By Barry McGuire
What The Heck Is An AFS?
An Agreement for Sale (AFS) (sometimes called a ‘right to purchase’ in BC) describes a purchase structure with seller financing. You negotiate a price; say $350,000 and a deposit. The seller is your bank (seller financing) for the rest of the purchase price (seller financing equals purchase price less the deposit(s)).
The legal title remains in the seller’s name. You, as buyer, now own a 100% beneficial interest in the property. You can use an AFS when the seller has clear title or a small mortgage. Quite likely, at least in Alberta’s depressed economy, you may find sellers with large mortgages equal to or very close to the complete purchase price.
An AFS is a way to buy property with seller financing, leaving a seller’s mortgage in place that you have not assumed. If you haven’t assumed, you don’t have to qualify.
Remember, the seller does not have to have a mortgage for an AFS to work. BUT, practically speaking, most AFS deals will occur where the seller has an underlying mortgage. You make payment to the seller on whatever he has lent you. The seller, if he has a mortgage, continues to be responsible for his own mortgage payment.
There are lots more details, but this is the basic picture.
History of the AFS:
Across Canada, this way of financing was previously much better known for both residential and commercial properties. Historically, banks would not give anyone a mortgage unless they had up to a 50% down payment, which was difficult to accumulate. This meant a huge segment of the buying public was excluded from the home-owning marketplace. Sellers had an extremely limited number of buyers because most buyers could never save a 50% down payment. In fact, within living memory, many deals in Canada were done by way of Agreement For Sale or Vendor take back mortgage (VTB).
Then, in 1946, to assist returning WWII veterans, the Federal Government decided that more people should own houses. They brought in a law called the National Housing Act, and Canada Mortgage and Housing Corporation (CMHC) was created to act as an insurer for the lenders. If a loan went bad, a lender could make a claim against CMHC for any of their losses.
This made lenders happy and reduced the size of down payments. Now, lenders can lend up to 80% of the purchase price or up to 95% if the mortgage is insured by CMHC or other insurer.
That kind of financing was a vast improvement on the 50% down scenario. Agreements For Sale became the forgotten financing tool.
The AFS Contract:
You can buy or sell a property, and here is the correct terminology - ‘by way of agreement for sale’.
A purchase contract (often called the 'offer' or 'offer to purchase') is submitted to the seller and the offer clearly says that the transaction is proceeding, 'by way of agreement for sale'. The words agreement for sale mean the seller is financing all or part of the purchase price. The offer or schedule to the offer provide the financing details. The buyer pays a certain amount of the purchase price by cash and the balance owed to the seller is described formally as the 'unpaid seller’s equity' but more commonly referred to as ‘balance owing’ or ‘unpaid balance’.
When selling or buying you can use:
- the standard purchase contract for your province, and;
- a financing schedule. Issues and concerns are different for buyers and sellers, so it is important to use a financing schedule that protects your interest as buyer or seller.
With an existing mortgage, you usually want the term of the AFS to match up with the term of the mortgage. That way, when the mortgage is due, the AFS is also due. Again, there are a lot more details, but this is the basic picture.
Why An AFS Is Different:
“But… What's the big deal? Isn't this just like an assumption of a mortgage?” The major difference is that title remains in the seller’s name! The seller continues to make his mortgage payments to his bank. The bank records don't change.
Protecting The Buyer:
If title isn’t in the buyer’s name, how does he protect himself? Each province has a different way of recording the buyer’s AFS interest against title. Let’s call it the ‘Notice’. The buyer has the right (but not the obligation) to register a notice against the title at the Land Title(s) Office/Registry. The notice claims an interest in the property as a buyer under an Agreement For Sale. However, that buyer will not get title until he pays off the seller, usually by arranging new financing. The seller then pays off his old mortgage with some of the AFS payout monies and pockets his profit. The buyer discharges his AFS notice.
Why an AFS is Attractive To The Investor Seller:
If you are an investor with property to sell, who is your target market? It may be more than those buyers with lots of money for big down payments and the ability to qualify for or assume any mortgage. What about those less financially fortunate buyers? What stops buyers from being able to buy and why would they need you?
For any seller, the most common financing possibilities, and the problems they face, are as follows:a) The buyer needs a new mortgage, is a good risk but cannot qualify with a traditional lender because of lender policies. If your buyer has a solid down payment and is capable of making the monthly payments, you may have a good candidate. Dig deeper.
b) Some sellers have big payout penalties on the mortgage. Some sellers hate paying real estate commission. An AFS allows the seller to avoid both these issues.
c) In a normal market, an AFS transaction allows a conservative seller investor to achieve a greater degree of certainty about the returns to expect from a property investment. The capital appreciation is locked in at the time the AFS is signed. Of course, when properties rapidly rise or fall in value as they have done in Alberta in the last five years, you might miss substantial equity appreciation or, in fact, lock in a huge gain.
d) Another advantage of an AFS over a normal buy and hold strategy is that your buyer is now responsible for all the normal ownership costs (such as property taxes, insurance, repairs etc.). You don't have property management fees.
