Mobile Home Park Mastery: Episode 69

Financing Failures

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Real estate leverage is an essential part of mobile home park investing. Without it you cannot hit the typical 20% cash-on-cash yield. However, what happens when the buyer uses the leverage improperly? In this fourth of our five-part series on “Lessons Learned from Failed Parks” we’re going to examine how some mobile home park buyers set themselves up for failure by agreeing to lending terms that are impossible to conquer. If you want to keep your credit and your investment dollars, you’ll want to learn what these failures are and guard against them.

Episode 69: Financing Failures Transcript

We all know what financial leverage means, but if you look up the work leverage, the definition of it on Wikipedia, you'll see that there's another type of leverage you might not normally think about. That one is the exertion of force by means of a lever on an object. The way that historically, even primitive people moved heavy objects was by using a lever. What it means is leverage is a lot of force, and if it goes your way, that's great. But if it's working against you, it's a real problem.

This is Frank Rolfe, from Mobile Home Park Mastery podcast series. We're doing a five part series on lessons learned from failed parks.

Episode four today is on epic financing fails. We're gonna talk all about the way that you can set up the leverage wrong and have that big old lever pushing on you instead of you pushing on the lever.

Let's start off with one of the most basic fails we see out there, and that is when a buyer utilizes seller carry on a property that's not bankable. Now think about this for a moment. Mom and pop is saying, "Yes, I'll go ahead and carry the financing on my property," but it's typically for a limited number of years. We've seen them as short as a couple years.

Well, what do you do if in a couple years from now, the property can't get conventional banking? Now why would it not be able to get it? Well, there's a lot of reasons. It may environmental issues. It may have survey problems. It may have floodplain problems. There's lots of things the banks won't touch, yet mom-and-pop will touch with their seller carry because they already own the asset.

It's often a good idea whenever you're looking at doing something that's all seller financing, if there's any question in your mind of, "Can I get this banked when this seller note expires?" Check it out. Go ahead and run the park by a bank or two. Call up a loan broker like MJ Vukovich and say, "Hey, I got a really good seller carry on this thing, but I'll be coming to you here in two or three years. Are you gonna be able to get me a bank loan on this?" Just make sure that you can.

There's no worser fail in the world of leverage than when you lose the property because you simply can't find a replacement loan to mom and pops.

Another epic fail is when your term is simply too short. Now, we all think that most mobile home park owners should start refinancing their debt roughly two years ahead of time. At least start the process in their mind. That gives you plenty of time to prepare a package to hit the banks, and if you're unable to get the financing, to try and sell the park off.

You can never really have too much time in today's topsy-turvy world of financing. We think that two years ahead is a pretty good limit. But what if your bank loan is just not very long to begin with? A three year loan under that scenario means you only have one year of comfort before you start having to refinance. If you set yourself too tight, if you give yourself only a one year note, it's very possible you won't be able to find a replacement in time.

When you can't find a replacement in time, what that's called is term default. And what term default means is even though you've been making all your payments, you're unable to pay off the bank in full with their balloon before it came due. Those are some of the saddest situations because typically the persons been doing great on the mobile home park, but they did not give themselves enough time on the refinancing.

I personally receive calls from people, calling me in desperation, wanting to know if I can get them a loan, even though I'm not even a loan broker, wanting to know where they can go to get a loan. I'll ask them, "Well, how much time have you got?" And they'll say, "I got 30 days." They'll never make 30 days. They'll never be able to find a bank, negotiate the loan, and have their legal department write it up and have a formalized closing in 30 days.

Don't back yourself into a corner. Try and give yourselves at least two years ahead on any loan to make sure you don't enter into a term default.

Now, a third financing fail is when you're not reasonable enough about your occupancy goals. This goes back to item one where you had the seller finance note, which you're gonna refinance in to a traditional bank note, but to get there, you've gotta get the occupancy up to what they call stabilization, which is roughly 80% or greater.

But you way over estimate your ability to do that. So you're starting off at 50% occupancy, and you've got to bring in and sell off one home a month for three years to get to 80%. Lo and behold you don't pull it off. You're unable to find enough used homes to buy. You're not able to find enough good credit customers to buy the homes. Don't set yourself in a position for failure. Don't cut it so tight that you're racing the gun to make sure you can get up to stabilization before your note comes due.

