What is seller financing in real estate?

Learning about seller finance is a huge revelation for many investors, perhaps as exciting and exhilarating as the feeling they had when they first learned about real estate investing.

“You mean I don’t have to go to a bank, apply for a loan, get an appraisal and pay a 25% deposit? Instead, I can negotiate my deposit and interest rate myself and only make payments to the seller over time ?! That’s great!”

This is a revelation for good reason. Once fully understood and mastered, seller finance can really be game-changing in building a real estate portfolio.

But while it’s easy to learn about this exciting new concept and then enthusiastically rush off and make deals with seller finance, many investors can also get frustrated and discouraged quickly.

“I cannot get a seller to accept my offers for seller financing,” they report discouraged.

This may seem daunting at first, but there is good news: with a simple adjustment of perspective and strategy, investors can get much better responses from sellers.

Learn more about BiggerPockets seller financing

What Investors Get Wrong About Seller Financing

First, let’s start by understanding the problem. The main mistake I see in many investors is offering seller financing in situations where it doesn’t really fit the seller’s situation and needs.

They see a property listed on the market, know nothing about this seller or their situation, and then make a financing offer for the seller. From the seller’s point of view, this offer is random, irrelevant and misdirected.

So what’s the solution?

It is better to specifically pursue those sellers whose needs and situations are suitable for seller financing.

In other words, it’s about buying a person – a seller who is a good candidate for seller financing – and not a property. Shopping for this person is better off-market than on the MLS, where getting to know your seller is difficult and unlikely.

So think about it. Seller financing is a solution to a specific problem. If you offer this solution to anonymous people who don’t have the mapping problem, it is irrelevant to them and they will refuse (and roll their eyes at the same time). But if you take the time to understand the problem – and identify the type of person who is having the problem – finding buyers for the solution will be easy.

Therein lies the important lesson: Seller financing is about the seller himself. It is about the person and the problem they are facing. It’s not about the property and certainly not about how the buyer wants to finance the purchase.

So when seller finance is about the seller himself – and the specific problem they have that could be well resolved by seller finance – this begs the critical question: what problems does a perfect seller finance candidate have?

While there are many different potential problems a seller could have that could be resolved by seller financing, I’m going to introduce you to the top three seller problems – and therefore the top drivers – that have resulted in great seller financing offers for me.

The seller may or may not perceive these as “problems” per se. At the very least, however, they perceive them to be important considerations that the seller must adequately take into account in his decision-making process.

Problem 1: You want to defer capital gains taxes

One of the main reasons for many sellers doing seller financing is the deferral of capital gains taxes through the “installment sale” structure. For this reason, non-owner owners (i.e., landlords) are excellent candidates for vendor finance – they are far more likely to have significant capital gains tax liability than most owner-occupiers.

Many sellers feel stuck because a) they don’t want to pay the tax and b) they don’t want to do a 1031 exchange just to trade in another responsibility. So if you suggest a path that will allow them to avoid both the painful instant tax bill and buying another property, you are suggesting a valuable and attractive option.

Well-structured seller financing can help you alleviate your capital gains without having to convert to another property.

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Problem 2: You don’t want to stop getting monthly income

Many non-using real estate owners bought their properties in order to create a secure source of income. So if they sell the property how will they continue to generate income (especially those who do not want to trade in for a replacement property as described above)?

Some sellers are financially conservative and uncomfortable with the stock market; they just want to invest their money where they feel safe – like in a bank. But with bank deposits paying so incredibly little right now, they need a way to keep making income after they are sold.

Well-structured seller financing can help you continue to earn a monthly income without taking responsibility for owning real estate.

Problem 3: They don’t know what to do with the money

While many sellers need and want their equity as a source of income, as described above, others don’t really need the money from the sale of their property. In fact, the prospect of getting a lump sum cash and feeling the pressure to manage that money feels like a burden to them.

Well-structured seller financing can relieve you of this burden. You can rest assured that you will receive a monthly loan payment and that your investment is secured by material collateral.

As you review these three main problems that will lead to the best financing options for sellers, keep in mind how much of them affects the property. Nearly nothing. It was about the seller, his situation and his needs.

How to find and negotiate financing offers for sellers

Now that we understand the key issues a seller may face that can lead to seller finance deals, how do we find and negotiate those deals?

Let’s break it down into two steps: find and negotiate.

Find the offers

Finding the offers is about identifying the people who are having these issues. My advice – and I do this in my own business – is simple: if you want to buy property with seller financing, focus on finding sellers who would have to pay significant capital gains taxes on selling their property.

Who is this? Non-users who have owned their properties for a long time and have experienced a significant increase in value. Even if you don’t know for 100 percent whether these sellers would agree to a seller financing offer, you know that you are fishing in a pond stocked with the type of sellers you want to catch.

Negotiate the deals

The key to negotiating the deal is that everything is about the seller – not you and not the property. Change your perspective from “I’m making an offer with seller financing because that’s how I want to finance this purchase” to “I am suggesting seller financing because I believe it is the best solution to the seller’s problems.”

As you present your proposal, frame the conversation around them and what they want to achieve, and position your proposal as your professional recommendation to help them get what they want.

In summary, if you want to buy more real estate with seller financing, you have to master the art of finding the sellers for whom this would be a relevant and valuable solution.

While most other investors continue to wander aimlessly through the MLS, asking the sellers at random to accept seller funding, you will be talking to perfect candidates out there and putting together offers for your portfolio.

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