Mobile Home Park Mastery: Episode 59

The Jekyll & Hyde Nature Of Economics In Deal Evaluation

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Nothing can make a mobile home park deal look more or less attractive than the numbers. Indeed, the economics have a Jekyll & Hyde ability to make any mobile home park investment change from a winner to a loser and back again at a lightning speed. In the third of a three-part series, we’re going to discuss how the slightest alteration of number assumptions can have a huge impact on a deal’s attractiveness. See how you have to be extremely focused on the numbers to know when a deal has passed from good to bad, or vice versa. These are economic patterns that need to be learned by any good park buyer.

Episode Transcript

We're in football season now, and it's amazing how games can often change so dramatically. There can be such a shift in momentum out of nowhere, and the same happens in many mobile home park deals you can evaluate. This is Frank Rolfe with the Mobile Home Park Mastery podcast series. We're doing the final of our three-part series on the Dr. Jekyll and Mr. Hyde attributes of some mobile home park deals. We're going to focus today on economics. How single things can so dramatically change your view of whether you want to proceed with the deal or not. We're going to identify what those are and why they occur.

The first one is the rent. Let's say you're looking at a mobile home park, and it's got a lot rent of $300 a month. Well, on the surface that doesn't mean a whole lot. That's not the critical data that makes it good or bad. The critical question is, "Where's the market rent at?" If the market rent is at $500 a month, and you're at $300, and that's definitely positive, so that's definitely a Dr. Jekyll moment because you're all excited that you can raise the rent so significantly. But what if the rent in the market is lower than the rent that you currently have in the park? So instead of a $300 lot rented in a 500 market, you're a $300 lot rented in a 200 market.

That would make you not want to buy the mobile home park simply because you can't raise the rent. You might even have to lower it over time, and even if you leave it as it is, the appraiser may lower your value anyway saying, "You can't be that much above market." So there's one Dr. Jekyll and Mr. Hyde moment on numbers is simply where the lot rent matches to the market. Another one is water and sewer. Is the water and sewer currently billed back? If the answer is "no", then you're Dr. Jekyll all excited because you know that you can probably go in and push the water and sewer back onto the customer. That's become common in our industry. It always should've been that way in fact.

Having people not pay for what they use is a bad system. It doesn't foster conservation. It doesn't even make any sense. Now many mobile home parks, moms-and-pops, they never elected to have this happen. However, that's probably not what you're going to do as a new buyer. If the water-sewer's not billed back, then that's great. You can go ahead and cut the water-sewer cost out of your P&L. But if it's already being billed back, then there is no opportunity there. So one makes you all excited about buying it, but the other makes you not want to buy it quite so bad.

Finally, are the vacant lots legal in the park? You know you only value the rent on the occupied lots, but are there any vacant lots? If the park you're looking at has zero vacant lots, then that's a big deal because you have no upside in filling lots. If it's got 10, or 20, or 30, or 50, then that again can change the whole economics of the deal. You can look at two identical mobile home parks for sale. One has zero vacant lots. The other has 10 vacant lots. The 10 vacant lot will look superior, and the zero may be that one little extra thing that makes you not buy it. So again, another Dr. Jekyll-Mr. Hyde moment.

Now another thing is on the costs themselves. There's a lot of different costs in a mobile home park, but there are only really two that are going to make you excited about buying it. One, water and sewer leaks. You'd be shocked how many parks we look at, mom-and-pop have let these water sewer leaks fester sometimes for years. The biggest one we ever looked at was in Kentucky. The park owner was letting the water and sewer leak at the rate of $5,000 per month because he had some crazy notion that it was impossible to fix it, and/or the cost to fix it would cost more than that $60,000 a year. That's completely crazy.

Somehow some plumber had got to him and played a mental game on him. He believed that these water and sewer leaks were all under the streets, so to fix them we'd have to rip out all the streets. Then fix the leaks. Then put all the streets back, so it would cost him hundreds of thousands of dollars to fix the leaks. In fact, we fixed the leaks almost immediately using a company called "American Leak Detection". Not one single leak was under his street, so he had wasted all that money for all that time. In fact, his streets were green with algae because the water had run for so long, and he could have fixed it so easily. So there is a Dr. Jekyll moment where you'd say, "Okay, I want to buy the park because it's got this big old water-sewer leak. I can fix that."

