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The Two Very Different Types of 1031 Exchange Sellers

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When buying investment properties, it’s very common to encounter Sellers who are going to do a 1031 Exchange when they sell. But did you know that there are two very different categories of 1031 Exchange Sellers…each of which having very different motivations? As Thoughtful Real Estate Entrepreneurs, we always Solve the Person, so it’s extremely important we understand which of the two categories our Sellers fall into. In this episode, Jeff describes the two types, and explains the unique opportunity and power that each of these Sellers give us.

Episode Transcript

When you’re dealing with sellers, you often come across people who say they’re going to do a 1031 exchange. Well, that’s a good insight to have. But the truth is there are two different types of sellers who are going to do a 1031 exchange. Two types, two totally different motivations. And it’s really important that you understand the difference between those two and you understand which one your seller is so that you can navigate this situation to the best of your ability and understand the power that you have in each negotiation as a result. Let’s cue up the theme song we’ll dive right into talking about 1031 exchange sellers.

Welcome to Racking Up Rentals, a show about how regular people, those of us without huge war chest of capital or insider connections, can build lasting wealth acquiring a portfolio of buy and hold real estate. But we don’t just go mainstream looking at what’s on the market and asking banks for loans, nor are we posting We Buy Houses signs or just looking for “motivated sellers” to make lowball offers to. You see, we are people-oriented dealmakers, we sit down directly with sellers to work out win-win deals without agents or any other obstacles, and buy properties nobody else even knows are for sale. I’m Jeff from a Thoughtful Real Estate Entrepreneur. If you’re the kind of real estate investor who wants long term wealth, not get rich quick gimmicks or pictures of yourself holding fat checks on social media. This show is for you. Join me and quietly become the wealthiest person on your block. Now let’s go rack up a rental portfolio.

Thank you for joining me for another episode of Racking Up Rentals. Show notes for this episode are at www.thoughtfulre.com/e71. Please do us a big favor by hitting that subscribe button in your podcast app, it really does make a big difference in helping other fellow thoughtful real estate entrepreneurs to find us. Onward with today’s episode.

So there are two different types of people who are going to do a 1031 exchange. And it’s really, really important that you understand which of the two buckets your seller falls into. And as soon as you do understand that you have a lot more power in the negotiation. So first of all, why do we even need to talk about this? Well, we need to understand our audience, this part is so lacking in kind of normal real estate, especially when you’re buying properties that are listed. And you don’t really get the chance to know anything about the seller. But we as thoughtful real estate entrepreneurs, we need to understand our audience. This is part of a process that we call solving the person and we say we have to solve the person before we can solve the deal. And each person, we just need to understand what is it that they actually want. And nobody wakes up and says you know what I want to do, I want to do a 1031 exchange, you know, nobody wakes up and says I want a drill. Now they’re thinking I want a hole. And there’s a reason why they want the hole. Well, no one wants a 1031 exchange, they want what they think the 1031 exchange is going to get them. And that is key to what we’re going to talk about in this episode. Because when you understand your audience, you can navigate those conversations better. And you can understand your own leverage in the negotiation far better, because you understand your role in how this transaction is going to play out better. So let’s just dive in, we’ll talk about this.

This is not complicated at all. But it’s something that we don’t talk about very much in my experience at all. And if again, if you are buying listed properties and working with real estate agents, hey, nothing, nothing wrong with real estate agents, I have a real estate license myself, but it’s just completely different thing. And in most cases, you would have no idea which of these two buckets your seller falls into when you are arm’s length away from them in a listed transaction. So here’s the first category. The first category is they’re selling this property that you’re talking to them about buying, they’re selling it because they want to buy something else, right. So they’ve got their eye on this other property, they think oh my gosh, I would love to have that property, or this is an amazing opportunity, I can make a lot of money off that property or whatever it is, they’ve got their eye on a replacement. And in order to buy the replacement, they actually have to sell this property first. And they have to sell it with the deferral of capital gains that are have to write a big check out of their proceeds for that. So they’re selling this property now to enable their ability to buy something else. I would say this is probably the smaller of the two categories, maybe say 20% of overall sellers, but I would guess that the other 80% the far majority of sellers I talked to are in the second category. And the second category is kind of the opposite of the first category, whereas the first category is they’re selling this property to enable their ability to buy something else. In this case, they’re selling this property because they want to sell this property. And then they need to go and find a replacement property. So these people are really trying to get out of the property they have now, and then they say, well shoot, I really don’t want to deal with this capital gains thing. So I better go find a replacement property to exchange into.

