Why do so many sellers reject my offer, when I ask for owner financing?
Aha! You’ve stumbled onto one of the largest disadvantages of buying real estate investments with owner financing. Sellers hate it. Most of the time, they’ll only accept your offer if they have no other choice. If you’re competing against another buyer with cash or talking to an unmotivated seller, your request for owner financing is just about pointless. Sometimes, it’s also impossible for them to owner finance your real estate investment. Consider the three scenarios from the seller’s perspective:
Two Buyers Want the Same Real Estate Investment
Imagine two investors approaching the same seller. One is offering a big, fat earnest money check and the other only has five dollars and a promise to pay later. Which buyer is more attractive? The one with cash. Frequently, a motivated seller will reject your request for owner financing in favor of an all-cash offer, even if your offer is higher.
The reason is simple. In real estate investing, cash is more than buying power. It’s credibility. If you don’t have it, sellers will reject your offers because they doubt your ability to close. You can be the most persuasive buyer in the world, but in the end, your cash (or lack of it) speaks louder than you do.
The Seller Is Unmotivated by an Owner Financing Offer
Your seller may be willing to cut the price… but only if you pay them in full. For example, I’m negotiating with a 86-year-old investor right now that is ready to liquidate his sizable real estate investment portfolio. He doesn’t care so much about the price; he just wants to close fast and move on with his life. There’s no way in hell he’s going to finance any of the purchase. He would pass away before the loan matured.
Banks have a similar perspective. Some people believe that a bank will offer them 100% financing for their real estate investment. But it rarely happens. One person already defaulted on the home, and the bank is ready to cut the property from their portfolio. In exceptionally rare cases (and in exceptionally large deals), the bank will consider it, but in the past five years, I’ve only been offered financing once from a bank seller.
Your Motivated Seller Has Little or No Equity
Not all motivated sellers are against owner financing; some of them will want to give you financing but can’t. The reason is equity. The seller can only finance the amount beyond what they owe. For example, let’s say you find a motivated seller with a house worth $100,000, and they have a first mortgage of $50,000. They’re willing to sell the house for $80,000.
The most owner financing you can ask for is $30,000. Why? When selling a property, you generally have to pay off all mortgages and other liens. So, when the seller transfers title to you, they’ll have to pay off their $50,000 mortgage. That leaves them $30,000 to owner finance, if they want. It’s impossible for them to offer anything beyond $30,000, because then they wouldn’t be able to pay off their mortgage.
Many times, the situation will be worse. In situations where they are motivated to sell, few people have any equity. They’ll usually mortgage the house as high as possible in order to postpone their financial problems, leaving no room for owner financing. For example, the seller from above might owe $80,000, instead of $50,000. If you bought the house for the same price, $80,000, it would be impossible for them to give you any owner financing.
The Truth: Owner Financing Is Frequently Inappropriate
Make enough offers and you’ll discover that owner financing is fairly rare. Most of the time, you’ll run into a seller with no equity, compete against another buyer, or negotiate with a motivated seller that is more concerned with terms than price. In those cases, you’ll have more success with more traditional financing or an all-cash offer.
Am I saying owner financing is a useless strategy? No! You just need to know when to use it, as well as how to persuade sellers to see the benefits. Over the next two days, I’ll post the answers to the following questions:
How can I convince sellers to owner finance my real estate investment?
When I find a seller willing to owner finance my real estate investment, what terms should I request?
Jon,
I appreciate your point on the appropriateness of owner financing in many situation, and in my experience it is a little more available than your article suggests. I don’t think that this is because of less competition where I live (Cincinnati) but rather because owner financing is sometimes the best solution for the seller.
I have a lot of luck with creative acquisition because I have taken the time to fully understand how it all works. Since I understand the concepts very well, I am able to structure a solution to the seller’s problems. As you correctly state, though, the best solution is often a cash purchase. The key is to know how to provide the best solution for the seller - not yourself.
One very good example is your own negotiations with this 86-year-old who is liquidating his portfolio. Depending on his current capital needs, the best solution for him may be to sell on terms and not for cash. Many times an older investor will liquidate in order to get out of the headache, not the investment. If he would like to continue to receive cash flow but he wants to rid himself of the headache of being a landlord, then you can purchase the properties from him on a land contract (contract for deed). If he sells for cash he will have to pay a large amount of the proceeds to Uncle Sam in the form of capital gains and recaptured depreciation. On the other hand, if he sells on a land contract, he will only have to pay capital gains on the portion of payments made to him that represent principal and of course there will be some taxable interest gains as well. This can be much more palitable for someone than paying one HUGE check to the government. As an estate planning tool, this gentleman can allow the land contract to run past his death, at which time his capital gains would be wiped out and his heirs can receive the remaining principal of the land contract without tax (they still have taxes on the interest paid of course). Depending on his needs this may be the best solution.
Good example of how to use owner financing appropriately. And you’re right about concentrating on the seller. Still, you’re talking about a relatively rare scenario. How often do you find a motivated seller with equity that is willing to delay cash out for the rest of their lifetime? Doesn’t happen often for me. Also, motivated sellers will rarely offer me better terms than the bank on residential purchases. I’m borrowing right now at 1% interest. Few motivated sellers are willing to beat that.
You are correct that it is a rare case that a seller will defer their principal to their heirs, yet the concept alone opens a great discussion with the seller about the options available to them. Out of the most common ways to creatively acquire properties (sub-to, land contract, least/option) I do more land contracts than anything else. In my experience, I am able to receive very favorable terms if I just ask (as long as I am still solving their problem). The most motivated sellers don’t really care about interest rate but how they are going to get out of their problem. That being said, I usually place a 3% rate on the contract as I thought the IRS will assume a rate if none is given. I am amazed that you are borrowing at 1% right now. Have you thought of loaning back out and getting an interst rate spread. I am paying 8.5% and 1 point on my rehab loans and something around 5% interest only on my longer-term hold loans.