Another item is the manager. How much is the manager getting paid? If you say, "Well the manager's making $30,000 a year," then there may be no excitement as far as that being a cost-cutting center. However, if the manager's making $100,000 a year, as we've seen in some parks we've bought, and the going rate's 30,000, then there's obviously big savings there. So when you're looking at the cost-cutting items in the park, sometimes they can be very exciting, and then sometimes not so exciting at all.

Let's move on to park-owned homes. Now these are probably the biggest single source of Dr. Jekyll-Mr. Hyde changes in momentum when you're going to buy a park. Mom-and-pop tells you, "Here, this park comes with 10 park-owned homes, 10 homes that we own, mom-and-pop owns, we're going to convey to you at closing, and you can then rent them. You can sell them. You can do whatever you want to do on them." Well, here's the first big question, "What will it cost to fix them?" If I say that that 1980s mobile home is worth $7,000, but it needs $8,000 in repairs, then that home isn't much of an asset. I'm going to lose $1,000 best case on that home, so that's not any good. If it's however a $7,000 home, and needs no repair, then it's an asset that's worth $7,000. So the cost to fix the homes is absolutely imperative.

The next item is, "How big is the spread between the lot rent and the home rent?" We have found that to truly pull off effectively the sell-off of those mobile homes to the customers, there has to be a $100 differential between their total all-in cost of home and lot versus lot only. If you don't have a $100 differential, then they don't want to own it because they want you to pay the tax, insurance, and cost of repair. So you've gotta have that delta built in. If you look at a park, and the market lot rent is 400, and the homes are renting for 425, then that's a Mr. Hyde moment, because suddenly your momentum has shifted.

"Oh Gosh. I don't know what I'm going to do with the homes because I'm probably going to have to lose every customer. No one's going to want to own them to save $25, and as a result I'll have to go in there and fix them, and rehab them. It'll cost me thousands of dollars, and run the ads, and show them." So the momentum has obviously been dramatically changed. Another item is the simple fact that there are park-owned homes. Many times momentum changes in the deal. Then it goes from Dr. Jekyll to Mr. Hyde simply because the pain and suffering that you have to do to unload those homes. Mobile homes are not super simple to do. You know?

Renting lots is super easy. You don't have to do anything but rent the ground, have access to working utilities, pothole-free roads, and you're in business. But when you get into the homes, it's a whole nother matter. You have to know all the laws on minimum habitability, warranty, often get your dealer's license. You've got to run the ads, answer the phone, set up showings, show the homes, sell the homes, repair the homes. So it's a whole nother matter, and sometimes you totally change the momentum simply by inclusion of park-owned homes, so that's a big deal. Another thing that can change momentum dramatically overnight is, "Where is the lot rent of the park in relation to the market?"

The reason that's such a big issue with park-owned homes is the only positive they have is the ability to reset rent internally. Think about that for a minute. If the market for a mobile home park lot in your market is 350, and mom-and-pop have priced them at 150 on the privately owned homes, on those park-owned homes, you can reallocate that to a full 350 day one. You don't have any notice provision. There's nothing, because it's all internal just to you. However, if your lot rent is above market or in line with market, then there's really no way to increase the lot rent, and that takes the only single positive out of the homes away from you. Again, totally changing the momentum. Going from a Dr. Jekyll to Mr. Hyde moment simply because there's no way you can internally reallocate the lot rent any higher than where it was at.

Now let's move on to the macro financials and how those can suddenly change a deal from good to bad. The first is, and this is very basic, if you're going to succeed in the mobile home park business, you've got to have a spread. That spread is a differential between the interest rate on your loan and the cap rate. A healthy park has a three point spread. A three point spread, which means buying it at let's say a nine cap, and financing it at a six cap. That three point spread will yield about a 20% or greater cash-on-cash return. That's very vital. That's what most people in the industry are after is 20% cash-on-cash return.

Obviously, that's great because in a market where CDs are paying 2%, that's like 10 years in one every time you get a mobile home park as opposed to competitive investment vehicles. However, some parks don't have a three point spread. There are parks out there that you'll see publicly advertised. You'll even get little postcards in the mail once you get on the brokers' lists. It'll say, "Yes, this park was sold. It was sold at a ..." say a six cap. Well, if it was financed at a five and sold at a six, that's only a one point spread. That's not very exciting. You can't really make any money at a one point spread.

