What is a seller carry back and why should a resort seller consider it

Resorts and campgrounds are expensive!

I know, I’m not telling you anything new. In fact, some resort owners voice concern about “making their resorts worth too much”, and are worried that “nobody will be able to afford it when it comes time to sell.”

Since there are very few buyers in the market who have millions of dollars in cash ready to buy their “dream resort”, bank financing must be involved for them to make their dream happen. Banks usually require a 20% down payment to do a commercial loan, and that’s a sizable amount. That means buyers looking at a $2,000,000 resort will need $400,000 cash for a down payment. A $3,000,000 resort will require $600,000 cash, and so on. So while the resort might be priced at a cash flowing price, it’s usually the down payment that is the biggest hurdle for a buyer to be able to buy. This is especially true for younger buyers who haven’t yet lived long enough to have sizeable savings in either cash, 401(k) savings, or measurable equity in their home or business.

This is when the strategy of a seller carry back can come into play. Let’s define this term and explore the pros and cons.

General Definition:

 Seller carry back financing, also known as seller financing or owner financing, is a real estate arrangement where the seller takes on the role of the lender, providing financing to the buyer. So, while a Contract for Deed usually finances the entire purchase price, a seller carry back is usually a much smaller amount, just enough to fill the gap for the down payment. Seller carry backs can also be used for other purposes, but for this article we are only referring to using it for down payment assistance. This arrangement has both advantages and disadvantages, making it a strategic option for both sellers and buyers.

Pros:

1.   Wider Pool of Potential Buyers: Seller carry back financing can attract a broader range of buyers, and younger buyers. This expands the market for the seller, potentially speeding up the selling process.

2.   Flexible Terms: One of the significant advantages of seller carry back financing is the flexibility it offers in negotiating terms. Sellers and buyers can work together to determine the interest rate, repayment schedule, and other financial details, tailoring the agreement to suit both parties' needs.

3.   Mailbox Money: Sellers receive a steady income stream from the interest payments made by the buyer. This can be an appealing option for sellers looking for a reliable source of passive income, especially if they own the property outright and don't require the full sale proceeds immediately.

4.   Potential for Higher Sale Price: By offering financing, sellers may be able to command a higher sale price for their property. This is because buyers may be willing to pay a premium for the convenience, flexibility and cash flow that seller carry back financing provides.

Cons:

1.   Default Risk: Seller carry back financing comes with the risk of buyer default. One of the options for seller collateral is to take second position behind the bank, or even third position if the SBA is involved. In other words, if the money is tight, the sellers are the last to get paid. If the buyer fails to make the seller carry back payments as agreed and also defaults on their bank mortgage, several things could happen. One, the bank could sell its position to the original seller for the loan payoff. Then the seller would be able to foreclose the first position on the property to be the owners again. At that point they could operate the resort again or work to sell to another party. Two, the bank could negotiate with the party in second position to help clear the title, thus allowing the bank to sell the property. As a last option, the seller could simply forfeit their second position without “fighting” with the bank and the new owner. As an example, this would mean if a resort sells for $3,000,000 and the sellers do a $200,000 carry back and the buyers default, the sellers have in essence sold their resort for $2,800,000.

2.   Incomplete Cash Out: Sellers who rely on the full proceeds from the sale to make another purchase or cover other expenses or taxes may find seller carry back financing less appealing. The funds are received gradually over time, limiting the seller's immediate cash availability.

3.   Interest Rate Risk: Sellers may face the risk of interest rate fluctuations impacting the overall return on investment. If interest rates rise, the seller may end up with a lower effective yield on the financing provided. It’s common that the interest rate on the seller carry back is higher than the interest rate of the bank loan, since the seller is taking the highest risk by being in second (or third) position behind the bank. They want to get paid for their risk.

4.   Legal and Regulatory Complexities: Seller carry back financing involves legal considerations. Documentation should be carefully drafted to protect both parties' interests.

Seller carry back financing can be a valuable tool in real estate transactions, providing flexibility and opportunities for both buyers and sellers. However, it's crucial for all parties involved to carefully weigh the pros and cons, considering their specific financial situations and long-term goals.

Consulting with real estate professionals and legal experts can help ensure a smooth and successful seller carry back transaction.