Daniel and I have bought over 13 properties using owner financing in 2017 alone! It’s a very powerful financing method that you can take advantage of but only if you know how to negotiate for them. The key is in the questions that you ask and the information you gather to quickly qualify to see if the deal has potentials for owner financing or not! For those who are still unclear about what owner financing is, there are multiple ways to do it. First, there is the subject-to, there’s the contract-for-deed, there’s the wrap around mortgage and so on. Depending on the situation, you’re going to have to use different sub-strategy under the owner financing strategy.
Before we go further, let me give you the context of how and why the owner financing should work. First, owner financing only works if there’s a benefit for the seller as well. If the benefit of owner financing outweighs taking the cash/buyer financing offer, you’ll have a deal. You have to be really good at showing why they don’t want to take the cash deal. There are many reasons but one that sticks out the most is the fact that the seller may have to pay a capital gains tax at the time of the sale. Capital gains tax only occurs when the seller is selling the property for a higher amount than their basis. Unless the seller is doing a 1031 Exchange or has a large loss carry-forward, the seller may owe capital gains tax if they end up taking the cash or buyer financing offer. One way for the seller to defer those taxes is through owner financing. So! Here are couple of questions to ask that will help you negotiate for the owner financing deals.
DISCLOSURE: I am not a CPA or an attorney so make sure you consult with licensed professionals to get professional advice on matters such as taxes or the law.
1. How long have you owned the property for?
This is a question to gauge whether there’s a likelihood for capital gains taxes or not. The longer the seller has owned the property, their basis may go down each year due to depreciation. For example, if a seller A owned a property for 2 years and seller B owned a property for 10 years, with the same exact property and the same exact numbers in play, seller B will more likely owe more capital gains taxes if they sell for the same exact amount. Therefore, the longer they have owned it for, you can later use that information to negotiate for owner financing.
2. How much did you buy the property for?
This helps us to calculate the seller’s basis. The basis is an accounting term to describe the “Current Book Value”. Which means, the basis is a number where we take the original purchase price (minus the value of the land) and divide that number by 27.5. Then, we multiply that number by the number of years that they have owned the property for. Now, we get figures that represent the total depreciation. We take the seller’s original purchase price and subtract it by the total depreciated amount that we calculated earlier. The resulting figure should be the basis. If the basis is $100k and the seller is wanting to sell the property for $150k, then the taxable income is about $50k for the seller. Depending on their tax bracket and their financial situation, they may owe up to 35% of that $50k for capital gains taxes. This another crucial information that will help us negotiate for owner financing.
3. If I gave you cash for this property today, what are you planning to do with it?
Another great question that you can ask. Sometimes, you may get an answer like “It’s none of your business”. Regardless what the answer is, you’re going to help the seller paint the picture of what could happen if you gave them a cash offer. You begin that by giving them a hypothetical. “Let’s say I gave you cash for $100k for this property, if you put that in your savings account, what percentage of interest would you earn? Like 1% right? How would you like to earn 4-5% on that money?” This is a great transition to the ‘owner financing conversation’. You’re getting your seller intrigued as to what you are about to propose. If you’ve asked question #1 and #2, and you know for a fact that they may owe capital gains taxes but still would like to collect cash flow without any of the ownership responsibility, you have a great situation for owner financing. It’s 100% up to you to negotiate this. Now, the closing question is, “Have you thought about selling this property on contract and deferring your capital gains situation? At this step, you won’t get an immediate answer and this is where the true negotiation begins. If they don’t say an immediate ‘no’, then you may have an opportunity to send them an offer. Before making any offers, make sure you have done your homework as to knowing what the comps are for the property and that it will cashflow for sure. Read my other article on “How to Analyze a Rental Deal”
Now obviously I can’t give you the entire training on how to negotiate for owner financing through a simple blog article. I’m going to break up the next few steps into different articles because there’s simply no way that I can fully explain the steps in one article. In fact, I have taken a 16 hour training on just how to negotiate for owner financing. You can get the training here: thekwakbrothers.com/learn
Stay tuned for the next few articles on how to finish negotiating for owner financing. I’m also going to include more questions to ask to the seller in the next part of this article!