What Is Seller Financing in Real Estate?

Learning about seller financing is a major revelation for many investors, perhaps even as exciting and intoxicating as the feeling they experienced 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 make a 25% down payment? Instead, I can negotiate my own down payment and interest rate and just make payments to the seller over time?! That’s awesome!”

This is a revelation for a good reason. Seller financing, once fully understood and mastered, can truly be a game-changer in building a real estate portfolio.

But while it’s easy to learn about this exciting new concept and then enthusiastically rush out and start making offers with seller financing, many investors can also find themselves quickly frustrated and discouraged.

“I can’t get any sellers to accept my seller financing offers,” they report back, disheartened.

While this may feel discouraging at first, there’s good news: With a simple tweak of perspective and strategy, investors can begin getting much better responses from sellers.

More on seller financing from BiggerPockets

What investors misunderstand about seller financing

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

They see a property listed on the market, know nothing about that seller or their situation, and then make a seller financing offer. From the seller’s perspective, this offer is random, irrelevant, and misguided.

So, what’s the fix?

The better approach is to specifically pursue those sellers whose needs and situations are well-suited to seller financing.

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

Think about it like this. Seller financing is a solution to a specific problem. If you go around offering this solution to anonymous people who don’t have the matching problem, it will be irrelevant to them, and they’ll decline it (and roll their eyes while doing so). But if you take the time to understand the problem—and identify the type of person who has that problem—finding takers for the solution will be simple.

Therein lies the important epiphany: Seller financing is about the seller themselves. It’s about the person and the problem they face. It’s not about the property, and it’s definitely not about how the buyer wants to finance the purchase.

So, if seller financing is about the seller themselves—and the specific problem they have that would be well-solved by seller financing—it raises the critical question: What problems does a perfect seller financing candidate have?

While there are many different potential problems a seller could have that could be solved by seller financing, I’ll share with you the three primary seller problems—and thus, the primary drivers—that have led to great seller financing deals for me in my business.

The seller may or may not perceive these as “problems,” per se. But at a minimum, they perceive them as important considerations that the seller must adequately address in their decision-making process.

Problem 1: They want to defer capital gains taxes

One of the main motivators for many sellers who do seller financing is the deferral of capital gains taxes using the “installment sale” structure. This is why non-occupant owners (i.e., landlords) make excellent candidates for seller financing—they are far more likely to have significant capital gains taxes obligation than most owner-occupants.

Many sellers feel stuck because they a) don’t want to pay the tax and b) don’t want to do a 1031 exchange to simply trade into yet another responsibility. So when you come along and propose a path that allows them to avoid both the painful immediate tax bill and the purchase of another property, you are proposing a valuable and attractive option.

Thoughtfully structured seller financing can help them ease their capital gains pain without needing to exchange into another property.


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Problem 2: They don’t want to stop receiving monthly income

Many non-occupant property owners bought their properties as a way to safely create an income stream. So, if they sell the property, how will they continue generating income (especially those who don’t want to exchange into a replacement property, as discussed above)?

Some sellers are financially conservative and are not comfortable with the stock market; they simply want to put their money where they feel it’s safe—like in a bank. But with bank deposits paying so incredibly little right now, they need a way to continue generating income after they sell.

Thoughtfully structured seller financing can help them continue to earn a monthly income without the responsibility of owning property.

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

While many sellers need and want their equity to drive 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 of cash, and feeling the pressure to manage that money, feels like a burden to them.

Thoughtfully structured seller financing can remove that burden from them. They can rest assured knowing that they will receive a monthly loan payment and that their investment is secured by tangible real estate collateral.

In reviewing these three main problems that lead to optimal seller financing opportunities, notice how much of that was about the property. Almost nothing. It was about the seller, their situation, and their needs.

How to find and negotiate seller financing deals

Now that we understand the main problems a seller may face that could lead to seller financing deals, how do we find and negotiate these deals?

Let’s break it down into two steps: finding and negotiating.

Finding the deals

Finding the deals is all about identifying the people who have these problems. My advice—which is what I do in my own business—is simple: If you want to buy properties with seller financing, focus on finding sellers who would have significant capital gains taxes if they were to sell their property.

Who is that? Non-occupant owners who have owned their properties for a long time and have seen a significant increase in value. While you won’t know with 100% certainty that these sellers would say yes to a seller financing proposal, you know you’re fishing in a pond stocked with the kind of sellers you want to catch.

Negotiating the deals

The key to negotiating the deal is to make it all about the seller—not you, and not the property. Adjust your perspective from, “I’m making an offer with seller financing because that’s how I want to finance this purchase,” to, “I’m proposing seller financing because I believe that is the best solution to the seller’s problems.”

As you’re presenting your proposal, frame the conversation around them and what they are trying to accomplish, and position your proposal as your professional recommendation for helping them get what they want.

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

While most other investors will continue to wander aimlessly around the MLS randomly asking sellers if they will accept seller financing, you will be out there talking to perfect candidates and stacking up deals for your portfolio.

2021-08-17 19:30:00

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