Why Does the Amount the Seller Owes Matter?

Question

Hey everybody, I'm brand new to real estate and I'm just learning about investing. Please forgive a really, really basic question, I'm just learning

I read that when considering an investment property, you need to know how much is owed on the house and how much equity the seller has. I read in one article that you should consider this moreso than the asking price.

Why do you need to know this? What impact will it have on me if the seller owes a lot or owes only a little on the house? How does that change my negotiations and what I will have to pay in order to own the house? Is it because I need to know what their baseline price is in order to be able to pay off their mortgage after closing, so I know what number they really couldn't go below?

Thanks everybody!

John Thedford · Answer

A seller will always look at what they owe versus what the selling price is. What they owe may or may not be a motive on whether to sell. If they owe more than the sales prices, they will have to PAY to sell their property. I had that happen. I found an out of state seller with property in Cape Coral. We came to an agreement at 120K. They owed about 190K and had to bring 70K to the closing table. It happens! Bottom line: if they owe more than the sales price it may or may not have an impact on their decision to accept an offer.

Chris Mason · Answer

A huge part of it isn't even specific to real estate investing, it's just buying/selling in general.

Consider two similar houses in Oakland. Worth $1m.

Seller 1: Owes $200k, and will walk away with something just below $800k if it sells for right at $1m, after closing costs, Realtors, etc.

Seller 2: Owes $700k, and will walk away with something just below $300k if it sells for right at $1m.

The person who is walking away with ~$800k really doesn't necessarily care if your offer is $20k this way or that. They are probably older, and either way they are set for life to be that hated California cash buyer in Florida or Texas. Things like making the process easy for them, and tugging at heartstrings, will go a lot farther and are more likely to work. They're too salty to care about ego stuff, "just under" or "just over" $800k is all the same thing to them.

Seller 2, who will walk away with ~$300k is going to care a lot more about $20k this way or that, psychologically that $20k puts them over or under $300k, and they are young so that sort of thing is more likely to matter. They're younger, this was their starter home, they still need to be in the East Bay, assuming they are buying their next home with 20% down that $20k this way or that is another $100k in buying power! They are more likely to care about top dollar and certainty than ease and heart strings -- their own kids are still young, after all, and they care more about their kids than your kids.

Kevin Sobilo · Answer

@Daniel Lemp, yes they would need to bring $10k to closing to make the deal work. It can happen, but does not happen often.

Like I said though, there are other ways to make a deal where the seller owes too much work. Not always, but sometimes there is a way.

Another example I didn't mention before is a short sale where the seller asks the lender to accept LESS than that is owed, but that typically only works when the seller has fallen behind on payments and has document-able financial problems.

Daniel Lemp · Answer

@Kevin Sobilo Thanks so much for the response. So for example, a seller owes $200,000k on a house that is worth $250,000. They ask for $250,000 and I want to negotiate. I know that I can't reasonably offer below $200,000 because they can't or won't sell for less than $200,000 because doing so would mean they actually lose money when they sell the house.

But if I'm a crazy negotiator, I offer $190,000 and they accept, they actually have to pay $10,000 out of pocket to get the house off their hands.

Am I understanding that correctly?

Kevin Sobilo · Answer

@Daniel Lemp, I don't know what the articles you read were getting at but I'll give you a couple thoughts.

The first is that obviously most sellers cannot sell for much less than what they owe because they can't or won't bring money to the table to pay you to take the house. There are exceptions to that rule. I once bought a house for $14k where the seller had to bring over $25k to closing because she owed so much more on her mortgage.

Fast forward a few years when interest rates may be higher and real estate prices have softened. You may have a seller whose property is worth a little LESS than what they owe! You are probably thinking you can't make a deal. However, maybe their interest rate is 2% lower than you could get. So, their payment is actually LESS than you would pay if you paid what the house is actually worth. You could buy the deal with a mortgage assumption or with a Subject-To approach.

In general knowing a seller's situation and their motivations can only help you negotiate and/or find creative ways to make a deal work.