So you’re looking at buying a mobile home park but the numbers and price just don’t equate. Some deals – as a last resort – can be solved with creative debt construction. But how does that work? In this week’s edition of the Mobile Home Park Mastery podcast series we’re going to focus on making deals happen with debt as the tool to tie the numbers together. You’ll see that there’s still hope for some deals if you can piece together an attractive debt structure.
Episode 117: Creative Deal Making With Debt Construction Transcript
In 2007, a giant mountain of single-family home debt, built on the premise that people make afford, suddenly collapsed like a house of cards and washed America into what is now known as the Great Recession. Now when you talk about creative debt, that's what people initially think of, and you can't blame them. It's been a big news story now for over a decade, but that's not what we're going to talking about today. And this is Frank Rolfe with Mobile Home Park Mastery podcast series. We're going to be talking about creative deal-making with creative debt construction. But not, in the matter of someone who cannot afford to pay for something, trying to figure out how to get credit to a later time when they might be able to make a payment or two. Instead, we're talking about when you have two intractable forces, mom-and-pop sellers who want a certain price and a buyer who only wants to pay another price. When those things don't come together, how in the world, what is the last resort way you can possibly forge a successful deal? And often the only thing left at your disposal when neither of them can match up is creative debt.
And so what are the typical forms of creative debt we use in trying to make deals with mobile home parks? Well the first one, the classic, is a construction of 0% down and nonrecourse debt. That's been around forever. We've done 12 different deals like that. And when you do those deals, you feel very empowered because you have no risk. So even though the seller wants more than you think the property is worth, with zero down and nonrecourse debt construction, you think, "Well, I'm going to give it a shot. And the worst that can happen if it doesn't work out is I can just walk away and give the property back." So that construction can often get the more timid buyer over the top, because suddenly the deal seems a lot less risky, which it is.
Now, there are other offshoots of that, however, which we should also discuss. Number one, it does not always have to be 0% down. You can sometimes construct deals at a part greater than zero, but far less than traditional down payments, which can be 20% to 30%. we've done a lot of deals out there, 5%, 10% down. Look at my very first park I ever bought Glen Haven, $400,000 purchase price. I only put down $10,000, and mom-and-pop seller carried $390,000 for 30 years. That $10,000 only accounted to 2.5% Down. It's not quite zero, but it's pretty close. And that gave me the feeling of power, the feeling of strength to buy a mobile home park that I thought was overvalued. In fact at that price, it was losing $2,000 a month, but I figured if I couldn't get it to turn, if I couldn't somehow find a way to build the revenue or cut the cost to get it back to where it was breaking even, worst case scenario, I'd just give it back. Had nothing to lose.
So low down payments with nonrecourse debt, that's one interesting kind of construction, but there's another type of construction. That is where you simply delay a typical financing arrangement and allow the purchaser to get on their feet, to make the necessary changes, to raise rents and cut costs and fill lots and get old abandoned homes back in service again. So under that arrangement, how it works is you again have typically a lower down payment, often 10% down, maybe sometimes 20% down, but you have a below-market interest rate. In fact, what you might have is the interest rate in year one, 0%; the interest rate in a year two, 1%; the interest rate in year three, 2%; year four, 3%; and onward until you get to some flat amount that you plateau at, whether it might be 4% or 5%. And what happens when you do that construction is all the money that would be going to the interest on the loan instead goes to the buyer and allows them to make capital repairs or to cover the negative, because perhaps you can't get the park to where it breaks even for several years of rent increases. It allows you to have the ability to get three years in or four years in without having negative payments.
In some cases you can even have it where the note has nothing due. Even with a standard construction, let's assume you had a deal that was 20% down and the interest rate was 5%, you could change the entire complexity of the deal if you didn't have any payment due, let's say, for the first two or three years. So now you've taken a lot of financial pressure off. Seller still gets the price he wanted, but he takes it a little bit slower into the future before he necessarily gets the price that he wants. Now can you get that kind of construction from a bank? Not always. Sometimes there are some banks out there that will do creative deal constructions on debt. They'll do interest-only transactions. Even large institutional lenders will sometimes do interest-only.
So again, it's one way to get a deal where the two ends don't meet to patch them together using zero down or a low down payment or a low interest rate that might stairstep up over time. But what other things can you do? How else can you construct things? Well, here's an interesting one we've done plenty of times, and that's doing a loan assumption. Now how does that work? Let's say mom and pop have a deal and they have debt on it and that debt is not performing very well, and so they're trying to sell you the deal for maybe only a little bit more than they paid for it, but it isn't going to really pencil out, not going to be able to get the appraisal on it; might be able to, you're not sure. Sometimes you can go to the bank that's carrying the debt and get really good terms from them because here's how the bank looks at it: if mom and pop are not doing well with a mobile home park, if they're losing money, that scares the bank. That may even force the bank to have that loan classified by the federal regulators.
