Apartment loan carry backs are becoming increasingly popular in today’s environment, as nominal interest rates on apartment loans increase by comparison to the bargain financing available in recent years. While more apartment sellers are deciding to carry back financing in larger amounts to support their asset prices in a tightening apartment loan market, many are unaware of the effect seller carried apartment loans may have on their overall financial picture.

Apartment loans on income producing property are generally available (for the lowest apartment loan rates) in amounts equaling the lesser of 80% LTV or the largest amount dictated by the property’s DCR. While low rate apartment loans have supported the expansion of apartment building asset prices over the past several years, the secondary financing markets are less and less comfortable providing sponsors with high CLTV junior debt to round out transactions with little money down. This often leaves the buyer needing to bring in 30% to 40% or more in the form of a down payment, which in today’s weaker second-lien / mezzanine financing market often means that a seller has two options: 1) Decrease the sales price to fit within buyer financing capabilities, or 2) Finance all or a portion of the down payment by carrying back a private apartment loan.

Seller carried apartment loans were all the rage in the 1980s, and while interest rates are not anywhere near those high levels today, asset prices are significantly higher and many prospective buyers are more highly leveraged, and therefore more thinly capitalized than in previous years.

A seller carried apartment loan is a private note between the buyer and seller wherein the seller takes a junior lien position to the first position primary apartment loan or apartment loans on the property. Generally the buyer agrees to pay the seller a fixed or floating rate of interest over a specified period of time, just like any other loan. Debt service can be adjusted to accommodate the buyers ability to service debt out of NOI from the property, so a property with strong positive cash flow can dictate monthly repayment terms, and a property which requires improvement to the rent rolls may allow you to structure deferred repayment, balloons, interest only terms, accrual features, amortization periods, the works. You can be rather creative with seller carry back apartment loans, particularly if you have a low basis in the property and wish to defer gains over time.

Speaking of gains, there are significant tax advantages and consequences to a seller carried apartment loan which vary immensely depending on your individual situation. While we never purport to provide legal or tax advice, in general you should note that a seller carried apartment loan has the following components from a tax perspective:

1. Interest – money which covers just the interest due on the apartment loan
2. Basis Recovery – principal reduction component in each fully amortized payment
3. Gain on Sale – also principal reduction in each fully amortized payment

For payments on principal & interest apartment loans, interest at the note rate is subtracted from the sum total of payments in a given year and the balance is considered payment to principal, which is then divided in the ratio of basis to gain to basis reduction and investment gain.

In most cases the following tax consequences apply to these three components of seller carried apartment loan repayment (although this is not to be construed as personal tax advice, for which we strongly recommend consulting a tax professional and legal counsel where appropriate):

1. Apartment loan Interest is taxed as income,
2. Apartment loan principal allocated as Gains are taxed as gains,
3. And there is no tax on Basis Recovery.

If you would not benefit from a 1031 exchange or if you wish to realize an ongoing income stream, enhanced ROI or deferred gain from the sale of your property at the price you believe it’s worth, and not the price the credit markets will finance, a seller carried apartment loan may be a viable option to help you achieve your goals. While they can’t advise you about your specific tax or legal ramifications, working with an experienced financier who understands how to properly structure seller carried apartment loan financing packages is imperative. A properly structured apartment loan seller carry can turn a low profit deal into a retirement package, a passive income, or a “payment by payment sale” structure which puts you in control of your gains and taxes.

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