The vendor take-back is really common among successful real estate investors. In fact, this consists in a second registered loan (subordinated to the bank mortgage) and granted by the multifamily property seller.
When concluding a vendor take-back, the seller lends an amount of the sale price (it’s left pending- as a balance) during some years. Consequently, it reduces the amount necessary as a down payment.
In some regards, a vendor take-back is like a debenture or a bond, which is a second registered loan (subordinated to the bank mortgage), signed before a notary, and published in the Land Register.
The vendor take-back offers many benefits both for the seller and the buyer. However, many experienced or inexperienced real estate investors aren’t able to conclude a transaction with a vendor take-back.
Here are 7 obstacles which impede a seller to achieve a transaction with a vendor take-back:
The seller needs all his money immediately
In the case where a seller needs all the money from the sale immediately, the VTB is virtually impossible. This may be due to 2 scenarios:
- The seller has bought the building within the last 5 years and he doesn’t have enough equity to leave a share of the transaction sale price on the table for a few years.
- The seller’s equity is sufficient, but he has a different goal in mind (like buying a business). Therefore, he needs 100% of the liquidity generated by the sale of his income property.
Supply and demand VS Market value
In such a market like the multifamily real estate, it’s all a matter of supply and demand. So, if the demand is high (many active buyers), but the supply is low (not so many buildings on sale), it’ll be difficult for a buyer to conclude a vendor take-back. The price offered for the building, based on the market value, will have a major impact too. For instance, if you offer 10% below the market value and you’re not the only one interested in buying the building, your chances to achieve a vendor take-back are quite poor.
Your broker and yourself are unable to highlight the vendor take-back advantages to the seller
First of all, you have to persuade the seller that this kind of loan will benefit him too. Apart from convincing him of the advantages, you’ll have to persuade him to trust you. Therefore, you must rely on your credibility as a real estate investor to prove that you’ll be able to repay the debt. Some aspects may help you to convince the seller to accept a VTB: your net worth, your credit file, your professional achievements and how you introduce yourself. As for the banker, you should convince him too, since he grants you a first rank loan.
Did you know? By agreeing to a vendor take-back, the seller manages risks. He must ponder whether the VTB is more advantageous than the risk of not receiving a full repayment.
For example, if you suggest a VTB which represents 100% of the down payment, the seller will wonder why he would take all the risks. (This is an example of what not to do!)
If neither you nor your real estate broker masters the vendor take-back concept, you’ll be unable to persuade the seller. Therefore, you should always make sure that a real estate broker represents you. Also, he should hold the right permit depending on the number of units, the type of building (residential or commercial) and he should also hold the CMS MREX’s title.
You chose an inappropriate first rank loan type
Which type of first rank loan you choose will impact significantly whether to achieve a VTB or not. To maximize your chances of success, you should decide if your first rank loan should be insured or conventional.
That is to say, if the original loan is CMHC-insured, the vendor take-back is still conceivable, even though it’s more complex to structure and your chances of success are poorer.
Did you know?
Your banker grants you the first rank loan and he reserves his right to accept or not subordinated debts.
A badly structured vendor take-back
How do you plan to reimburse the vendor take-back influences the seller’s decision. However, it mostly influences the banker’s or the first rank loan holder’s decision. For instance, you may wonder:
- Is it a progressive repayment of interest and capital?
- Is it a monthly reimbursement of the interest, added to a “balloon” of capital at the VTB’s term?
- Is it a payment holiday during the term and a balloon payment (capital and interest) at the end of it?
It’s important to choose the right structure according to the circumstances, in order to satisfy all parties involved requirements.
With a balloon loan, no payments are required during the term but this kind of loan must be fully reimbursed at the end of the term. As for the buyer, he’ll have to pay compound interest annually. That’s to say, each year the interest adds to the capital on which new interest is calculated. Hence this loan’s name; its balance increases year after year.
Its principal advantage lies in the liquidity increase during the term, because no payments (neither capital nor interest) are made. However, the buyer will pay a higher price at the end of the term.
Neither your account manager nor your mortgage broker has the expertise in this kind of financial package
Have you ever heard: “This bank manager or this mortgage broker claims a vendor take-back is not doable anymore.” If so, you likely encountered a financier who has never dealt with a VTB as a second rank loan. Indeed, very few account managers have an experience or an adequate training, and the same could apply to many mortgage brokers. Moreover, bank’s computer systems are not conceived to allow vendor take-back. Also, do not hesitate to ask questions, to consult many different professionals even if it means to substitute one of your team members by a more skilled one!
For the specific case of your transaction, the vendor take-back is too risky
Because a mortgage broker claims a vendor take-back is impossible shouldn’t push you to change your mortgage broker systematically. Actually, it’s important to keep in mind that he may be right! Also, some elements may explain why the VTB is too risky.
First, the building doesn’t allow you to increase the revenue or to cut down on the expenditures sufficiently to release a new sum of money (leverage effect). The kind of money that could help to repay the VTB in case of financial hardships.
Secondly, you have a precarious salary, job or credit file. Then, it may be insufficient to reimburse the VTB without the additional income you would earn with the building possession.
Lastly, the presence or not of escape clauses will affect the risk associated to the vendor take-back term (final and full repayment date, resolutive clause).
The vendor take-back is a powerful tool for a real estate investor who wants to reduce his down payment on a purchase and maximize his investments’ output. If you want to become a master of multifamily financial packages, you should have a good grasp of the required maths to financial engineering.