Risk vs. Reward is a huge topic with successful mobile home park owners. In this episode we are going to review what the concept of Risk vs. Reward is, and then go over in granular detail many of the top risks to be concerned about, and what your percent of success or failure might be with that trait. While Vegas offers you riches, it rarely delivers, and mobile home parks are more of a game of skill that always rewards those that used good planning and diligence and have done their best to mitigate chance.
Episode 153: Gambling With Big Chips Transcript
Investing and gambling should have nothing in common. When you invest, you're supposed to be using strategy. You're supposed to be using your money in a manner which you can't lose it, and that you're going to try and get a higher rate of return without your loss of capital. But when you gamble often, in search of high rates of return, you can lose everything that you bet. In fact, it happens more than it happens that you win. Now, in today's Mobile Home Park Mastery Podcast, we're going to be talking about the one element that both gambling and mobile home park ownership have in common, and that is the concept of risk and reward.
Obviously nobody in Vegas is ever going to go down and gamble on any game if they don't believe there's a chance, however slight, they may win a really, really big prize or amount of money. And the same is true of mobile home park owners. But we look at it a little differently, where all the time try to gauge the risk and the reward to see if they're in a healthy profile, and then additionally figure out how to mitigate that risk. So we're going to go over today not just the easy stuff, not the parks that don't have a lot of risks. Those aren't interesting. And those have nothing in tandem typically with gambling. A park that's basically full with no park-owned homes in a big metropolitan area with markets rents is not something that typically has a lot of reward in it, doesn't have a lot of risk in it. It's almost closer to a bond.
So let's instead talk about mobile home parks that have higher elements of risk and decided whether or not that risk is worthwhile, and then how best to try and mitigate it. Let's start off with some high risk items. First one being, trying to fill a lot of vacant lots. So if I'm looking at a mobile home park and it's got a lot of vacant lots that I need to bring homes in on and then rent or sell those homes, that's very high risk. Why is it such high risk? Well, I don't know if the customers are going to be able to afford those homes. I have no idea, when I start that adventure, how much money they earn, how much money they have for a down payment. And it's very likely I'm going to guess wrong. And if I guess wrong, I'll bring homes in that are too expensive for my customers to buy. Additionally, I'll have capital investment necessary to get those lots ready and to bring in the homes. So quite a bit of risk out there trying to fill vacant lots.
Now, how do I mitigate that risk? Well, there's really two items. Number one, I try and mitigate that risk with test ads. These are ads you typically do in the largest metro newspaper and Craigslist, and they're titled pretty simply. What you do is you put the name of the area where the mobile home park is in all caps at the start, so the customer knows exactly where the metro area of the park is located. And then you say two and three bedroom mobile homes for sale or rent from, and then a price point that is basically the lot rent plus the assumed payment on a new home, which is typically around 400 a month, includes lot rent and a phone number. And you run that ad for 10 days to see how many calls you get. If you get 20 to 30 calls in a 10 day period, that's considered a fairly high level of demand and therefore it's mitigated your risk to some degree.
Also, if you can use a home financing program, one like the 21st Mortgage's cash program, which pays all of the costs of lot preparation and bringing in the home and completing the home, that again mitigates the risk is you can go very, very fast and very large numbers of homes with very little metal capital.
What about raising rents in a big way? That's going to be another high risk adventure. Some states don't allow it all now. They have rent control and you can't raise rents in any significant manner, but there's very few states that have rent control. So in the other states where you don't have rent control, what do you do about raising rents? Let's say the park you're looking at has a $200 lot rent with the market is $400. Well, how do we mitigate that? Can we raise the rent? First off, yes you can. We found most times you can raise the rent without much pushback, about $50 once a year, $50 monthly.
But how yet can I even further mitigate what I'm doing? How can I make sure when I raise the rent, I won't lose customers? How can I make sure when I raise the rent, I won't have huge amounts of pushback? First thing is back to the test ad, how was your test ad results? It is possible that when you raise the rent, you may lose some marginal customers. And if you do that, you'll have to replace them. You want to make sure you have enough demand to do that obviously. Also I need to do very, very detailed market comps. I need to see what the rent is at every other mobile home park in the market. And then I need to look at it on street view to make sure where I fit into that spectrum.
Another way you can often get an ideal of how a rent raise will work is to look at the cars the residents are driving. If they're driving nicer, newer cars, it means that they typically have got higher incomes. They can actually obtain debt, and therefore increases of the rent. All that you're just trying to get it up to market will not be dealt with greater risk of people having to end their stay in the mobile home park.
Another big risk factor is private utilities. Now, what do those mean? It means well water. It can mean packaging, plant septic or the lagoon on sewer. The problem with private utilities are, you're always afraid if they're going to break, you're always afraid of, in the case of water, would you potentially poison someone and you just don't really like being in the water or sewer business. Who would? It's very expensive. A lot of risk involved in it.
So how do you mitigate that risk? Well, we do, number one, great due diligence on that private water, or private sewer system, to make sure that it's safe and fully compliant with the law. And also to do diligence on the possibility in the future something goes wrong to do some kind of utility conversion to city utilities.
Another risk you have out there with mobile home parks or smaller metro areas. Those can be scary. Metros of 100,000 and larger have always historically performed well because they have big chamber of commerce, diverse employment among a number of sectors. We prefer education, we prefer healthcare and we prefer government because those rarely lay people off, and they certainly never shut down.
