Suggestions how to structure deal with potential seller

[REIGirl]

Greetings!
My husband and I were recently driving around and came across a property, though not listed for sale, appealed to us as it fits within our strategy and niche. As we pulled around from the back alley to the front of the house we saw an elderly man tending to the yard which we presumed was the owner. My husband approached him and indeed he was the owner. The man said he would love to sell his property as he is retired. He owns another property which he would also be happy to sell as a package within his property management company (he stated he would prefer to sell it with the property management company for tax reasons as the properties are registered under the company). We pulled land titles and it seems the property of interest does not have a mortgage tied to it, the other property has a fairly small mortgage.

My question is, with only a minimal amount to put towards a down payment at this time, how might we best approach this opportunity. We were considering asking if he would be willing to be our mortgagee thus financing the deal and we put about five percent down with the intention to refinance within five years. Any other ideas or suggestions as to how we might go about this opportunity?

Thank you in advance for your insights!

 

[Owenb]

I have sent you a pm

 

[Thomas Beyer]

Yes that could work although it is probably best to get a 50-75% mortgage ie that amount as cash to seller and then he'd carry 15-25% in second position. Tough to convince anybody to get only 5-20% cash down.

If you assume a company that adds a while layer of complications as you inherit not only the tax liability when you sell but also any other financial or legal obligation tied to the corporation such as unpaid tax bills, potential lawsuits or past financial problems or CRA issues. As such you need to also look at 3-5 years of corporate financials and tax filings. You need to calculate the accumulated tax burden and deduct this from the purchase price for the corporation.


Best strategy is to continue to chat and build a relationship with the gentleman, do your due diligence on house and corporation, get two new mortgages lined up and then convince him to carry 15-25% in second position for perhaps 5 or better 10 years ie a monthly cash flow to him in addition to 50-75% cash upfront ( from your cash and new mortgage ).

Bon chance !!

 

[Martin1968]

This is a complicated deal. Seems like the properties are assets within the (pm) company, and the owner wanting to sell the company shares to you? His benefit would be, no tax on a share sale. Your benefit would be nothing really unless you buy the props way below market value.

As above post already suggests you need to do your due diligence, but I think you might run into problems with traditional financing due to buying shares.

In the first place I would suggest to make it an asset sale.
If you desperately need the currents owner financing, then that's a decision you have to make but I would advice against it if you don't know your way around business sales. And even if you do, I still wouldn't. Just buy the assets

Good luck!

 

[Thomas Beyer]

Ok to buy shares and add 2 new mortgages within corp.

But the share value has to reflect tax ( and other ) liabilities. Getting a mortgage also will be harder than a personally owned asset, but not impossible. Key is proper DD.

 

[Martin1968]

The good thing is that it's a company with some hard assets under its belt, but frankly we don't know enough to really comment or advise on the proposal. Is this management company merely there in order to benefit for lower (personal) taxes? Were the hard assets originally bought under the corporation or were they moved into it for reasons previously stated. Is this PM company a full fledged business with other properties under construction contract?

Yes you can add several loans to a corporate company (if the numbers are showing) but higher interest rates and shorter terms are the norm in general.
The biggest problem I see beside that, is that there simply is not enough downpayment.
You said you want to ask to ask the current owner to be a mortage holder, and who knows he might as long as you are willing to agree to a share sale. Even when he has to wait a little while longer for all the money to be his, it could be worth the wait.

However, since you need to qualify for the other 65-75% (whatever that number is) I would think it to be to complicated to banks seeing you have to disclose the structure of the deal as well as proof of funds.
Nothing is impossible but it would be easier to do an asset sale and try to scrape together the minimum 20% downpayment. Anything else you would have to go through, with minimal succes to pull it off IMO, would give me headaches thinking about it.

 

[Thomas Beyer]

The good thing is that it's a company with some hard assets under its belt, but frankly we don't know enough to really comment or advise on the proposal. Is this management company merely there in order to benefit for lower (personal) taxes? Were the hard assets originally bought under the corporation or were they moved into it for reasons previously stated. Is this PM company a full fledged business with other properties under construction contract?

