Mobile Home Park Mastery: Episode 57

Jekyll & Hyde – The Impact Of Slight Changes In Deal Variables

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We all know the story of Dr. Jekyll & Mr. Hyde, where a drug could cause a gentleman to morph into a monster and back again. Mobile home park variables can cause a similar effect. In this first of a three-part series on the Impact of Slight Changes in Deal Variables, we’re going to discuss the impact of park-owned homes on mobile home park desirability, and identify which attributes make a deal attractive instead of a disaster. You’ll be amazed at how just the slightest tweak can turn a deal from attractive to devastating and back again.

Episode 57: Jekyll & Hyde – The Impact Of Slight Changes In Deal Variables Transcript

We all know the story of Dr. Jekyll and Mr. Hyde, a good-natured doctor who when taking a potion unleashes his inner demon. He goes from good to bad and then back to good again when the potion wears off. This is Frank Rolfe of the Mobile Home Park Mastery Podcast series. We're starting a three-part episode on the impact of slight changes in deal variables, because as you'll see in a moment, some very normal things you'll find in mobile home parks can make the deal go from good to bad, just with very slight adjustments of the facts of that one item.

In this, the first part of the three-part series, we're going to talk about park-owned homes. Now, you might say, what's a park-owned home? These are mobile homes that are owned in conjunction with the park itself, so basically homes, when you buy the park, that come with it. Typically, they're things that mom and pop bought at one point and brought in and sold or rented. Other times they're homes that other people owned, who then later vacated the park for whatever reason, and mom and pop took those homes through abandonment proceedings. So basically, any home that comes with a park is called a park-owned home.

Now, we've talked in the past episodes that you have to separate the lot rent from the personal property rent in these things. Basically, you've got the lot rent, which is the rental of the land, and then you have the amount on top of that, which is the personal property rental, because mobile homes, in fact, are personal property. They are not real property.

Let's start on the front end. We just run with the assumption that the lot rent and the home rent must be separated, and that the value of the park and the cap rate that can be applied to it is all based on the real property income, which is lot rent, never on the personal property rent. But given that assumption, let's look at how we can change the deal from good to bad and back again, based on some very slight changes in the deal variables.

Let's start off with the lot rent. Now, one of the great things about park-owned homes is that the person in the home has no idea the allocation of how much of their rent that they pay you goes towards lot rent. Let's assume we're looking at a mobile home park where the lot rent is currently $200 a month, but the market lot rent is $400 per month, and the home is currently renting for $600 per month. We're saying the park-owned homes, is it good or bad? Well, if you're buying the park, and the market's at 400 and the lot rents at 200 and the home rents for 600, then it's good, because I can internally raise that rent on the customer without their knowledge, without any pushback, because they don't care, because I will internally allocate from that 600 of rent they pay 400 to lot rent, as opposed to 200. In so doing, I've doubled the amount of income.

So that's great, right? Of course, it would be, but let's look at some other scenario. Let's say that my lot rent is in the park already running at 400, and the market's at 400, and the park-owned home income is also at 400. We had a deal just like that a few years ago, the craziest deal. The homes were renting for $300 per month, but the lot rent in the market was more than $395 a month. There was no way to reallocate, really, and make any sense of it. I'd have to go to the customer and say, "Here, buy the home, and your rent doesn't change one dollar." That's what we had to do, and people were not happy, and we lost many people out of there.

So sometimes that lot differential can be good, but sometimes there's no lot differential there. And then sometimes you can't even make a differential between what the home is renting for and the lot rent. So it could go from being very attractive in the case of a 200 rent and a $400 market, with a $600 home cost, to being not good at all if the lot rent is at 400, the market's at 400, and the homes rent for 400. But changing the lot rent, that's one variable that really can help you.