That's an embarrassing process for the bank and will change the amount of reserves it has to put up. So they would maybe instead have a new person, someone with new vision, new energy, step in and take over that loan as it sits on their books, thereby saving you a lot of the initial costs, third-party reports, all kinds of issues. So sometimes loan assumption is the creative deal-making way to get things done as far as the debt goes, literally just stepping into the shoes of mom and pop. And your down payment, well that would be whatever you're going to give mom and pop perhaps above their debt. But we've done that construction many times. We've even done zero-down deals, not with mom and pop, but with the bank. We've gone to the bank and said, "Look, you've got a loan, the loan's not doing well. What if we step into the shoes of the borrower on a zero-down basis just to save the day, as the white knight to come in and make the loan work again?" Often, they'll agree to that.
Now another interesting construction method is the master lease with option. Now, how does a master lease with option work? Well, it's a little more complicated, so let me explain it to you. In fact, I can only explain it really in the form of an example. Let's assume you have a mobile home park that's owned by a mom and pop, but they've done a terrible job with it. In fact, they've haven't owned it for that long, and in the short period of time, they've made the park worth less than it was when they bought it. So let's say they have a note on it for $800,000 and they happen to pay $1 million on it, but now it won't even appraise at $800,000. They did all the steps wrong. They've let a lot of people move out. They've lost occupancy, they never raised the rents. They had costs that ran wild. As a result, now it's not going to appraise enough that anyone could buy it, because in order to buy that mobile home park to give the price that they want ... Let's say they say, "Well, gosh darn it, I'm not going to put money into this. I've got to get $900,000 for the mobile home park."
And it will never appraise for $900,000, not even close, and he's got $800,000 of debt. Sometimes what you can do is a master lease with option, and here's how it works. You go to mom and pop and say, "Look, I can't buy this, as you're aware, through a bank because it won't appraise, and therefore they won't make a loan as large as I would need in order to buy it. But instead what I will do is I'll go ahead and take over operations. I'll go ahead and fix this mobile home park and then once I get it fixed, then I'll go ahead and close on it."
So let's assume they say, "Okay, we'll take a gamble on it," and they give you a three-year master lease with option at $900,000. What that means is you have three years to make that park worth $900,000 so you can go forward and buy it. So how do you do that? What do you do magically during the master lease period? Well typically, what most people do obviously is cut costs and raise rents. Although sometimes you can also take old mobile homes that are abandoned, get titles to them, and bring those back into service for not a lot of money as well. Or maybe you have some vacant lots and you can bring in RVs to fill those.
Now the one thing you can't do on a master lease with option is go out and buy mobile homes and bring them in to fill vacant lots. You can't do that for several reasons. Number one, you don't own the mobile home park. You'd be crazy to do that. What if you don't end up buying it? Why would you want to own mobile home parks in a park you don't even own? Also, all the creative financing programs out there, like 21st Mortgage, they won't do that unless you already own the park. So since you don't own it, they won't do those programs with you. But typically, you can do a lot of damage simply by cutting costs, raising rent, and filling some lots. And let's assume three years later you've done all this things and now the park is worth $1 million. You still get to buy it for $900,000, so you already have $100,000, theoretically, of net equity on the day of purchase. It's a very, very interesting construction that a lot of people don't think of, but it can be very, very lucrative.
Now in all these different constructions I've named, some people may say, "Well now, wait a minute now, aren't you getting into the danger zone here? Aren't you pressing, aren't you overpaying for mobile home parks?" And of course the answer would be possibly yes, on the front end. If you're buying a park that you think is only worth $600,000 for $700,000 and tying it together with zero down and low interest, then yes, you are stretching, to some degree. But the good news is typically you can make any mobile home park work that's close to the price seller wants with time. With time, what you can do is you can go in and raise rents, you can fill lots, you can go and take abandoned homes and bring them back to life again. You can cut costs.
So it possibly would be that you can make a construction that can buy you time. That's the essential ingredient you need. And if you really look at it, that's what most of these different creative deal-making with debt concepts are. They're basically just buying you time. They're giving you time to get on your feet to make the payments before the payments escalate. Now if it was a stick-built home and you were doing this, it might be a recipe for disaster. You can't really push the rents on a stick-built home much, and there's hardly any costs to cut. And in many ways, perhaps, that's what fueled the 2007 Great Recession. But here, we're talking something a little bit different. We're talking an asset that typically has a lot of room to improve on.
And that's the magic ingredient that makes all of these creative debt structures successful, is the simple fact that most mobile home park lot rents are insanely low. Many mom-and-pop costs are way, way too high. There's always occupancy you can fill. And these ingredients, this is what yields the ability to buy a mobile home park. And if you can carry it just for a brief while, a year, two years, three years, in many cases, that can bridge the gap and make everything tie together. So when you have those cases where the seller wants a certain price and you don't want to pay it and you don't think it's worth it, you might look into the possibilities of creative debt construction. That may be the magic ingredient that can make your deal possible. This is Frank Rolfe with Mobile Home Park Mastery podcast series. Hope you enjoyed this. Talk to you again next week.