Yes you can add several loans to a corporate company (if the numbers are showing) but higher interest rates and shorter terms are the norm in general.
The biggest problem I see beside that, is that there simply is not enough downpayment.
You said you want to ask to ask the current owner to be a mortage holder, and who knows he might as long as you are willing to agree to a share sale. Even when he has to wait a little while longer for all the money to be his, it could be worth the wait.

However, since you need to qualify for the other 65-75% (whatever that number is) I would think it to be to complicated to banks seeing you have to disclose the structure of the deal as well as proof of funds.
Nothing is impossible but it would be easier to do an asset sale and try to scrape together the minimum 20% downpayment. Anything else you would have to go through, with minimal succes to pull it off IMO, would give me headaches thinking about it.

Why so negative ?

They have a seller willing to sell them shares. They and the assets can qualify for a mortgage. Seller has time and they have some cash and ingenuity. Put 2 and 2 together and get the deal done if the seller is willing to sell shares at a reasonable price.

Get an accountant involved to structure it and to assess tax liability.

Very doable .. assuming seller plays ball and carries 15-30% of purchase price at sat 3-8% interest for 5 or ten years in second position which is very reasonable for an older guy that wants cash flow if he gets 50-65% or so of his post-tax property value in cash !

 

[Martin1968]

Why so negative ?

Uhm, It's September 5? Lawnmower quit yesterday........had to rake leaves by hand........

They have a seller willing to sell them shares. Then and the assets can qualify for a mortgage. Seller has time and they have some cash and ingenuity. Put 2 and 2 together and get the deal done if the seller is willing to sell shares at a reasonable price.

Seller wants share sale but they haven't asked yet if he wants to carry mortgage

Get an accountant involved to structure it and to assess tax liability.

True, you would want accountant involved. Get a good business minded accountant.

Very doable .. assuming seller plays ball and carries 15-30% of purchase price at sat 3-8% interest for 5 or ten years in second position.

Remains to be seen and I would say never to assume things. To assume he will agree 5-10 yrs at 3-8% is a wide spread.

I think the best advice we could give is to go talk with the gentleman first. Once you have is answer you can ask some very legit and realistic questions. Let us know how you make out.

 

[REIGirl]

This is why I love this forum - you guys have been so helpful, thank you very much! We will try to contact the gentleman this week once he is back from his travels and build more rapport with him as well as find out more info about the corp. My impression is that the pm company is merely for personal tax reasons and is not a full fledge corporation. The reason we wanted him to carry the mortgage was because it would be very difficult for hubby to qualify for another residential mortgage right now due to debt to income ratio. I will keep you guys posted as to how we proceed.
Much Thanks!!

 

[Thomas Beyer]

This is why I love this forum - you guys have been so helpful, thank you very much! We will try to contact the gentleman this week once he is back from his travels and build more rapport with him as well as find out more info about the corp. My impression is that the pm company is merely for personal tax reasons and is not a full fledge corporation. The reason we wanted him to carry the mortgage was because it would be very difficult for hubby to qualify for another residential mortgage right now due to debt to income ratio. I will keep you guys posted as to how we proceed.
Much Thanks!!

Carrying a small VTB behind a new first is very reasonable for an older guy that wants cash flow if he gets 50-65% or so of his post-tax property value in cash !

The issue here is POST TAX.

Example:

The assets are worth $410,000 each. No mortgage. Let's say he bought them 50+ years ago for $30,000 each with $10,000 each in land value rest house. His book value in the corporation is now $20,000 for both houses. If he sells to you (or anyone) he has a capital gain of $760,000 plus $40,000 accumulated CCA as he depreciated the houses from $20,000 to 0. Not sure what province this is but income taxes are 50% in most, so he has to pay 50% on half the gain ie $190,000 plus accumulates tax savings over the years, say $10,000. So his tax bill will be around $200,000 although he may use some of it for the life time exemption of some $800,000 in "active" companies. Perhaps that is why he has a PM firm as he claims it is "active". It is not really as rental income clearly is defined as "passive".

