Why and How to Use Seller Financing When Pursuing Self-Storage Acquisitions

If you’re pursing a self-storage acquisition, there are many places to seek capital; but investors rarely talk about one that has real opportunity: seller financing. Learn how this approach can benefit both buyer and seller and help you close more deals.

Katherine D’Agostino, Founder

February 5, 2022

9 Min Read
Why and How to Use Seller Financing When Pursuing Self-Storage Acquisitions

Seller financing is a fantastic option for buyers of self-storage facilities, though few ever incorporate it into an offer. An agreement that benefits you as the buyer and makes sense to the seller can help you close more deals than any other instrument in your investment toolbox. Let’s explore how this strategy can be a win-win when pursuing real estate transactions.

Benefits for Buyers

For the self-storage buyer, the primary benefits of using seller financing are speed and simplicity of the transaction, plus lower fees. It can be advantageous to buyers in good financial standing, but it’s also viable for less bankable buyers, including those with poor credit or who have perhaps reached the maximum a bank will loan.

“Obviously, the benefit to you as the buyer is that lower down payment coming into a deal or perhaps no down payment at all,” says Scott Meyers, principal of Kingdom Storage Holdings, which acquires and develops self-storage. “If a seller is in a position where they’re going to carry the majority of the note and be in the place of a first lienholder, like a bank would, they may carry 100%. If not, we’re financing 75%, 80% or 90% with the seller. Then we just need to come in with the equity piece. We don’t have to go out and apply and qualify for a loan.”

This helps buyers with financial challenges in part because there isn’t a loan on their balance sheet or credit report. “Therefore, it improves your ability to borrow for the next project,” explains Meyers, who’s also founder of the Self Storage Investing Academy. “It frees up that amount of capital that would be on your balance sheet shown as a liability, as a debt.”

Advantages for Sellers

That sellers are even in a position to offer financing is one of the great testaments to self-storage as a high-performing real estate sector. “One of the beauties of self-storage is that because the asset class does so well, many owners who’ve owned these facilities for a number of years have paid them off or paid them down,” notes Meyers. “Therefore, the owner has a low loan basis.”

This gives the seller certain advantages and incentive if they’re able to offer financing to the buyer. For starters, they may avoid or reduce their capital-gains taxes and depreciation-recapture liability. If they’re able to loan all or part of the purchase price, they aren’t only going to get more for their facility because they’ll collect interest payments, the loan is also secured by a promissory note, mortgage or deed of trust. Plus, the facility is the collateral.

If a buyer wishes to coax seller financing, they should remind the self-storage owner that there are tax benefits and passive/interest income, according to Fernando Angelucci, founder and president of Titan Wealth Group, a national self-storage investor and syndicator. One way to offset the seller’s tax liability is to spread it over a longer period as opposed to taking it all in one year, he says. This can be done by setting up an installment sale in which the buyer pays a portion of the principal year over year. “Whatever portion of the principal amount you pay to the seller, they are only paying that percentage of the capital gains and the depreciation-recapture tax. This is usually the first and most important benefit that we relate to sellers.”

Passive income can also be a motivating factor, particularly if an owner wants to get out of the operational side of the business but doesn’t want to lose out on proceeds. Financing moves the owner into the banker’s seat and allows them to collect interest on the property. They no longer have to do any of the work but can still collect dependable income each month, Angelucci notes.

“When you look at the total cost of the facility, we may be buying it for $1 million, but over a 10-year term on a 25-year amortization, we are actually paying $1.5 million or $1.75 million in total costs,” Angelucci says. “Ask the seller, ‘Would you like to experience that financing income, or should I just give that money to the bank?’ They’ll realize it is a way to get additional revenue on top of their purchase price that they would not be able to get if they just took the cash up front.”

Mike Wagner, founder of The Storage Rebellion mastermind group, agrees seller financing can be a smart strategy. “Seller financing is always going to be on my radar. That’s why it’s a question I’m going to pose to every seller, regardless of the merits of the deal,” he says. “Just because I propose it to the seller doesn’t mean it is the path I’ll ultimately take; but I want to know in the early stages of our conversation, as we’re developing a relationship with the seller, if it’s on the table.”

When bringing up seller financing as part of a potential deal, Wagner recommends making the point that, as the buyer, you might offer a little more for the property if the seller is willing to take payments over time rather than get all their money up front. By having a serious conversation about the benefits, including the amount of money that’ll go into the owner’s pocket vs. Uncle Sam’s, you can often turn an initial no into a yes.

Of course, this can take practice and nuance, but it’s ultimately about relationship-building. Understanding why a person is motivated to sell can give you insight to the deal and help provide practical reasons why seller financing might be beneficial for both parties.