Set yourself some goals, but make sure that they're reasonable goals that you can hit. Because once again, there's nothing worse in the world than term default. If you've gotta get up to stabilization to get that bank loan, and you're not gonna clear the trees, you're gonna lose the property. Make sure that you set any occupancy goal in a reasonable manner.

Item number four: over leveraging. Now that's hard to do in today's mobile home park world because I don't know any banks out there allowing you to do zero down notes. I don't even know any out there that are letting you do 10% down notes. The industry norm is roughly 20 to 30%, which is historically accurate. There have been times in my career and Dave's career, when we've seen mobile home park banks allow people to massively overly leverage. Back in the mid-2000s, they were doing, just like they did on mortgages, basically zero down, no income documentation mobile home park loans. They were even doing conduit loans as low as $250,000 in the last cycle.

What happens when you over leverage is, you often set yourself up for failure, because unless you can find a bank that allows you to continue with the over leverage, then once again, you're back into the world of term default. You won't be able to find any bank to replace your loan, and when you find a bank, it's gonna require so much down, that you possibly don't have that even on hand. Always be aware of over leveraging. You don't see it right now, I don't see it right now in the marketplace, but again, always be careful for it and watch for it.

The next one is when you have variable rates on your loan, but you have no ability to push the rents. In our very first book we wrote called The 10-20 System, the whole concept was you buy something at a 10 cap and you push it up. Now, back then interests rates were roughly seven, what's key is a three point spread. So what it means is in today's world, where interest rates are at five, we could've written the book The 8-16 Method. But that doesn't matter. The numbers don't matter.

What matters is the concept of being able to push the net income of the property to make it even more valuable. The key way to push any mobile home park's value is by raising rents because as I've said and written many times, our industry rents are crazy insanely too low. The guy from Duke, Charles Becker, the economist says our rents are at least 50% too low. I think he's wrong, I think they're more like maybe up to 100% in many markets.

But nevertheless, there's some markets where the rents maybe at full market rate. In those cases, you can't push the rents, but if you have variable rates on your lending, what do you do as those rates go up like they're doing now and you have no way to increase your revenue and your net income to cover that? Always be careful about variable rates on properties where you can't push the rent.

The next epic fail is kind of a crazy one. It's destroying your own personal credit with no problem on the part of the park. We bought a park in foreclosure it's been probably half a decade ago, and it was a pretty sad case because the borrower had bene doing a great job managing the property. When I first pulled up to the property, we knew nothing more about it than just the address from the bank.

I was amazed to see it was in great working order. The sign out front was nice, all the signs inside were nice. It was well-mowed, the roads were in great condition. There was nothing wrong with the property. What had happened is, that the borrower had done some stupid stuff on their own. They had bought a McMansion, they let it go back to the bank. They destroyed their credit and when it came time to get a new loan the couldn't. Not because the park could not meet muster, but because they couldn't meet muster because their credit had been ruined. As a result, they went into term default, went into foreclosure. Then we bought the park in foreclosure.

So, what does it mean? It means, as Warren Buffet says, "It takes a lifetime to build your reputation, only moments to destroy it." Always be careful with your personal credit. Don't just focus on your businesses credit and think, "Hey, well my personal credit doesn't much matter." No, your personal credit matters enormously.

Most banks out there are not going to issue you a loan if your personal credit is shot. So just be very careful in the things that destroy personal credit. The number one thing I've seen in most epic fails in parks is when the owner buys a home that they can't afford, a giant mansion, and then defaults on it. It's super common unfortunately, and not good for you as a park owner.

Now, the next fail is one that most people wouldn't even think about, but you need to be aware of it. And that's defeasance on a park if you're looking at buying and selling it quickly. Now, defeasance is a punishment. What it is is when you do a CMBS, commercial mortgage backed security, those bigger loans that started at about a million and up, those are fantastic loans, they have fixed interest, typically 10 years in length, they're non recourse.

