With commercial mortgage rates at historic lows and a good availability of funds, we don’t see too many occasions where alternative finance options such as an agreement for sale, or a vendor takeback, are used.
There are, however, times when an alternative strategy is required for the buyer to fund the deal.
A buyer might not be able to meet the lender’s typical 75 per cent loan-to-value ratio (the buyer may only be able to come up with 21 per cent, but the seller is motivated to make a deal).
Maybe the cash flow from the property will not adequately cover the lender’s typical 1.1 to 1.4 debt service ratio.
As an example, if the owner of an office building receives $200,000 per month net rent from tenants, a lender will typically not give a loan that requires monthly payments above $280,000, which represents a 1.4 debt coverage.
There are times when a seller might, for many reasons, desire to sell a property but does not immediately require the sale proceeds.
By offering attractive terms to a buyer, the seller might be able to negotiate a more favorable price.
What is an agreement for sale?
An agreement for sale involves the basic transfer of control of a property without transfer of title.
In this situation, a binding agreement is executed by both buyer and seller.
The agreement provides similar remedies to a seller that would typically be available to a financial institution, in the event of default by the borrower.
What is a vendor takeback mortgage?
Unlike an agreement for sale, title does transfer to the buyer upon closing.
The vendor registers an instrument against the title in the amount of the mortgage.
A mortgage document, similar to what a financial institution would require, is executed by both parties.
Simply stated, this strategy is identical to a typical transaction except the vendor, rather than a bank, is holding the financing.
Is one better than the other?
This depends on whether you’re a buyer or a seller. As a broker, I have facilitated both procedures on several occasions.
Generally speaking, a buyer prefers a vendor takeback because they obtain title and a seller prefers an agreement for sale because it provides an extra measure of comfort due to the fact title remains in the owner’s name.
It’s best to obtain legal advice before entering into either type of agreement. It’s important that both parties are fully aware of their contractual rights, obligations and responsibilities.
Make sure all the basic terms are identified within the initial sale agreement such as loan amount, term, interest rate, amortization period, amount of payments (when they commence and whether monthly or bi-weekly) and whether there is a penalty for early prepayment.
A seller needs to complete a thorough review of the buyer’s financial status, which might include but not be limited to a personal net worth statement, three to five years notice to reader business financial statements and a personal credit check.
If you’re investing, there are a number of items outside of the financing that you may want to consider:
* What factors need to be considered to make a prudent investment decision?
* What is the relationship between cap rates and interest rates?
* Is there really a benefit to paying a commercial mortgage broker?
* And once you’ve bought a property, should you take your commercial mortgage renewal at face value?