“I’ll say, ‘You know, you stand to make $1 million on this after you pay off your debts. Your grandson’s college is probably going to cost you 50 grand a year,” Angelucci says. “If you really need the million dollars now, pay all the taxes on that right now. You have the income to cover all the taxes on that right now.’ That’s usually when their ears kind of perk up, and they say, ‘What are you getting at?’ I explain that if the goal of selling this facility is to get your grandson through college, then why don’t we structure the payments so that each quarter or however [often] the college bills, we will give you a payment equal to the tuition, plus some percentage on top just for comfort—a little bit of a buffer.”

The benefit for the buyer is this is a temporary arrangement, as the student may only need to attend college for four years. “If I can use seller financing for four years and have some type of balloon in year four or five once the kid’s out of college, then that could be plenty of time to raise the value on the property with a little of my own money out of pocket,” Angelucci explains. “Once that balloon time comes, my facility’s already worth two or three times more than when I bought it, and I could refinance it very easily and maybe even pull a bunch of cash out.”

Countering Obstacles

Negotiating for seller financing isn’t without challenges, so it may take a bit of convincing. Even if the seller is interested, they’ll probably want to run it past their accountant. That person is likely to argue it’s a bad idea because the owner won’t be getting the full amount up front, plus they’ll be taking a risk that the buyer may default. “It’s up to us to say, ‘Well, hold on a second. You actually get more. You can pay less taxes, and you can defer them,” Meyers explains.

Another counter argument is the seller has all the same protections as a bank, including the ability to reclaim the facility if the buyer does default. “The aim is not to get around the [accountant], but to diffuse some of the reasons why they think seller financing is not in the best interest of their client,” Meyers says.

Seller financing can also be a challenge when a real estate broker is involved because the agent’s commission is based on the entire purchase amount and usually paid in full at closing. To avoid the broker dissuading the owner, Meyers recommends talking to the agent and owner early in the process about having the broker’s fee come out of the down payment. “It needs to be part of the calculation because you don’t want that conversation to be had when you’re not in the room or for it to be a surprise when they get the closing statement,” notes Meyers. “The worst scenario is at the 11th hour, realizing the seller is short and not able to pay the broker.”

Solutions for the Finance-Challenged

Among the many reasons a self-storage asset has trouble getting to a solid underwriting model are low occupancy, under-market rental rates and poor record-keeping. In these instances, if the debt-service coverage ratio doesn’t work but the owner still wants top dollar, seller financing may be the only option.

For the buyer, seller financing buys the time needed to build a track record that’s acceptable to a bank. Just be mindful about timeframe. “We always talk in months vs. years because it is difficult for sellers to imagine their life in five to 10 years,” explains Wagner. “I think you’re much more likely to get someone to agree to 12, 24, 36 or 48 months. I’m not looking to own a property for 10 years with seller financing. The role seller financing plays for me is taking a property from where it is unfinanceable by a bank, generally speaking.”

Wagner says you should never taking short-term money for a long-term project or long-term money for a short-term project. If you do, “you’ve got an inefficiency that’s going to eat into your profits,” he says.

For self-storage facilities with a lot of deferred maintenance, seller financing can pay for it. You just need to get creative, Meyers explains. “For example, we say to the seller, ‘Our interest rate is going to be low for the first year. It’s going to be 4% for the first six months because we have to keep the cash for the new doors, website or landscaping—whatever the case may be. Then, in the second year, we want you to increase the interest rate by 1% to 2%. And then, in the third year, we’ll be fully amortizing.’”

Other strategies are to defer payments for six months to a year, negotiate a repair credit or talk the seller into contributing cash toward the maintenance that needs to be done, particularly if you’re going to be doing the work, Meyers adds.

When structured right, seller financing is a good deal for buyers and sellers. As you can see, there are as many ways to make a mutually beneficial deal as there are Public Storage locations in California. So, get creative, present it carefully and user seller financing grow your self-storage portfolio!

Katherine D’Agostino is the founder of Self-Storage Ninjas, a self-storage feasibility-consulting firm. A former marketing-communications executive turned sensei, Katherine has a background that includes 24 years of creating and implementing business plans for a wide range of companies. A self-storage owner herself, she focuses on delivering unbiased reports that enable investors to make informed decisions. To reach her, call 402.570.5021; email [email protected].

About the Author(s)

Katherine D’Agostino

Founder, Self-Storage Ninjas

Katherine D’Agostino is the founder of Self-Storage Ninjas, a feasibility-analysis firm delivering unbiased reports resulting in facilities with high occupancies and the highest possible returns. Contact Sensei Katherine via her website, www.selfstorageninjas.com.

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