"Upside Opportunity": A Community Lender's Perspective
by Tony Petosa and Nick Bertino
As cap rates continue to compress, many investors are having difficulty finding worthwhile returns on stabilized manufactured home communities. Cap rates have been as low as 6% and sometimes lower for high-quality, well-located properties in major metropolitan and destination markets. As a result, many owners are contemplating making investments in communities that they believe have upside potential. These would include communities with higher vacancy rates, some with a high percentage of park-owned homes and also properties with expansion potential.
Many investors are now asking questions with regard to how lenders will approach these "upside opportunity" properties from an underwriting perspective. Listed below are some common questions, along with responses.
Q: I am considering buying a community with 50% park-owned rental homes. How would a lender underwrite these homes?
A: Lenders prefer communities with resident-owned homes. When residents own their homes they have a vested interest in the home and the community typically reflects "pride of ownership." That being said, a high concentration of park-owned rental homes within a community does not necessarily mean that the property will not qualify for financing. However, there are some underwriting guidelines or adjustments to take into consideration.
Park-owned rental homes are personal property and, as such, lenders typically do not want them as collateral for a loan they are making on the community. Because of this, when lenders are underwriting cash flow from a manufactured home community, they will usually give credit for site rent only and will not include extra income derived from the park-owned rental homes. Obviously, this will have a negative impact on the resulting cash flow available for underwriting a loan. But all is not lost. On the expense side, for instance, underwriters need to remove any expenses related to the operations of the park-owned rental homes. This adjustment helps offset some of the underwritable cash flow lost as a result of removing the excess income from the park-owned rental homes. To make this adjustment a simple one, it is helpful if the owner can separate the expenses related to the rental homes on the operating statements. Such expenses can include repairs and maintenance, supplies, personal property taxes, and even payroll for personnel working on the homes. After removing both income and expenses related to the park-owned homes, the resulting cash flow number is what the lender will use to determine what loan amount the community can support. Often times the specific income and expenses related to the park-owned homes are about even.
Q: I want to purchase a property that is currently 25% vacant. Will anyone lend on a property with that much vacancy?
A: In recent years, lenders have required a minimum stabilized occupancy rate of 85%-90% for a property to qualify for a permanent loan. However, a property that has been operating below that occupancy level may still qualify for permanent financing. A lender that actively finances and understands manufactured home communities is likely to be more open to this scenario. For example, assume that the community in question is located in an overbuilt market and has been running at 75% occupancy for several years. In that case, one could make the argument that the property has "stabilized" at 75% occupancy. In other words, an underwriter would be relatively safe in making the assumption that the community will continue to operate at a 75% occupancy rate in the foreseeable future. When underwriting the property's cash flow, the lender will simply apply the actual vacancy rate of 25% to the gross potential income when sizing the loan amount.
A bigger concern for a lender would be a property whose occupancy is declining year over year. In a situation like this, it is difficult for a lender to determine if the drop in occupancy will continue. The perception or assumption is often that it will decline further. But when a property has consistently operated at the same occupancy level year after year, the lender will be more comfortable with the assumption that it will operate at that same occupancy level going forward. In general, it is helpful to outline in the loan request package a plan for addressing vacancy. This often includes setting up "model" homes and outlining financing sources, possibly provided by the community owner, available to the residents.
Q: I just purchased a property that is 30% vacant. Instead of moving in new homes, I am going to rent out the vacant sites to short-term RV tenants. Will lenders give me credit for RV income?
A: Yes. Renting vacant mobile home sites to short-term RV tenants is an excellent way to capture additional income. Furthermore, this is an income stream that lenders have been willing to give credit to in terms of underwriting cash flow. Generally speaking, lenders will underwrite short-term RV income based on the most recent twelve-month period of collections. This works most often in seasonal markets such as Arizona with high demand for RV sites. In seasonal markets there is usually less of a management or resident concern related to RVs being placed among residents occupying sites with existing manufactured homes.
Q: My community has room for expansion, but it will be several years before this happens. What financing options are available?
A: You should consider separating your property into two separate parcels: one parcel consisting of the existing sites and one expansion parcel consisting of the to-be-developed sites. This enables an owner to obtain attractive, non-recourse permanent financing on current improvements while not encumbering the expansion parcel. This way the permanent loan is underwritten based on cash flow from existing sites. There would be little benefit gained by including the expansion parcel in the permanent loan collateral since unimproved land does not generate cash flow. If the value of the existing "operating" property supports the loan request, there is simply no reason to include the expansion property. Actually, there is every reason to exclude the expansion parcel since it is "trapped" by the lien of the mortgage, and at best is subject to release requirements. There may also be prepayment penalty considerations. By putting in place cross-easements and reciprocal use agreements (should there be any common amenities or facilities that benefit both parcels), the owner can finance the expansion parcel later with a separate construction or bridge loan and, thereafter, its own permanent loan.
Tony Petosa is Regional Director and Nick Bertino is Associate Director for Wells Fargo Commercial Mortgage. They specialize in arranging financing on manufactured home communities and RV resorts, offering both direct and correspondent lending programs. Petosa and Bertino can be reached at 760/438-2153; 760/438-8710 fax; and via email: anthony.j.petosa@wellsfargo.com, nick.bertino@wellsfargo.com.