So let’s just broadly compare and contrast right, the first people, they’re selling to buy something else, they’re moving toward something, whereas the second people, they’re moving away from something, they’re selling the property because they just don’t want to own it anymore, for whatever reason they might have. And they need to go find a replacement. So if you think about this, just broadly, in terms of like what each person wants the first category, they want something new, they want to buy this other property, the 1031 exchange as a means to that end. But the second group, what they want, is they want to get away from what they currently have. They what they really want is to not have what they have anymore, but then they feel like they have to go find a replacement property. So their want is not moving towards something, it’s actually moving away from where they are right now. So two really totally different scenarios and mentalities for each of them. And of course, if the better you understand your audience, the better job you can do, helping them get where they’re going. And the better you can help them get where they’re going, the better you can craft a deal, that’s going to create a big win for you as well.

So let’s talk for just a moment about what is your leverage in each of these two situations, because your leverage is definitely present in both of these, right? If we stop and say, Well, okay, which is better for us as a buyer, category one, or category two? I would argue that they’re both great for us in just two completely different ways. So what is your leverage in each of these two situations?

In the first category, these people are selling their property because they want to buy something else. And if we come along, and we are their buyer, then we are a key character in the overall story that is enabling their vision, right, they’ve got a, I’m thinking of a watch the Super Bowl last night. So I’m thinking of a coach standing on the sideline with a binder full of you know, plays, and they’ve got their play drawn up, that’s going to allow them to buy this new property that they want to own. And you now are a key one of the x’s or the O’s on that play sheet, showing them how they’re going to get to where they’re trying to go. And when you are a key player, now you have some power in the whole situation. Now, I want to note, when I say power, I don’t mean that we are finding power. And then we are going out and turning the screws on people to exert power. But it’s very important to understand the leverage that you have in any situation, even if you don’t need to or choose not to use it, understanding that it’s there is very, very important. And there are lots of ways that we can very silently make our power powerful. By without exerting the power, the seller understands your role and how important you are in the whole transaction to and then you have more say in how things go. So let me give you a quick example.

I’ve once bought two properties from a guy. So when I sent him a letter, it was about property a, and he called me back and he you know, we just started doing our normal thing where we’re talking and I’m seeking to understand my audience, I’m trying to solve the person. And in this conversation, of course, I find out that he has another property in my city too. And he lives out of town like 800 miles out of town, like a long way. And he’s got two properties in my town. And so of course, I asked him, Well, would you be interested in selling this other one too, because I once I found out where it was, I thought, Gosh, these are both great locations. And he said, Yeah, you know, I might. And as we talk more and more and more, what I found out is that he had his eye, he and his wife had his eye on a property on the coast of California. And their idea was they wanted to sell these two properties in my city. And they wanted to 1031 exchange them into this property on the coast in California. And then they were going to do short term rental with that property for a few years. And then ultimately, they would convert that property from being an investment property to being a personal use property. And so they had this great vision, but they had to absolutely had to sell both of these two houses in my city in order to accomplish this idea. And they had a very specific property in mind, and it wasn’t going to sit around waiting for them forever. They had to get it figured out. Well so here I am, in the city where the two properties are 800 miles away from where the guy lives the seller and I have now put both property’s in contract with separate purchase agreements. And he now needs me to perform on both of these deals, I have to sort of land these two planes more or less simultaneously in a coordinated manner. Because if I didn’t, then he would not be able to accomplish his goal. So that gave me a lot of power.

Now, again, I didn’t exert that power in any kind of, you know, negative way. But it definitely the subtext of the situation was such that when I went back to him, after my due diligence period, I said, you know, what, we found this little problem in that little problem, I’d like to adjust the deal in the following ways, he didn’t have quite as much ability to just turn his nose up and walk away, because he really needed me as much as I needed him. And that creates a great, powerful situation. And ultimately, we closed both of those deals, he got all of his 1031 exchange money and proceeded to do his deal. So a better happy outcome for everybody involved, but a very interesting dynamic, because he needed my cooperation and my performance, my dependability, and whatnot to execute his plan to buy the thing he wanted to buy.