Now, another is the age of the homes themselves. Typically in a mobile home park, homes from the 1970s are worth about $1,000 to $4,000 each. 1980s homes, $5,000 to $10,000 each. 1990s homes, $10,000 to $15,000 each. And homes from the 2000s and newer, typically $15,000 to $25,000. When I look at the value of those homes, just as personal property ... in other words, I'm not going to, in the sake of this exercise, put any of the income from that into the lot rent ... I'm simply going to say to myself, "Okay, well, this park has X number of park-owned homes, and they're at least worth some amount of cash as personal property."

But look how different the age of the homes impacts that. If you said, I've got 10 park-owned homes, and they're all from 1990s, then I might say, well, they might be worth $100,000 to $150,000. But simply changing the age of the homes to 1970s might make them only worth $10,000 to $40,000. That's a huge change. That a 10-for-1 change in valuation. So again, the age can Dr. Jekyll and Mr. Hyde your deal significantly. Let's say that you wanted to pay $500,000 for the park, and mom and pop says, "No, no, I must have 600,000, but it comes with 10 park-owned homes." Well, the deal will probably work if they're from the 1990s or the 2000s, but it probably won't work if they're from the 1970s. So the age of home is huge.

What about the condition? There's another Dr. Jekyll and Mr. Hyde. Let's assume that you've got a 1980s home that you say is worth $5,000. Well, that might be a $5,000 asset if it's in perfect condition. But if I have to go in and rehab that home at a cost of $5,000, then it really isn't worth anything at all. I put $5,000 in it, only to resell it for $5,000, and my net profit is in fact zero.

You know, our typical cost, our average cost in rehabbing a home is $4,000. Typically, 2,000 parts and 2,000 labor. What that means is, a 1970s home in poor condition that's worth $1,000, I might lose $3,000 per home, just in rehabbing them enough to sell them. And before you say, "Well, can't you just sell them as they are?" Well, in some states, the answer is no. There's what's called the minimum habitability warranty, and that means you've got to bring the home up to minimum standards. In those states that have that law, typically what that means is you can have no holes in the roof or ceilings, a couple small holes in the floor, you have to have hot water and cold water, a bathtub, a sink, a toilet, a heater, and air conditioning, unless the windows open. And you can't sell anything, regardless of price, unless you meet those conditions.

So often, the condition is set in stone by state mandate. But the bottom line is, if the homes are in poor condition, instead of those being an asset, those homes might be a liability, a huge Jekyll and Hyde change. Dr. Jekyll, the good guy, would say, "Oh, those homes are all worth some amount of money and positive," but then again, if you change the condition, you become the evil Dr. Hyde, and the homes, instead of being an asset, are in fact a liability.

Another big issue is, where is the park located at? Check this out, check how big this changes things. If you've got a 1980s home in Arkansas, you'll be lucky to get $5,000 for it, but if you have that same home in Colorado, even a small town of Colorado, that home might sell for $20,000 or $30,000. Now, the reason is simple, because a median home in Arkansas might only be $80,000 for a stick-built home. But in Colorado, it might be $300,000 or $400,000, and it's just supply and demand. When the homes are really expensive, you have a greater pool of people needing to buy inexpensive homes, and thus you end up with a much higher price point.

Where's the highest in America? Well, you can probably guess: Los Angeles area. The homes at that park in Malibu called Point Dume often sell for around $400,000, so that shows the differential, from about $400,000 in Southern California, that same home, same year in another state might only be worth $4,000. Again, a huge Jekyll and Hyde change in valuation, even based on geographically where the home is located at.

Now, here's another Jekyll and Hyde change: the sheer number of homes and the management woes associated with those, because we all know that park-owned homes are the hardest thing in a mobile home park to manage. The land is simple. You rent the lot out. All you have to provide is a functional road, water, sewer, electrical access, and sometimes gas, and your job is done. But when you have a park-owned home it's different. If it's a rental home, you have to make repairs. When the homes go vacant, whether you're trying to sell or rent them, you have to rehab the home, run the ads, show the home, and when you have an interested customer, do a credit application and ultimately do the actual paperwork itself.