As such if you buy shares they would be worth around $620,000 although the properties are worth $820,000.

Hence, it is VERY important to get a tax opinion if you buy the shares as YOU will be stuck with the tax liability of assets worth $820,000 but with a book value of $20,000.

Tough to get the $600,000 out of the company if the company gets a new mortgage of around $600,000 ( or 75% of value) as there are tax consequences.

In almost all cases it is better to not buy the shares but the assets, and to let him deal with the tax issues.

Let's say they are worth $410,000 each and you can get a 75% first mortgage of about $300,000 and he carries $60,000 each as an interest free or 10 year amortizing loan at say 5% then you need only $50,000 each down to pay. An amortizing loan at 5% over 10 years is about $1300/month which will kill most cash-flows immediately. As such ask for interest only and pay the balance in 10 years on a refi as your mortgage will have been paid down well over 20% by then.

Bon chance !

 

[Cory Sperle]

From what I understand, it seems that you already own a primary residence (or another residential mortgage), and your looking to purchase an investment property however lack the cash/qualification to put the required 20% down and go to a conventional bank, so your looking to put 5% down and refinance in 5 years. The problem with this, is you will then have to pay out the existing lien with a new one, which is very very very difficult in today's real estate market. We know longer live in a world where real estate appreciation is automatic, and realistic expectations today would be very modest value increases over 5 years.

Wayyy too much complexity and potential problems with creative strategies to a simple and inexpensive purchase. Save for the 20% and work on your debt servicing. I have seem too many times nice folks bypassing the bank in favor of creative strategies and ending up in serious trouble. Just because you can buy with 5%, or 0% down doesn't mean you should.

 

[Thomas Beyer]

From what I understand, it seems that you already own a primary residence (or another residential mortgage), and your looking to purchase an investment property however lack the cash/qualification to put the required 20% down and go to a conventional bank, so your looking to put 5% down and refinance in 5 years. The problem with this, is you will then have to pay out the existing lien with a new one, which is very very very difficult in today's real estate market. We know longer live in a world where real estate appreciation is automatic, and realistic expectations today would be very modest value increases over 5 years.

Wayyy too much complexity and potential problems with creative strategies to a simple and inexpensive purchase. Save for the 20% and work on your debt servicing. I have seem too many times nice folks bypassing the bank in favor of creative strategies and ending up in serious trouble. Just because you can buy with 5%, or 0% down doesn't mean you should.

Depends on the cash flow, upside and interest rate on the VTB. If they ask for interest only and pay the balance in 10 years on a refi as the first mortgage will have been paid down well over 20% by then, leaving enough room to pay out VTB.

 

[Matt Crowley]

So his tax bill will be around $200,000 although he may use some of it for the life time exemption of some $800,000 in "active" companies.

@ThomasBeyer what does this mean the "life time exemption"? I'm not familiar.

@REIGirl lots of good points above. For the seller, the highest gross price they will receive for a property is free and clear, not selling shares. However, there is a legitimate opportunity here to solve the guy's problems and it is a pretty interesting tax questions so worth the effort in my opinion. Buying shares of a company that owns real estate is not a big problem, you look to after-tax effects. It is a lot more common for large portfolios that hold several properties than for two houses.

5% down will almost certainly be negative cash flow (not sure what market you are in)...so you will need to find a way for there to be more equity in the stack. One solution to create that equity is to pay the after tax value of the shares at a strike that is well below the appraised value, but that leads to a more advantageous after tax situation for the gentlemen looking to sell. Equity doesn't always have to be cash!

Getting him to carry a 2nd is not a bad idea but I would run the numbers on the after tax effect of buying the shares first. You want to avoid 8%-12% preferred debt where possible and if we are talking two houses I'd look for a way to take him out of the deal. 3.5% debt much cheaper even at higher LTV.