But on a different note, our category number two, these are people who are selling their property, because they just don’t want to own it anymore. And that that could be for lots of different reasons, right? Maybe they just don’t want to be landlords, maybe they feel the market is about to correct, maybe they’re moving or whatever it might be, they’re selling because they want to sell. And the important part is not the exchange for them. The important part is the deferral of capital gains in the process of moving away from this property that they currently own. And so what is your leverage in that situation that well, what you actually have the possibility of doing is taking this seller group and redirecting them towards something that would be far better for us and potentially far better for them. And that is a seller financing agreement in the form of an installment sale.

Now, an installment sale is something that a seller can use to sell their property in a way that will achieve many of the same things as a 1031 exchange. Now, it’s not identical, per se. But if the goal is to not get all the capital gains bill at one time, which is a very simple way of putting it than the installment sale, it can be a great tool to help accomplish that, as well. So there have been many, many sellers. I mean, probably the majority of the sellers, I have bought properties from have been in this situation where they wanted to sell the property that they owned, and they kind of felt obligated to do a 1031 exchange. I’ll give you a quick example.

Just from a few months ago, my seller came to me and said, I want to sell this property. And yes, we’re going to do a 1031 exchange. I said, Great, what is it you are excited to buy? And he said, Well, you know, we haven’t figured that part out yet. But we just, we think we want to get out of this city because the landlord tenant laws are changing. And I think we can get better rent over in this other area. And I said, Okay, okay. But I noted he didn’t say he really wanted to buy something else. He just wanted to get out of this property and kind of felt like he was handcuffed and had to do a 1031 exchange. So throughout this process in this conversation, I of course, bring it back around. And I said, you know what, let me just bounce an idea off you here. I noticed that it doesn’t sound like you’re really excited to buy the next property, you’re just kind of more excited to get rid of this one. But it seems like the capital gains deferrals an important point. What if there was a different way to do this? What if we use the installment sale structure and I gave you a down payment, make monthly payments to you each month, and that would kind of allow you to accomplish much of the same thing, but without needing to go to the extreme effort of finding a replacement property, and then just being a landlord in a different sense. And now maybe from long distance, that doesn’t sound like a lot of fun. Do you agree with that meet your needs better if maybe I just helped you defer your capital gains through the structure of our transaction? And of course, after a little deliberation, and his clarification questions from him, and him talking with his wife more, they said, they said Yeah, actually, that sounds like it makes a lot of sense.

So to sum up these points of leverage in group number one where the person is moving towards a new property, your leverage there is that they really need you to perform. And that gives you power in the negotiation dynamic and maybe making adjustments in the due diligence period, etc. Whereas group number two, these people who are moving away from their current property, and just feel like they don’t really want to do a 1031 exchange, but they kind of feel like they have to, this is an excellent opportunity for you to redirect that energy that they have towards capital gains deferral into a structure that you might like better as a seller.

So my friends, there are two types of 1031 exchange sellers and they are really, totally different. from each other, you almost might say they’re totally opposite from each other. And while the rest of the world is out there, you know, putting blindfolds on and grabbing darts, darts would be offers in this metaphor and throwing them at a dartboard or hoping to even hit the dartboard at all. Not understanding what they’re trying to hit, or the audience who represents the seller of this property. That’s not what we’re doing. We’re dealing directly with our sellers, we are understanding them to the best of our ability and knowing the difference between the two types of 1031 exchange sellers makes a big, big difference.

And with that, that concludes our episode today of Racking Up Rentals. So again, show notes for this episode are at www.thoughtfulre.com/e71. Please do us a big favor by hitting that subscribe button in the podcast app. And if you are feeling charitable, even go a quick step further. Take about 45 seconds and just write and review the show on Apple podcasts or Spotify or wherever you listen to it. That’s super helpful to us as well. And I’m very, very grateful.

Did you know too, that we have a Facebook group for us TREEs as thoughtful real estate entrepreneurs? It is called Rental Portfolio Wealth Builders; and we would love to have you join us over there. Just go to group.thoughtfulre.com and you will be redirected right to that page where you can hit the Join button.

Hey, if you liked this episode, please take a screenshot of it, post that screenshot to Instagram and tag us. We are @thoughtfulrealestate.

So I’ll see you in the next episode. Until then, this is Jeff from the Thoughtful Real Estate Entrepreneur signing off. Thanks for listening to Racking Up Rentals where we build long term wealth by being a win-win deal makers. Remember solve the person to unlock the deal and solve the financing to unlock the profits.

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