Negotiating Seller Financing: The Definitive Guide
I love seller financing.
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No bank, no recourse, no fuss.
Unfortunately, finding sellers willing to offer financing is not easy, but it's worth the pursuit. Seller financing is probably more common to my real estate investment niche (mobile home parks) than others, but just about any deal with a low existing loan balance (or owned free and clear) has the potential to be a seller-financed deal.
So, how do you convince a seller to carry back a note?
Get in the Mind of the Seller
Talk with the seller and try to shake out his/her priorities and concerns.
If the seller only wants you to speak with the broker, not a problem, you can still get a lot of the information you need to cater your offer to the seller’s priorities.
Perhaps the seller has a forthcoming loan maturity and is concerned with surety of closing / execution, which becomes more of a priority during recessionary markets or when pursuing distressed deals.
Perhaps the seller is going to execute a 1031 trade and need some flexibility on the closing timing. The vast majority of the time, it’s going to be all about price, but you never know so it’s always best to ask.
If I have the opportunity to speak with the seller directly, I also ask what he/she plans to do with the sale proceeds. The goal here is to get the seller talking and hopefully they’ll give you some ammo to better position your seller-financed structure.
If the seller is not going to execute a 1031 trade, is not looking to immediately use the cash and is just going to put the funds in a savings account earning next to nothing, seller financing becomes a compelling alternative.
Just be sure to use the soft sell here â it's tempting to try and tell the seller that he'd be crazy to pay the taxes and put the money in a money market account earning next to nothing instead of receiving a dependable stream of loan payments from you. Instead, just ask pointed questions and listen.
Once you’ve determined the seller’s priorities / concerns you are in a better position to not only win the deal, but perhaps steer the seller towards carrying back paper via a first or perhaps a second (if your bank will allow it) mortgage.
Bond With the Seller
If you’re lucky enough to deal directly with the seller, don’t be shy – set up a call or two.
Talk about other things besides the deal; ask questions about how he got into real estate investing, etc. This isn't disingenuous, it's just good business. You're asking the seller to award you the deal AND give you a sizable loan to purchase the property, it certainly won't hurt your odds if the seller happens to like and even trust you.
Regarding trust, make sure you put your best foot forward. The seller’s worst nightmare, is that you are going to take over their beloved property, run it into the ground, default and then give him back a problem asset with negative cash flow.
This is especially true if the seller is retiring and is using the loan payments to fund their golden years. They might not have the energy or desire to turnaround the property.
Consequently, we make sure we share a lot of detail with the seller regarding our operations, background and business plan for the property. Once again, this is a soft sell, we are just trying to look as professional as possible and demonstrate how much thought we’ve put into the turnaround plan.
Okay, but what if the seller and broker still says they want an “all cash” offer?
Make Two Offers
When targeting a mobile home park deal, we often make two offers, one for an all cash deal (you’ll go out and secure your own financing) and one that includes a seller carried note.
The seller carried note offer needs to be more attractive on one or more points for the seller to take the bait. Typically this is a meaningful higher price than your all cash offer, but as discussed perhaps the seller has some other concerns that could be addressed in the seller carried offer.
Often sellers just get fixated on a number and will not sell until they hit that number. If you are able to secure below market debt terms with a longer maturity via seller financing, you might be able to pay the seller slightly more than market and hit his/her number while still achieving your return targets.
The key here is to run your numbers and try to set the terms of both offers to where you are indifferent to which offer the seller chooses. Of course, we don't pursue this strategy if the seller has a sizeable existing loan, but if you know the seller could carry a note, why not ask?
If you are fortunate enough to secure attractive seller financing on a deal, make sure you don’t relax your due diligence efforts.
Without the watchful eye of the lender lurking over your shoulder during the closing process, it’s easier to miss a red flag.
The lender will have several (risk adverse) people look at just about every aspect of your deal and (if it’s a commercial deal) will require a phase 1 environmental report, perhaps a new survey, an appraisal and typically a property condition report, all of which are deal screens that help ensure a big problem is not overlooked.
These reports are not really needed for seller-financed deals (but make sure you get the phase 1 report regardless!) so step up your diligence to avoid a disaster acquisition.
Furthermore, be weary of the seller that secretly wishes you crash and burn so he / she can foreclose the mortgage, take back their asset and keep your down payment. These sellers are rare, but they do exist. Remember, the seller knows a lot more about the property than you do, so if they are bending over backwards to sell you the deal, double check your due diligence before signing the docs.
While certainly difficult to find, a properly priced seller financed deal is a beautiful thing, especially if you don't have already have numerous banking relationships and would prefer to forgo the slow torture that is the loan underwriting and credit decision process.
The best way to find seller financing is to ask for it in every offer you make. Eventually you’ll find a seller that would prefer the fixed payments to a taxable lump sum at closing.