But when you have a smaller metro, you don't have as many of those kinds of employers. In fact, you don't have that many of any employers period. So what do you do? Well, to hedge that risk, again, back to the test ad. How much demand is there? Want to make sure that the market has enough folks out there who are employed looking for affordable housing. So that's an important item.
I also want to see really high home prices. I want to see really high apartment rents. I want to see really low market vacancy. You can find all those items on bestplaces.net. And I also just want to make sure, once again, who are the top employers in that metro? Are they industries I have faith in? Are the hospitals? Are they universities? Are they some private employer like Snapper Mowers I don't really have a whole lot of confidence because I don't really know if that product is selling or if it is not?
Other risk items, complicated environmental or legal issues. Things regarding pollution, things regarding city hall saying, "Hey, we hate your park. We want to shut you down." Those can be very, very risky. That's a very, very risky game to play. There really isn't any way to mitigate it, except just wading into it and trying to solve it prior to closing. Sometimes you can, sometimes you can't.
Now, are there other ways to mitigate those high risk scenarios? Yes. Another way you can mitigate those in many ways is by getting seller financing with a very, very small amount down a non-recourse debt. You'll see that over and over again in the world of high stakes gambling and mobile home parks, the one card that can typically change the profile of your entire deal is simply the one that includes seller financing and a non-recourse format with a small amount down. That is definitely something that will typically tip the scales more in your favor.
Now, what about some other ideas when you have really, really, really high risk parts? That was a profile of parks that have most things working properly, but maybe one big problem. What do you do when you have parts that have a ton of problems? These parks are so rough and tumble, so screwed up, you can't get conventional financing on them. You're not even really sure if you should even mess with them. These are the kinds of parks that typically they have two kinds of buyers. People who want to buy a park who don't have a whole lot of capital, so they're willing to put up with things that other people will not. Or people who are actually fairly experienced and just occasionally like to take that one wildcard deal and bring that property back to life. So what would these kinds of parks be? These would be things where you have massive amounts of vacancy. Things where you are massively under the lot count, the lot rent that you should have in that market, where the market itself shows all kinds of signs of distress and instability.
So how do you attack those and mitigate that kind of a park? A park that when you pull in, you can't even be nowhere to begin, it's so rough. Well, basically here are a couple ideas for that. Number one, back to what we said a moment ago, try and do a seller finance deal, one in which there's nonrecourse debt. But in this case, one where there's almost no down payment at all. My partner, Dave, and I have done 12 deals. It had zero down, true zero down, not fake zero down. Not ones where zero down, but then you have to write some big checks to bring the thing back to life in the forms of capital. But things where really you're buying it for zero down. So that's one way to gain confidence, right? Because all you have at risk in the deal is nothing. And if you don't like it, you can always give it back to the seller.
Another one, master lease with option to buy. This is a form that most people have never heard of, is a great way to hedge your risk so that you're not gambling quite so riskily. So how does that work? Well, what you do is you enter into an agreement where you take over management of the park, but you don't buy it yet. And then you have the ability to buy it typically for three to five years at a certain set price. This allows you to test out your theories without actually risky to any of your own capital. If it doesn't work like you like, you can simply walk off and give it back to the seller. But more than likely, you'll hang in there and probably solve the thing. And then ultimately, you can then refi or sell the things simultaneously with your purchase. It's a great way to do things. You really have no risk throughout. And you get to test your theory of how to turn it around without knowing if you really can, but with no downside back to you in the event that you cannot.
You've probably noticed in everything we just discussed, that although we know we are gambling, because in anything in life, you must have risk. Every time you pull out of your driveway, you have risk that your car will break down. You could have an accident, anything could happen. But there has to be a reward commensurate with that risk. And also you have to make sure that you are properly trying to hedge the risk that you are taking. Now, in Las Vegas there's some games where people can do that. Certainly people who play poker or blackjack, they could, in many ways, try and hedge the risk by looking at the cards and trying to remember what cards have been seen. I think that's illegal card called card counting. But even beyond that, there are typically tables of odds. You can memorize of certain card combinations that are going to give you a better chance of success or when you might want to fold.
But there's other games in Vegas where there's no hedging of your risk, nothing at all. If you play roulette and you put your money down on a certain number and you don't hit it, you lose. There's no way you can really hedge that. And that has nothing to do with good investing. Benjamin Franklin once said that diligence is the mother of good luck. Well, he's exactly correct. All of us need to put a lot of thought into what we're doing. We need to look at all the systems and things, all the different traits the park has. And we need to decide, based on that, how do I mitigate that? And is it really worth taking the risk?
Typically, a mobile home park has to give you greater reward as you take greater risk. That's what we call a healthy risk reward relationship. So when you're looking at a mobile home park, it's okay for there to be risk. You have to make sure that whatever risk you're taking has an equal amount of reward. You would never want to do a deal that has high risk and low reward, and you would always want to do a deal that has low risk and high reward. And in every case, whenever any deal has risk, you should always be looking for ways to mitigate that risk, to ensure that you're successful with your mobile home park investment.
This is Frank Rolfe, the Mobile Home Park Mastery Podcast. Hope you enjoyed this. Be back again soon.