Unpacking Seller Financing

Fundamental Principle

Seller financing is all about using empathy, creativity, and a win-win mindset to make great deals possible.

Our Story

Our First Deal

In September 2018, we were still in the early stages of building our rental portfolio. We’d acquired our first property through a turn-key provider, learning the basics through a relatively simple transaction. Shortly thereafter, we purchased our first duplex and were feeling rather cash poor (though energized by our momentum).

When our realtor brought us an incredibly priced 13-property portfolio, we knew it wasn’t one to miss. We also knew we had neither the funds, nor the experience, to manage an acquisition of that size all at once. Luckily, through our personal network, we found an investor looking to diversify their money market portfolio - and the idea was born.

Nick had recently finished Brandon Turner’s book on low/no money down deals, and had been exploring the concept of Seller Financing through Podcasts and online forums. This felt like the perfect scenario to give the concept a shot.

Through extensive conversations with the agent, we’d begun to better understand the seller’s needs. This out of state seller was looking to leave behind the hassle of long-distance investing, and needed to pay off the loan (though he wasn’t opposed to the idea of longer-term cash-flow). He also didn’t want to deal with vacating the properties, and repairing them to sell one by one on the NMLS, so he had a limited buyer audience. Nick floated seller financing to the agent (and spent time walking her through the concept, and why it could be a win for all) and the owner agreed - so long as we could meet his capital needs to pay off the loan.

And that’s where our partner came into the picture. We didn’t have the funds to cover the down payment, but our partner (who didn’t own any rentals at that point) was able to secure traditional financing and bring the necessary cash to the deal. After some negotiation, we landed at the following.

Today, we’re in the process of refinancing the properties into a commercial loan, capitalizing on the current low interest rates. In hindsight, with the leverage of a small buyer pool, we could have pushed for a longer term (or even better rates). Nevertheless, this was an awesome deal and we saw a big return on our time and creativity.

The Next Two

Buoyed by our good fortune on the first deal, we’ve done two seller-financed transactions in 2019, acquiring a four unit portfolio (independently) and a thirty-two unit portfolio (with a partner).

We’ve continued to bring a mindset of empathy, creativity, and mutual gain to the table in working with sellers - and this has earned us a reputation in our local markets. In fact - our third (thirty-two unit) deal came from the seller’s agent in our first acquisition, as she knew we could close.

That said, we’ve learned some hard lessons along the way. In our second acquisition, we structured the deal with four separate loans, one for each home (to simplify sales if needed down the line) and put them in Nick’s name. In doing so, we failed to realize this would count against our ten conventional loan limit. Turns out, no matter the lender, if it shows up under your name when a bank pulls your report - it counts towards your limit! (Ouch!)

We’ve also learned the value of maintaining relationships - and recognizing that the deal isn’t done once you close! Recently, we’ve been refinancing properties into commercial loans to capitalize on historic rate drops. We reached out to the seller on our third portfolio to discuss the possibility of refinancing with them for a lower rate and extended amortization. Keeping our loan with the seller is a win-win, as it simplifies the process for us and protects them from a massive capital gains hit (and protects their ongoing cash flow).

These have been exceptional opportunities for us to massively increase our portfolio, and because we’ve proven that we close, these deals will continue to find us. While you’ll see more seller-financing opportunities with portfolios, we add this option on every offer we make. You never know a seller’s motivations - and on the right deal - it’s an awesome win-win.

The Mechanics of Seller Financing

What is it?

In a seller financing agreement, the seller handles the mortgage process and carries the note, vs. a traditional financial institution. The terms are whatever you and the seller agree on, so you’re only limited here by your own empathy and creativity.

Why would a seller agree to seller financing?

When you’re looking for a seller who may be open to financing your purchase, you’re seeking some sort of distress that you can resolve. This might include:

• Property Distress - The property has fallen into disrepair, and the owner is not interested in or able to maintain(ing) it.
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• Capital Gains - If the property has appreciated significantly in their years of ownership, the seller will face significant Capital Gains taxes if they simply cash out. Seller financing enables them to spread this out over the loan term.
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• Large Portfolios - There is a small market of buyers for a large portfolio, and selling each unit individually involves kicking out residents and making costly repairs.
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• Time - Owners who self manage rentals often decide the burden is too much, and may want to get out quickly to reclaim their time.

In offering a seller financing option, you resolve distress by providing a solution to that pain - be it cash, ongoing passive cash flow, a quick closing, etc. The seller also now has a collateralized, cash-flowing loan, and the peace of mind that your debt is backed by a real asset (that they understand and value - as they’re the previous owner!)

Why should you consider it?

Honestly, after your first few deals, securing traditional financing becomes a bit like having a colonoscopy. By that - we mean it’s painful, time-intensive, and if you can find a viable alternative - you should.

As we’ve grown our business, we’ve faced hurdles like debt to income ratios, the conventional loan limit, and the down payments required for traditional financing. While we’ve identified commercial lenders who can work with us on residential properties - they’re hard to find, and certainly can’t offer the flexibility of deal structure you find with seller financing.

With seller financing, it’s all about understanding what’s important to the seller and to you - and building terms that work for both. We’ve done interest only, full term amortization, balloon payments - it’s really about crafting an agreement where everyone wins.

In other words, seller financing enables you to close on loans you couldn’t otherwise in a timely manner, allowing you to lock up great deals before they disappear.

When shouldn’t you do it?

It’s not a magic bullet - the fundamentals of real estate investing still apply. You still need a deal that cash flows (or has enough total return that it makes sense for you to feed it on a monthly basis.) Bear in mind, you’re looking for distress - so expect some deferred maintenance or challenges with inherited residents, and build it into your numbers.

Remember our mistake, and avoid putting the loan in your personal name - unless you don’t mind if it counts against your conventional loan limit.

And finally - you’re now tied to this person with an ongoing business relationship. You know Wells Fargo is easy to reach, and they’ll honor a written contract without question. Not always so with a seller you’ve just met. Make sure you feel comfortable pursuing a long-term relationship - and if you have any nagging concerns - think twice and look for another deal.

Pitfalls & Deal-Breakers

When first exploring a seller financing agreement, be sure to understand the current financing. If there is a bank loan in place, there will likely be a due-on-sale clause, and the loan will need to be paid off before seller financing can occur.

When negotiating terms, watch out for rates that break your cash flow (if you can’t afford to feed the deal). Even more critically, watch out for terms that are too short. Refinancing takes time - especially in a large portfolio scenario. If you can’t refinance with a year to go on the term, it’s likely not worth pursuing. You need a margin of error for things to go wrong (because they will).

Your Next Steps

If you’re inspired, and ready to look for your a seller financing opportunity, we can recommend a few next steps:

• 1) Network in your community and look for owners who have moved out of state, may be retiring, or who have dealt with tough recent evictions. These are all great candidates for a seller financing deal.
• 2) Look for portfolio and high-equity deals, as these are great candidates for seller financing.
• 3) Build your knowledge with Brandon Turner’s previously mentioned book on low/no money down deals, and continue your learning via forums and podcasts.
• 4) Specific questions about seller financing? Reach out to us in the comments below, we’re always happy to chat further about your specific situation.