There are few things more attractive about the mobile home park business than seller financing. Non-recourse seller financing allows the buyer to escape the hassle and scrutiny of bank lending, while at the same time offering some degree of insurance against fraud (you have not yet paid the seller in full), the ability to give the park back and walk clean in the event of catastrophe, and often includes a below-market interest rate and longer loan term.That being said, there is a trap often used by sellers that is baited with seller financing, and it is important to always be aware of, and stay clear of, this danger. The trap begins with a seller who is having trouble finding a buyer. Maybe the park's vacancy is too high, maybe the location is too rural or in obvious decline. Whatever the cause, the seller can either sit on the park for an eternity, or find a creative way to attract a buyer. And what can be more attractive to a buyer than an easy to qualify, below market interest rate loan. Of course, there's nothing wrong with a below-interest rate seller note. But not when it is used as a trap. And many times, that's exactly what is being set. You see, the seller knows that the park will never hold up to the scrutiny of a bank the appraisal, the independent review of the numbers, even the negative logic of the loan officer. To keep you from finding out that the park is overpriced, or in a bad neighborhood, or basically completely unable to be financed, the seller offers to carry the loan and cuts the bank out of the loop day one. That's the first leg of the trap. The second part of the trap is to bait the deal with a super low interest rate to make the park look like it is a profitable investment, even though it could never carry a regular bank debt load of the same size. If a park is a 4% cap, then what better way to disguise the poor performance than with a 2% interest rate on the mortgage? The seller is effectively cooking the books with the buyer's blessing. When you accept a cash-on-cash return that is spiked by ridiculously low interest rates, then you may be getting into trouble.
The final part of the seller trap is to offer only a short loan term, maybe two to five years, and the below-market interest rate for only the first year or so. What this does is to put the buyer in a negative cash-flow situation almost immediately, and force the round of bank loan requests that normally end in nothing but rejection. Faced with the loan coming due, and no bank loan prospects, the buyer often gives the park back to the seller, less his 20% down payment. There are sellers out there who have sold the same park two or three times under this framework, garnering 60% of their purchase price in down payments, and still owning the park. So how do you avoid this trap? It's easy.
- You should never run your numbers based on any scenario other than one that considers legitimate bank debt.
- And never buy a property without finding out, with great detail, that it could have a real bank loan if needed.
Seller carry should be treated as gravy an extra perk but not a structural part of the deal's economics. If the park could support an 8% interest bank loan, and the seller offers 4%, then that's an extra spike on your yield until the loan runs out. But you should always run the financials as if a bank loan is involved. So the next time you see a deal with seller carry, make sure you don't get sucked into a trap. Stay conservative and rational, and run your numbers based on a real bank loan. Because, sooner or later, that's how your deal will ultimately be judged by a buyer or lender.