Seller Financing: What it Is and How to Use it To Invest in Real Estate

In This Article

You want buy a deal,but cannot get a mortgage. What should you do? You should just forget about the deal and move on, right?

No! That is loser talk. Instead try to approach the owner with a seller-finance strategy.

When you have lack of capital and/or credit then seller financing can be the strategy for you to consider. Seller financing is a forgotten strategy that is starting to make a comeback given the current condition of the credit market. Utilizing this strategy can allow you buy an asset that is not feasible given either credit, cash, or asking price constraints.

What is a Seller Finance Strategy?

Seller-finance strategy is a strategy wherein the seller of a free-and-clear asset (typically but can be a property with a small mortgage on it) becomes your bank along with being the seller.

Pros and Cons of Seller Financing

Pros

• You get the ability to purchase the asset on terms that maybe more beneficial for your capital investment table.
• Seller gets monthly payments and the benefit of treating the sale as an installment sale thus allowing them to defer any capital gains taxes that may be due.

Cons

• You maybe locked into a mortgage with a pre-payment penalty or may not be able to resell the property immediately. This strategy is typically not meant for flipping but can definitely be used for that purpose if structured correctly.
• The biggest downside for the seller is that they do not get all their money at the time of the sale unlike a traditional transaction. If that is a big con to the seller then you can guide them on a process of selling their note for a note buyer for a lump sum.

Who Would be Willing to Accept a Seller Finance Strategy?

The answer to that question is it depends. You will need to define a Marketing Thesis which should identify the seller and asset profile within a specific trade area that you theorize would be most accepting of a seller finance strategy. My marketing thesis for a seller finance strategy is defined below:

Marketing Thesis Layout

Seller

Ownership Type: Out of State and/or Absentee Owner

Equity: 50% to 100%

Date of Last Purchase/Refinance:  1995 or earlier

Asset

Tax Record Description: 3S-B-3U (3 Story-Brick-3 Units) or 2S-2U (2 Sotry-2units)

Asset Type: Multifamily or 4C (Commercial Apartment Building)

Areas: Newark, Jersey City, Clifton

Once you define your marketing thesis then you can utilize Tax Records and/or a third party vendor like ListSource to purchase a list of leads that match your criteria and develop a marketing plan to target the leads.

You should develop a marketing plan that defines you how and when you will be reaching out to your list of leads. Remember: It usually takes Seven Touches before a lead would think about reach back out to you.

Once You Get Them to Call You… Then What?

Slowly but steadily your leads will start calling you as long as you are consistent with your marketing efforts. Once you start getting calls then you need to set up appointments to meet with your leads ideally in person. When you are meeting your leads for the first time you should be to find out as much as you can. This is when you have to be like a Bloodhound or a Detective. To make sure you find out the right facts you should develop a list of questions that you want the seller to answer.

Below is the list of questions that I usually try to work into conversation so that I can better understand the sellers needs, wants and pain points:

1. Why are they looking to sell?
2. How much cash do they need and how much cash do they want?
3. What will they be doing with the cash exactly?
4. How soon do they want to sell the asset?
5. Do they have enough monthly cash flow coming in to pay their expenses?
6. Do they owe any mortgage on their property?
7. Are they willing to take payments instead of a lump sum of cash? (Try to make this question unnecessary by having your marketing educate the sellers on seller financing benefits)

Once you have collected your answers then you can start drafting a offer that is a win for the seller which will turn into a win for you. There are many ways to compose a seller finance offer and the best advice I can give is to setup an offer that solves your sellers’ pain points and addresses their cash needs.

Three Seller Financing Offer Types

1. 100% Seller Financing Deal: In this offer the seller funds the whole deal as a note since they have no need for the cash but rather need higher monthly payments than they are able to get from other sources.
2. Seller Wrap Financing: In this offer the seller funds part of the deal by “wrapping” their current in-place first mortgage together with an additional amount needed to make the deal work. Usually this option is only acceptable to the highest of motivated sellers who are in some type of cash flow constraint who would consider this option.  (Disclosure: This offer structure may violate the due on sale clause of a mortgage document so please make sure that the seller is aware of that risk upfront and make sure you review the mortgage document as well)
3. Second and Third Lien Offer: In this offer the seller takes a second & third lien mortgage assuming that the first mortgage is assumable or you can bring a first mortgage from another private lender. This strategy is highly creative as it allows the seller to sell their second mortgage position to help satisfy their cash needs while still retaining monthly payments from the third mortgage. This strategy can be executed but you will need to really educate the seller on its benefits before presenting them this type of an offer.

Seller financing strategy can be a win-win for both you the investor and the owner of an asset. You need to understand the seller pain points and educate them on the benefits of seller financing to be successfully in executing this strategy. Done correctly you can invest in real estate even with the constraints of limited cash and credit.

Share your creative investment strategy structures in the comment boxes below.

Happy Investing.

Photo: katsrcool (Kool Cats Photography)

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.