In summary, an AFS gives the investor seller other financing alternatives.
AFS Seems To Have Lots of Positives. What about Negatives?
Let’s talk about some negatives, and this is not an exhaustive list.
- What about an AFS being outside the typical ‘due on sale’ clause if the seller has a mortgage (meaning once a sale is made, the owner (seller) must pay out or discharge their mortgage)? In our experience, use of the AFS has not triggered an existing mortgage ‘due on sale’ clause. Most likely because title remains in the seller’s name and the seller continues to make his mortgage payments. Now, just because lenders haven’t objected, doesn’t mean they couldn’t. If the lender says they don’t like your AFS because it violates their due on sale clause, then, as with any other strategy, you need a Plan B, because if the lender wants to fight, you don’t. Think about your exit strategy in these circumstances.
- The seller is not supposed to increase their underlying mortgage or HELOC. Most sellers don’t, but this can be tricky to monitor. An increase in mortgage might make the mortgage more than the AFS amount and a destitute seller might not be able to come up with extra funds at payout.
- One buyer client could not refinance as quickly as he wanted and so paid the seller money to extend the AFS. The seller was supposed to apply those payments to his existing mortgage, which originally was the same principal amount as the AFS. But the seller put the money in his pocket. Now the AFS is smaller than the underlying mortgage and the seller has no money over and above the AFS amount. Next time our buyer client would make those payments himself or be more careful about it.
- You absolutely need both parties to be represented by lawyers who understand AFS. Without that, there’s a great chance that one or the other lawyer will kill the deal, mostly because they don’t understand the strategy. Overall, an Agreement For Sale can, more than buy and hold, be administratively more complicated to set up, make payments, monitor, organize insurance and close out the AFS.
- If you as buyer under an AFS want to sell to an ultimate third party, you generally need the cooperation of the seller in drafting an offer. Why? Because lenders and title insurance companies want the seller’s name in a contract to be the same name as on the title. If at all possible, obtain a full power of attorney as part of your AFS setup.
- When you are a buyer and your AFS matures and you are discussing a new mortgage to pay off the AFS, your lender (like lots of lenders) might have trouble understanding your AFS purchase. Some of our clients have had to use private lenders to get the title in their own name for a period of time and then refinance with a mainline lender. TIP: allow yourself twice as much time for any financing related to an AFS.
- SUMMARY: there may be other negative issues when using an AFS. However, so far all our clients have been able to work their way through any difficulties and have done some amazing deals.
Why An AFS Is Attractive To The Investor Buyer:
- No money down. The seller wants to sell but has negative equity. They bought at the height of the boom. Prices have fallen. Their high ratio mortgage now has a principal balance larger than the fair market value of the home. They can't sell it with a realtor because real estate fees will take up to $10,000+ dollars that they don't have. Remember this is negative equity. Even if they do sell, chances are their mortgage is closed and paying it out would trigger a large payout penalty. Think of the negotiating possibilities for you as an investor buyer under this scenario.
- Very little money down. The seller has positive equity but not too much. His real estate commission and pay out penalties could easily chew up $20,000. If the seller calls you, he might be happy to hear how you can save him money. These first two scenarios are the most common in the AFS world.
- The seller has positive equity but he doesn't need his money. Most sellers need the money from their sale but some don't. You can show the seller how to potentially save thousands of dollars in real estate commission and payout penalties, earn a better return on his equity than he could in the bank and, if the seller is also an investor, to defer profit on his taxable gain.
- Buyer (YOU) now controls the property. This is powerful! With a properly negotiated and drafted purchase contract and AFS you can:
- assign your interest in the AFS, in other words sell your contract;
- lease-option to a tenant buyer, or;
- iii. sell an option without a lease, or;
- make a straightforward sale at a profit to another buyer
An AFS can work well for the above examples.
Agreements For Sale are a valid investment strategy which, when properly implemented, can be effective and profitable. There are more things to discuss including a more complete discussion of downside issues which should be reviewed in detail with your legal counsel before entering into any AFS, whether you are buyer or seller.
As always, your best result can be expected by thoroughly educating yourself and then proceeding carefully, ensuring comprehensive due diligence with a great team in support. If you have any questions or comments, please contact us at RMLO Law LLP firstname.lastname@example.org.
A lawyer for more than 37 years, Barry’s practice emphasizes investment real estate. He is senior counsel at Ritchie Mill Law Office in Edmonton, Alberta. Barry started investing in real estate almost 40 years ago. He currently owns 20 doors and continues to invest in real estate today.