Seller financing versus outside subordinate debt

Compare seller financing and an outside junior loan through the cash each actually supplies, the payments required before stabilization, and the amount due at the same exit date. A deferred seller payment can preserve liquidity while creating a larger payoff. A third-party note can provide cash at closing while consuming more of the property’s early surplus.

This example assumes the senior lender expressly accepts either complete subordinate package. That approval must cover the amount, lien or other security, current payments, accrual, maturity, and remedies. Agreement between a buyer and seller alone does not establish senior compatibility.

Reconcile purchase credit with funded cash

Assume $10 million of common acquisition and initial project uses, excluding the junior financing’s own fees. The senior loan supplies $6 million. Either subordinate route supplies $1 million of financing value, leaving $3 million of basic buyer equity.

Seller S accepts a $1 million purchase-money note instead of $1 million of cash consideration. Its legal and closing costs are $15,000. Outside lender O advances $1 million but deducts $60,000 of fees, leaving $940,000 of actual cash. The buyer must supply the fee difference in addition to the common equity.

O’s fee is shown once: either use $940,000 net funding against the common budget, or show $1 million gross funding and $60,000 additional uses. Doing both would double-count the fee. S’s credit reduces the seller’s cash receipt; it is not a bank wire available to pay an unrelated contractor.

Specify current pay and deferred interest

S accrues 8% simple interest during the first twelve months without compounding. That creates $80,000 of deferred interest. During months 13–18, S requires current simple interest on the original $1 million principal at the same 8% rate, totaling $40,000. The deferred $80,000 remains due at payoff and does not itself earn interest in this example.

O requires 10% current simple annual interest on $1 million throughout the 18-month hold, totaling $150,000. Both notes are assumed to permit full repayment at month 18 without another premium. Their contractual maturities are later, and no extension is required for this exit.

These are negotiated hypothetical terms. A seller note is not automatically deferred or cheaper, and an outside lender can offer its own accrual or payment structure. Replace the assumptions with the actual notes before relying on the comparison.

Follow a limited opening liquidity account

Assume the buyer has $3.1 million of total available cash before closing. After the required contributions, S leaves $85,000 and O leaves $40,000. The property generates $80,000 during year one and $40,000 during the next six months after senior debt service and all other modeled property cash uses, but before the junior payments.

Assume those amounts can legally be used as shown and no additional reserve or distribution restriction applies. The senior lender has approved the stipulated payment and retention arrangements.

The outside loan uses more of the early liquidity. The seller route has not eliminated its interest expense; it has postponed $80,000 of it.

Put deferred interest back into the exit

Suppose the sale provides exactly $1 million for the junior layer after senior payoff, selling costs, and all other modeled exit uses. Under O, that repays its $1 million principal and leaves the owner’s separate $10,000 liquidity intact.

S requires $1.08 million at payoff: $1 million principal plus $80,000 deferred interest. The owner contributes $80,000 from the $165,000 retained cash, leaving $85,000. Comparing only the sale settlement would make S look worse by $80,000; comparing only the pre-sale reserve would make it look better by $155,000. The complete difference is $75,000 in S’s favor.

That equals the difference in total financing expense: S incurs $120,000 of interest plus $15,000 fees, or $135,000. O incurs $150,000 interest plus $60,000 fees, or $210,000. Principal is equal and excluded from this expense comparison. No time-value adjustment is included.

Verify that the documents permit the modeled cash path

A senior lender may restrict the subordinate lien and payments differently. The historical Dean Owner agreement, section 6.18(a) and its defined permitted encumbrances, illustrates document-specific restrictions on liens. It does not authorize either hypothetical note or establish a standard seller-financing exception.

Ask counsel to reconcile the senior consent, junior note, security, payment restrictions, default notices, and enforcement arrangements. If O’s current payments are blocked while still contractually due, the model needs an outside funding source or an agreed change. If S must compound deferred interest, the $1.08 million payoff is wrong. If S’s note cannot be prepaid at month 18, the assumed exit must change.

Also separate financing from purchase disputes. The buyer should not assume it may withhold a note payment because it alleges a seller representation breach; counsel must review the actual documents and applicable rights. Preserve the seller’s payoff and release process even when the parties remain cooperative.

The relevant choice is the complete cash path the senior lender and junior capital provider will accept. Closing liquidity, current payments, deferred claims, and final payoff must reconcile together before either source can be called the better solution.