Rookie Reply: Seller Financing 101

Ashley:
This is Real Estate Rookie, episode 140. My name is Ashley Kehr, and I am here with my co-host, Tony Robinson.

Tony:
And we would like to welcome you to the Real Estate Rookie podcast where all we do is focus on that beginning part of the journey so that the listeners like yourselves can get the inspiration, get the motivation, get the determination that you need to get started in your real estate investing career. So, Ashley, I’m super pumped to be here with you today.

Ashley:
Yes. And today we have another question from my Instagram DMs. Me and you, I was thinking about this the other day when we were talking about, we always loved to say slide into the DMs.

Tony:
Yeah.

Ashley:
So we have Brendan Flannery who slid into my DMs and has a question for us today. He said, “Hey, Ashley, my name is Brendan. I attended BPCON2021, and my biggest takeaway was go bigger, do deals with more zeros.” First of all, I love that, and Brendan, I wish we could have gotten to meet at the BiggerPockets Conference. If you guys did not go this year, make sure you check it out for next year. It’s not been announced yet where it will be, but sometime in the fall of 2022, and you can get great takeaways like Brendan here.
Okay, so Brendan says, “I am looking at a 10 unit. The numbers work really well on the 10 unit whenever it is fully occupied. The current owner does not owe any money on the property and said he is willing to consider owner financing.” Tony, do you want to explain real quick what owner financing is?

Tony:
Yeah. Absolutely. So typically when a buyer looks at a property to purchase, most people don’t have 100% of the funds to go out there and just pay cash for a property, so they typically go to some kind of lending institution, a bank, a credit union, private money lender, someone like that to get access to the funds. And then they get a loan to buy that property, then they make payments back to the bank or to that lender over time to pay off the loan that’s due.
With owner financing, instead of going to a bank or credit union or some other lending institution, the owner is actually acting as the bank in that situation, so the buyer agrees to a purchase price with the seller, who’s also the owner, and then they make monthly payments to the owner for some predetermined time period until that amount is paid back. So that’s the general premise of owner financing.

Ashley:
Yeah, that was a great explanation. Thank you, Tony. Okay. So Brendan continues to say, “Currently the property is listed at 1.9 million. I have been trying to go to all of my local banks to get financing for the property. The problem is the current owner only has four of the 10 units rented out and he is not advertising, nor does he want to take on any other renters. The banks are requiring at least 75% occupancy. I wrote the seller a letter and mentioned owner financing. He said he would be interested in owner financing. Now the problem I’m having is I don’t know where to start. I was wondering if you had any suggestions and what terms should I start with?”
Okay. So the first recommendation I would have is for Brendan to do a little research on the property. Find out if there is a mortgage on the property at all, so if the seller maybe need some money to pay off a portion of the mortgage. You can do that by going to PropStream, a software, then you can put in the property address and they will tell you if there is a mortgage or a lean on the property. That does cost money to sign up for PropStream, but they do have a free seven day trial. And I know I sound like an ad right now, but they are not an affiliate of us. I just use them.
You can also go to your county records, so the clerk records and pull them up. So I know for Buffalo, for Erie County, they’re software program they have, it’s to use, but it only works on Windows computers, it will not work on a Mac. But if you do enough searching, you can find where to pull these records to find out if people have loans on the property. And then where it gets a little tricky is, in PropStream they estimate what the actual loan balance is and on the clerk’s records for your county, it will say when the loan was taken out and what loan amount was taken out, but doesn’t estimate the balance for you, but you can guesstimate that by working backwards and putting together an amortization schedule. But of course, that’s just going to be a guess as to what they owe or even just ask the seller if they owe anything on the property.
The second thing you need to figure out is how much money do you have for a down payment or do you want to put down? And just because you have large amount of money, it doesn’t mean you have to put it all down, but just start working off of that. How much do you feel comfortable putting into the deal of your own cash?
Or do you have partners? There definitely is such a thing as 100% seller financing. So that doesn’t mean you can’t try and go after that, but before you go into negotiating with the seller, I would start to think about that as what you have and then taking the property, running your numbers on it and say, “Okay, what payment amount does it make sense for me?” So I just did a seller financing deal for a mobile home park. And the seller actually told me I need $2,500 a month. And so I worked backwards. Okay. This is the imbalance of the owner financing. I need to get him to $2,500 a month. So I amortized it over 25 years at three and a half percent. Boom, I got that number for him. So what number do you need? And start there. Tony, what else would you add to this?

Tony:
Yeah, you’ve made some really, really good points so far, Ashley. I think, along the same lines of what you just mentioned of that seller saying, all I need is $2,500 per month. That is golden information for you as the buyer. He just gave you the… I don’t know. I’m trying to think of some woody metaphor of how important of information that is. but I can’t think of anything, but that is just golden information. Because as the buyer, you want to be a professional information getter or a pig, I’ve heard this on another podcast before.
You want to be a professional information getter, because the more information that you have about the seller, about their situation, the better job you can do at creating a win-win situation. So for you, Ashley, you said $2,500 per month, that’s great information, because now you can structure the deal in a way that gets the seller to the number they want, but still gives you the terms and the structure that supports your business goal. I wanted to highlight that because I think it’s a really, really important point.