Typically, if you're not getting a three point spread, you're not going to hit your 20% cash-on-cash return number, so that may totally change your momentum on the deal. When you run the cap rate, even though you like the way the park looks and other attributes, you get a hold of the cap rate, and the cap rate, again, is a fraction. It's the net income over the cost of the deal, and you divide the net income by the cost of the deal. When you derive that cap rate, and then look what it will cost to finance it as far as interest rate, if you have less than a three point spread that may sour you on the deal.

It becomes more of a Mr. Hyde moment where you want to drop it. However, when you derive the cap rate against your financing, you might have three points or greater, which is a Dr. Jekyll moment. Then you'll want to press forward. Also remember that different deals have different interest rates. The big conduit lenders, the agency lenders, they use lower interest rates than most of your small town banks, so that could have some impact on it. Yet there's also one more item. How much can you push the rents?

If you're looking to buy in a mobile home park at a five cap, but you can push the rents almost immediately up where you're now at a seven or eight cap, then you have your three point spread back. But that three point spread is a huge barometer of your enthusiasm in buying the deal because if that spread is very small, it's going to sour you on the purchase. But if it's large, at least three points or greater, then it's definitely going to make you want more enthusiastically to buy it. Now this next one is really interesting because you can take almost any deal out there and change the momentum, and change it from a Dr. Jekyll to a Mr. Hyde, and back and forth on who carries the debt. Most people in the industry are desirous of that known as "seller financing". That's where the seller acts as the bank.

They provide all of the debt on the deal. We prefer those. In fact, that's how I got in the industry. That's how Dave got in the industry. I had never seen before the availability of seller financing. It's so prevalent in the mobile home park sector that that's really what gets a lot of people attracted. So many times if you're not totally thrilled with the deal, it's average, it's not really compelling, and you suddenly throw on the availability of seller financing, that can often push the momentum totally in your favor into buying it.

It's a total Dr. Jekyll-Mr. Hyde pivotal moment whether mom-and-pop will carry the paper. So when you're looking at a deal that is just average, sometimes you can change that by saying, "Hey, mom-and-pop, I'll still buy it if you carry the paper," and that'll push you over the top. It could also pull the rug out from under you. If you thought that mom-and-pop were going to carry and they suddenly change their mind and don't want to carry the paper, that could very well scuttle the deal. So that's a very, very pivotal item.

Finally, how much down you're going to put. There's an old saying in the business that, "Any deal can be cured with zero down non-recourse debt." You know, that's not far off. That is kind of true. People will do crazy things to buy deals with zero down, which means no out-of-pocket cost and non-recourse debt, because what it means is you have nothing at stake in the deal. I bought a park once in San Angelo, Texas, and that's exactly how it was pitched to me. Zero down, non-recourse. Why would you not do it? Now it had all kinds of problems. It had 70 abandoned homes in it. It only had one resident in it. A complete total mess.

But the very fact that I could tie it up with zero down, and non-recourse debt, and give it back any time I wanted for free, was all it took to push me over the top to want to do it. Often you will do that. Now there are limitations to that. Zero down non-recourse debt is not going to save you if you buy a property that's environmentally contaminated because they can still come after you. I wouldn't do it in a million years if the park is completely illegal because you might be sucked into all kinds of litigation, and that costs you money. But many times on the deal that's marginal, it's average, it's a Mr. Hyde, you don't really think you want to do it, you can suddenly switch back to a Dr. Jekyll positive moment simply by the offer that you can buy it now for zero down.

Zero down is key. Now you'll notice I also said "non-recourse". That's because the zero down deal with recourse doesn't get you anywhere. That means you put no money down, but you still have everything at risk in the thing because if the deal goes south, you have to pay the differential between the loss and what it sells for at auction and what you had it bought for. However, zero down non-recourse, that alone can sometimes make you do things you wouldn't normally do, and that alone is the most pivotal Dr. Jekyll and Mr. Hyde moment in any mobile home park you'll look at buying.

This is Frank Rolfe with the Mobile Home Park Mastery podcast series. I hope you enjoyed our three-part series on the Dr. Jekyll and Mr. Hyde things in mobile home park purchasing that can totally swing the deal from a "I want to buy it" to "I don't want to buy it." We'll be back shortly with some new and exciting topics. Again, thanks for being here, and talk to you next week.