And even then you have to worry, will they stick or will they in fact default, and I'll get the home back once again? So even though the homes might be a positive, even if you're in Colorado, where the homes are worth $20,000 per home for those old '80s homes, it may create such a management hassle that you still don't really value those assets very highly. Most people I know would rather have a park with no park-owned homes than one with park-owned homes where the park-owned homes are worth money. People are literally willing to walk the value of the homes, simply to avoid the hassle of having to deal with them. It's very Dr. Jekyll and Mr. Hyde on that frontier.

Now, here's another thing. Who owns the homes? If you're not in the mobile home park business, you wouldn't think that matters much. I mean, who cares who owns the homes, because the homes aren't worth much anyways, so why do I care? Well, the problem is, if you have one person own most of the homes, now they have you over a barrel. Let me give you a real life example. I once had a park, and it had one guy that owned 15 of the homes in about 40 occupied lots. So this one guy owned about 30%, or better than 30%, of my total inventory. When he got crosswise with me over raising the rent, he pulled them all out, and it scuttled my economics. It took me years to build my way back out of that mess. I didn't know any better. It was early in my career. I had no idea that such a thing could happen.

But the fact is that what makes mobile home parks wonderful investments is that each customer only represents one tiny piece of the revenue. If you've ever looked at shopping center investments, you've seen the opposite. A big strip shopping center still only has typically four or five tenants, so if one tenant leaves, that's 20% of your revenue. It's a entirely different impact, and you're constantly worried about what happens with your residents. In mobile home parks, not so much, because if any one resident leaves, it doesn't really impact you very much. But it does, on a much larger scale, when someone owns many, many different homes. So it's Dr. Jekyll and Mr. Hyde yet again.

If you have every home owned by a separate party, things are great, but if you have every home or many homes owned by a single party, it's gone from great to horrible. There's a thing you need to know on that front, called the Lonnie dealer. What the heck is a Lonnie dealer? It's somebody who read the book Deals on Wheels by a guy named Lonnie Scruggs. He wrote the book back in the '70s. They used to sell a quite a bit of it. I think there used to be 5,000 Google searches a month, in fact, for Lonnie deals.

But over time, Lonnie died, and then the book kind of fell out of favor, because when they changed the laws and introduced the SAFE Act in 2008, everything in the book was kind of negated, because Lonnie's concept was building up notes and income streams from notes. You can't do that under the SAFE Act very simplistically. But the big item is, don't let someone own that many homes in your park, and when you see that, the fact that one person owns a lot of homes, again, you go from a Dr. Jekyll, the respectable, kindly doctor, to the ghastly demon of Hyde.

Now, another item is the financing issues involved in these park-owned homes. If you have a park with park-owned homes in it, you have a problem you might not think about, and that is simply banks hate them. Banks hate park-owned homes. They want to make real estate loans, they don't want to make personal property loans. It distresses them that you have to make them think about value in the homes. The very act of having homes in the park can make the park unable to be financed by a bank. The Dr. Jekyll part of the homes would be, oh, well I get these homes, and they come with the park, and they're worth $10,000 apiece, and I've got six of them, and life is great. And then suddenly, it can change to Mr. Hyde, when the bank says, "Oh, I'm sorry, we don't like financing parks where one party owns more than a few of the homes in the park." So once again, Dr. Jekyll to Mr. Hyde, thanks to park-owned homes.

What's the lesson learned from this? Well, number one, when it comes to park-owned homes, the very fact you have park-owned homes can create a trajectory where the slightest changes really have huge impact. When you change those deal variables around, when you change the age of the home, the underlying lot rent, the condition of the home, where the home is located, the management woes of the homes, who owns how many of the homes, and then having to get your loan on the park, you soon realize that park-owned homes have the capability of being either Dr. Jekyll or the evil Mr. Hyde. It's all in how the variables play out.

Again, this is Frank Rolfe for the Mobile Home Park Mastery Podcast series, starting a three-part series here on the impact of slight changes in deal variables. We'll be back next week to talk all about the impact of private utilities. Thanks for being here. We'll talk to you again soon.