Using Seller Financing for a Self-Storage Real Estate Transaction: Opportunities and Risks

Seller financing is growing in popularity for self-storage real estate transactions. One reason is that it may allow a deal to close more quickly. It may also enable the seller to command a higher price. However, this lending option carries unique risks not inherent in conventional escrow contracts.

When a self-storage seller offers financing, it can make their property more accessible to buyers who may not qualify for traditional loans. The seller can also negotiate a higher sale price by providing attractive financing terms, particularly in today’s high-interest-rate environment. Finally, by accepting payments in installments, the seller may be able to spread their tax liability over several years, reducing their immediate financial burden.

On the other hand, future payments from the self-storage buyer may lose their value due to inflation. After all, the cost of all real estate changes over time. Any seller offering a loan should consider shorter loan terms or adjustable interest rates to protect against asset devaluation.

Payment risk is another concern. When a self-storage seller acts as the lender, they take a gamble. They often rely on a down payment as the sole qualifier for buyers, which may be insufficient unless all conditions align perfectly.

Seller POV: Qualify Your Buyer

If a self-storage owner is interested in providing an acquisition loan, it’s essential that they qualify the buyer through proper due diligence. It’s important to understand and confirm the borrower’s character before entering a financial partnership. The following steps are addressed to the seller, however, the buyer should also be aware of them, so they can prepare.

Assess collateral. Verify that your self-storage property is adequate to secure the loan. If not, require additional collateral from the buyer such as other real estate they own, investment accounts, cash reserves or personal guarantees tied to valuable assets. Work with legal counsel to perfect liens on all collateral to ensure enforceability in case of default.

Understand buyer motivation. Why is the buyer seeking seller financing instead of a traditional self-storage loan? Assess whether their reasons suggest financial instability or strategic planning.

Confirm creditworthiness. Obtain a copy of the buyer’s credit report and Fair Issac Corporation score. If you don’t have access to credit-bureau data, ask the buyer to provide it through services like Credit Karma.

Investigate legal history. Find out whether the buyer has a history of being involved in lawsuits, as frequent litigation may be a red flag.

Verify experience. Inquire about the buyer’s past property ownership and management experience, including challenges they’ve faced and how they addressed them. Ask about their plan for effectively operating your self-storage facility.

Evaluate capacity. Assess the buyer’s ability to repay the debt beyond the property’s net operating income. Review their financial statements, including tax returns, income statements and balance sheets, to assess their ability to meet obligations. Consider whether they have other income sources to supplement shortfalls from self-storage cash flow

Request a business plan. Ask the buyer for a detailed plan that outlines projected income and expenses for the self-storage property, strategies for increasing occupancy and revenue, and contingencies for financial shortfalls resulting from market downturns, increased competition or unexpected expenses. Unforeseen shifts—for example, a competitor lowering rates—could reduce occupancy and revenue, making it harder for the buyer to make payments. Use debt-service coverage ratio (DSCR) calculations to stress-test their financial plans against adverse scenarios to ensure their ability to repay the debt under challenging conditions.

Plan for risk. When offering seller financing, it’s essential to address potential operational and market risks to protect both parties. Inexperienced buyers, especially those who are new to property management, may struggle and make mistakes. The seller, financially tied to the asset’s performance, will bear the consequences. To overcome this, include clauses in the purchase agreement that require the use of a professional self-storage management firm.

Draft comprehensive loan documents. Work with experienced legal professionals to draft contracts that include personal guarantees, assignment rights and conditions requiring professional property management tied to DSCR metrics.

Buyer POV: Vet Your Expert or Seller

There are many real estate “masterminds” out there who claim to offer guidance for purchasing self-storage properties, often promoting deals that require little to no down payment and minimal experience from borrowers. However, it’s crucial to approach these claims with caution.

Conduct rigorous due diligence on the expert and any self-storage seller to whom they connect you. Find out how many transactions they’ve closed and how long ago. How many of those transactions are seasoned at five years or more? Is the expert willing to give you seller references?

Bear in mind that no one offers a reference who might speak poorly about them. Still, don’t let the real estate expert decide which references you contact. Ask to choose from a list of candidates. I recommend that you reach out to the last three sellers the expert worked with and those with the most experience. If the list is short, consider this a potential red flag.

Find out how things went from the seller perspective. If they provided financing to their buyer, were they paid back in full? Did the buyer refinance out of the original purchase?

Before entering any transaction, ask tough questions to identify its strengths and weaknesses. If a self-storage deal sounds too good to be true, it most likely is. Don’t be afraid to walk away and stick to your financial requirements.

Avoiding Litigation

If not handled properly, the offer of financing can expose a self-storage seller to legal disputes. To minimize the risk of litigation, they should follow these guidelines:

Use a clear and detailed purchase contract to define all terms of the loan, including interest rates, payment schedules, late fees and remedies for default.
Specify those remedies for default, such as foreclosure of the property or additional penalties. Establish timelines and requirements for curing defaults to prevent prolonged disputes.
Similarly, specify any and all the conditions under which the loan may be accelerated or foreclosed.
Include provisions for dispute resolution, such as mandatory mediation or arbitration, to ensure clarity and prevent future conflicts.
As noted above, investigate the buyer’s creditworthiness, operational history and financial capacity. Ensure that all representations made by the buyer are documented and verified.
Avoid ambiguity by ensuring all legal documents are clear and free from vague language. Engage legal counsel experienced in real estate transactions to review them.
Periodically verify that the buyer is meeting their loan obligations, including property maintenance and financial commitments.
Require regular reporting from the buyer, such as financial statements and occupancy reports, to ensure the property’s performance aligns with projections.

A Win-Win

Seller financing is a valuable tool for self-storage real estate transactions, especially in today’s challenging interest-rate environment. However, it requires careful planning, thorough buyer qualification and strong legal agreements. By following the above guidelines, sellers can balance the advantages of faster sales and higher prices with the complexities and risks that come with carrying a note. With proper preparation, this loan option can be a win-win strategy for both parties!

RK Kliebenstein is the founder of Coast-To-Coast Realty Advisors, a family-owned real estate agency based in Palm Beach Gardens, Florida. With more than 40 years of experience in self-storage transactions totaling billions of dollars, he’s been part of the formative teams behind companies like real estate investment trusts CubeSmart and Extra Space. He’s also advised thousands of independent owner-operators throughout his career. To reach him, call 561.797.2721 or email [email protected].

About the Author

RK Kliebenstein

Principal, Coast-to-Coast Realty Advisors LLC

RK Kliebenstein is principal of Coast-to-Coast Realty Advisors LLC. He has more than 30 years of self-storage industry experience, from creating business strategies to disposing of mature assets and everything in between. He’s the author of several books, including publications on how to invest and make money in self-storage. He’s also a frequent speaker at industry events, For more information, call 561.797.2721; e-mail [email protected]; visit https://askrk.com.

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