Ashley:
I’ll just add to that real quick. That was not my initial offer. I found out that he wanted that $2,500 after my third time and visiting the property. And I was sitting down with him with, I think, was my second offer. And we just sat down and we scribbled out my letter of intent that I gave him showing what my offer was. And that’s when he was like, well, I need $2,500 a month. And just me spending a lot of time with him listening, I was able to get to that point. So that’s a huge thing, is just listening to the person. And if you can get face to face with the seller, that’s even better.
So even if you don’t come with an offer right away to the seller, Brendan, you can go and ask to sit down and talk with him and see if he’s open to that. And that’s where you’re going to get some information. And that’s a little due diligence period, before you even make your offer.

Tony:
It’s definitely about the relationship building, when you’re going with owner financing. Now I will say, being super transparent, I’ve never closed on an owner finance deal. I’ve had a couple deals where we got pretty close, we ended up going a different route, but I just want to clarify what the key ingredients are when you are talking about seller financing.
So there’s the actual purchase price, which is what you’re buying the property for. There’s the down payment, which is how much cash you’re given to that seller upfront. There’s the term of the loan, which is how many years you’re going to be making those payments. And then there’s the amortization period, which is how long is that purchase price? How many years is that purchase price spread out over? All of those different levers, your purchase price down payment term and amortization period. All of those are negotiable.
And people often ask us, Ashley, “Hey, what’s the perfect structure for this partnership. What’s the perfect structure for this owner finance deal. What’s the perfect structure or X, Y, Z?” And we can’t say what the perfect structure is because we don’t know all the unique, specific circumstances that you find yourself in, but just know that those are the four different kind of boxes you can play in to better suit both your needs and the seller’s needs. So again, it’s the purchase price, the down payments, the amortization period, and the term of that loan.

Ashley:
Yeah. And that’s so important that you said that there’s no perfect structure and it’s going to vary by seller, it’s going to vary by buyer, it’s going to vary by the deal. And there is no wrong structure, as long as it’s legal, but when you put that together, if the numbers work for you, you have a deal. It doesn’t matter how you work it out. And one thing to remember too, is that somebody else may be getting 2% seller financing, $0 down. And maybe you’re going to end up paying $20,000 down at 5% interest. But if you are still money on that deal and you’re still getting a return, that’s better than you not getting the deal at all. So as long as it doesn’t end up being a bad deal.
Another thing to think about too is if this seller financing is going to get you into the property and you already know that there’s a value add, and you’ll be able to refinance out of the property easily, just you need a little bit of time. I think this is a perfect situation for Brendan, where once he gets that 75% occupancy, maybe you are willing to negotiate and work with the seller more on worse terms, such as maybe a higher interest rate or something like that, knowing that you just need to pay that for a couple months, and then you’re going to be able to refinance out of the property.
Of course, you don’t want to be losing money. You still want to be cash flowing and you have the opportunity to put this value add in. But if those terms get you into the property, that doesn’t mean they’re bad. And also think outside of the box too, what are some other things the seller might need? So the one I’m working on now, in year three, in year four, he’s getting a $25,000 cash payment each of those years on top of his loan payments. And that was to decrease my down payment. So the amount of money I’m giving out now is lower. And that’s just being deferred until year three and four, which gives me more money to do improvements to the property and more time to come up with that cash.
So think outside of the box and be willing to negotiate, don’t be afraid to do three, four offers. And you don’t have to have your offer perfect the first time, so don’t stress. Throw something out there that works for you and let the seller know that you’re willing to work with them and negotiate.

Tony:
What great advice, Ashley, on being creative and proving that, again, there’s no box you have to fit within. If you want to tell the seller that you would buy them a car after three years, you can do whatever you want. It’s whatever gets the deal done. I want to talk about maybe another alternative to owner financing just in case Brendan’s not able to work this out. Do you have anything else to add on the owner financing piece?

Ashley:
No, let’s move on.

Tony:
I want to bring this up because we’re struggling with this at a property that we’re looking at here in Southern California as well. It’s a small motel and a lake city here. And the owner’s financial recordkeeping is almost nonexistent. We’ve asked for financials. They don’t have them. The property’s only partially operational for the last 12 months. So just a mess to lend on. So I reached out to a few lenders as well, and they’re all saying, “Hey, without better financials, it’s a motel. That’s basically weird right now.” They’re not willing to lend on until they see that it’s a stabilized property. So what we’re looking for now is what’s called, bridge debt or bridge lenders. And these lenders essentially help you purchase commercial properties that are in transitionary periods.
So this property that’s only 40% occupied, that would be a good candidate for bridge debt because what bridge lenders allow you to do is, they’ll say, “Hey, we’ll give you the money to purchase rehab, stabilize the property.” Typically, it’s 12 to 18 months, sometimes a little bit longer. Slightly higher interest rates, but it’s just enough cash to get the property purchased, stabilized and then you go back out 12 to 18 months later and you refinance with more cheaper, lower costs debt with one of the traditional lending institutions.
So Brendan, if for whatever reason, you’re not able to come to an agreement on the owner financing piece, don’t feel like the deal is dead in the water, go out and see if you can find some bridge lender and talk to other investors in your area to see what other options they might be aware of.

Ashley:
Well, Tony, great advice. So hopefully Brendan, you can take some value from that and I’m going to actually bullet point everything we talked about and send it to him after this, so he doesn’t have to wait a couple weeks to hear this episode. But thank you everybody for listening and make sure you send Tony or I a message on Instagram if you have a question that you would like to play on The Rookie Reply. My name is Ashley @wealthfromrentals and he’s Tony @tonyjrobinson. And we’ll be back on Wednesday.