. But even here, high sale prices and even higher borrowing costs are beginning to push valuations in certain property segments downward. These days it seems many buyers are inclined to wait on the sidelines to see where the floor might be. And many sellers, motivated or otherwise, can’t afford to make a deal in this declining market environment.
While that sounds like a recipe for stagnation, there are creative ways to structure CRE transactions that can work for both parties. We’ll review three of those opportunities in this blog.
The first two strategies put more of the burden on the seller than the buyer but still provide a route for a successful close. In these cases, the seller won’t immediately have access to the full amount of the sale proceeds, but they provide a fairly safe alternative to terminating a purchase and sale agreement.
The third option reflects a strategy where the buyer may need some financial assistance to get purchase over the finish line.
In seller-backed financing, the seller becomes the lender. They collect a mutually agreed upon down payment and offer the buyer an interest rate that’s possibly several points lower than banks can provide today. The parties can negotiate various other terms and conditions in ways banks might not be willing to – not just interest rates, but repayment schedules, for example. If the buyer defaults, the seller once again is the property owner and retains the down payment and the principal and interest payments made up to that point in the amortization table.
Seller-backed financing arrangements are negotiable but usually fairly short term. They often include scheduled balloon payments several years out that motivate the buyer to seek alternative financing and subsequently buy the seller out as soon as possible.
The Seller Becomes an Investor
Alternatively, with lending requirements tightening and loan-to-value ratios decreasing, the seller could contribute a significant amount of the purchase price (e.g., 30-40%) to the deal acting as a limited partner. Then the buyer will have enough cash on hand to qualify for a traditional loan from a bank or, in some instances, from a high-net-worth individual who’s seeking a risk-adjusted return on their investment but at a higher interest rate than a traditional lending institution would require.
This investment arrangement could remain in place until the property is re-sold, or it could be limited to a shorter, specified period of time after which the buyer would obtain new financing (presumably at lower rates) and buy the seller out of the asset.
Whether high interest rates are to blame or not, in some cases a buyer can’t access sufficient capital in the lending markets. One option they have is to augment their own capital with funds from a group of third-party investors acting as limited partners. This not only raises necessary capital but also helps spread the investment risk. The ownership percentages and shares of the return would be negotiable and dependent upon the particular investor’s risk profile.
For More Information
These are very high-level descriptions of just three of the creative options available to CRE buyers and sellers who are struggling to close deals in this challenging market. For more information on any of these approaches, or to discuss your situation in greater detail, please contact us at Fountainhead Commercial.