We love the loan type, the only problem is, if you wanna prepay it, you have to pay something called defeasance. You have to buy enough treasuries to cover the sum of all the payments and the principle at the end. And then defeasance can sometimes be a penalty up to 30% of the loan value. It could even be higher based on certain metrics of when you got the loan and the interest rate.

That's fine if you're gonna hole the property for seven, eight, nine years because at the very end of the conduit loan, the defeasance becomes very small. But if you go to buy the mobile home park and then quickly resell it after a year, you're gonna pay a huge penalty to do so called defeasance. That's gonna really eat into your profits.

Now, everybody who's owned a bunch of properties has sold a property at least once under CMBS loan and paid the defeasance. If the buyer is offering you a big enough price you can go ahead and pay the defeasance and it's still a great sale. But just be careful. If your program, if your plan is to buy a park and then quickly resell it, probably about the worst thing you could do would be to put conduit debt on it because you will have that defeasance when you go to sell it and that's not an epic fail, no one ever went broke taking a profit. But nevertheless, it's kind of a shock, a surprise you may not have counted on.

Another item in that same vein, is not getting a release price on excess property when you get your loan. Now I'm talking mostly on mom and pops here because that's where most of our stories would come from. What happens is, when you buy the park from mom and pop, it sometimes comes with mom and pop's house, maybe a storage facility, maybe just the mobile homes inside of it. But all of those items that are in a giant bag of collateral for the loan and you can't sell off any of that collateral unless you get a release on it from the loan holder.

What it means is, you've gotta get a release price in advance on those types of loans because here's what'll happen, case in point, I had a park. It had a mom and pop house, I was doing great with the park. Seller note, paying the payments. But the house was doing me no good. It was sitting there vacant. I found someone who would buy the house at a big price, they liked the looks of the house, even though it sat next to a mobile home park. But I forgot to get mom and pop's permission on the front end. When I came to them at the end, told them I was going to be giving them a check shortly for $100,000, they said, "No, we won't take it. We won't let you sell off our old house. We think that's an important part of the property."

Of course it wasn't at all, nobody wants a house next to a mobile home park in today's world, but nevertheless it screwed everything up. I had to then go out and get a bank loan only at the end for mom and pop to say, "No, don't pay us off. We've changed our mind now. We will take that extra money and release the home from the collateral pool." What a crazy amount of wasted effort and time and money and those third party reports to get a loan, simply 'cause I had failed to get a release price on the front end.

Similarly, we've had cases where you've got four or five park owned homes that aren't worth much of anything, 1970s homes worth a thousand a piece, we don't get a release price, then we go to mom and pop later and say, "Hey mom and pop, we wanna go ahead and sell that home off to the customer," in which case they then say, "Oh yeah, well give me $10,000 as a release price." Why so much? Because again, you waited til the end of the movie. When you go to people saying, "I need to get the release," the price always escalates. Always get your release prices in advance.

Finally, the biggest item in all mobile home park epic financing fails is when the borrower fails to understand that we have a banking cycle in America. Our financial markets are never stable. They're always going up, they're always going down. Just look at how things have gone in the stock market over the last week or so. Everyone thought things were going great, then the bottom falls out. Look at the price of oil. We thought it was going to a hundred and now it's on the way down to 50.

The same happens with banking industry. It's hot and then it's not. Never forget, we always operate in a world of risk. Always in a world of cycles. Never cut things too close. Imagine if you're running a barge down the Mississippi river. These giant barges, they take forever to maneuver. It's really hard to make the front of the barge go one direction or the other.

A good Mississippi pilot is always thinking way ahead, playing it safe, starting to turn left way ahead of when they need to turn left, because they know it takes so long to react and so many things can happen. There's so much risk out there.

Every borrower of every mobile home park, needs to virtually tattoo on their arm the fact that they should never cut things close, 'cause we are always at risk at all times in this crazy economic cycles that we call America in 2018 and soon to be 2019.

Always be worried. Always be trying to hedge your risk. Always be trying to mitigate the risk. That's the key to avoiding epic financing fails in mobile home parks. This is Frank Rolfe, the Mobile Home Park Mastery podcast series, doing our lessons learned from failed parks. We'll be back next week to talk about epic market fails.