 

[Thomas Beyer]

@ThomasBeyer what does this mean the "life time exemption"? I'm not familiar.

@REIGirl lots of good points above. For the seller, the highest gross price they will receive for a property is free and clear, not selling shares. However, there is a legitimate opportunity here to solve the guy's problems and it is a pretty interesting tax questions so worth the effort in my opinion. Buying shares of a company that owns real estate is not a big problem, you look to after-tax effects. It is a lot more common for large portfolios that hold several properties than for two houses.

5% down will almost certainly be negative cash flow (not sure what market you are in)...so you will need to find a way for there to be more equity in the stack. One solution to create that equity is to pay the after tax value of the shares at a strike that is well below the appraised value, but that leads to a more advantageous after tax situation for the gentlemen looking to sell. Equity doesn't always have to be cash!

Getting him to carry a 2nd is not a bad idea but I would run the numbers on the after tax effect of buying the shares first. You want to avoid 8%-12% preferred debt where possible and if we are talking two houses I'd look for a way to take him out of the deal. 3.5% debt much cheaper even at higher LTV.

Google lifetime capital gains exemption

For example here
https://davidson-co.com/wp-content/uploads/2013/07/July2013-Update-Web.pdf
Essentially about $800,000 of gain is tax free of "eligible property" such as shares of a firm with active income or a farm. Generally NOT rental properties though !!

 

[REIGirl]

So here's the update...

Good news is that the seller is very flexible on financing the deal (he doesn't have any mortgages)

Bad news is the asking price is way too high IMO and way over ($167,000 over for one of the properties) the city assessed values (which I know is not necessarily market value). We didn't realize that an identical property next door was recently listed (though not sold) for about $130,000 more than we were hoping to pay, so the owner is basing his price on that.

Also, he is pretty insistent about selling through the corp. in order to save on taxes.

Anyway, he seems like a wonderful man, he has our contact so perhaps we will do business with hi in the future. Either way, we learned something new through all the feedback we got from this forum. Thanks!!!

 

[Thomas Beyer]

"Saving on taxes" doesn't really exist. It means you overpay and you pay his taxes later.

Many old unmotivated sellers exist with low mortgages and huge cash flow

Get a handle on numbers and taxes payable via an accountant.

You can also buy well below market value but agree to pay him a high interest on his VTB mortgage so that lowers taxes initially quite a bit and then defers his taxes annually. Or agree to pay him a management fee for 5-10 years in exchange for lower price. Many creative options available.

 

[Martin1968]

Appreciate the update! If numbers don't make sense don't start on it.
question I have tho is, what is he trying to sell you? Did he specifically mention he wants you to buy the shares of his corporation and put a total price together incl the price of the real estate?
Just wondering.
Thanks again!

 

[REIGirl]

You can also buy well below market value but agree to pay him a high interest on his VTB mortgage so that lowers taxes initially quite a bit and then defers his taxes annually. Or agree to pay him a management fee for 5-10 years in exchange for lower price. Many creative options available.[/QUOTE]

That's a great idea that we didn't think of regarding a lower pp and higher interest.

 

[REIGirl]

Appreciate the update! If numbers don't make sense don't start on it.
question I have tho is, what is he trying to sell you? Did he specifically mention he wants you to buy the shares of his corporation and put a total price together incl the price of the real estate?
Just wondering.
Thanks again!

He just said he would like to sell the properties in the property management company which basically just consist of two residential properties in which himself, his wife, and children all have shares. He is following the advice of one of his kids who told him it would be better for tax saving. My husband suggested he talk to an accountant since his son is not one.

 

[Thomas Beyer]

He just said he would like to sell the properties in the property management company which basically just consist of two residential properties in which himself, his wife, and children all have shares. He is following the advice of one of his kids who told him it would be better for tax saving. My husband suggested he talk to an accountant since his son is not one.

Share price needs to reflect tax liability. No real tax savings here unless you overpay.