Mobile Home Park Mastery: Episode 348

Really Understanding Recourse

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All borrowers prefer “non-recourse” lending, but is “recourse” really a deal killer? It’s all a matter of perspective. In this Mobile Home Park Mastery podcast we’re going to explore the issue of recourse and analyze the real risk and how to mitigate it.

Episode 348: Really Understanding Recourse Transcript

Webster's dictionary defines recourse in two different ways and really both apply. One definition of recourse is a source of help in a difficult situation, and another definition is the legal right to demand compensation or payment.

This is Frank Rolfe with the Mobile Home Park Mastery Podcast. We're gonna talk all about recourse. Now we all know that most people prefer nonrecourse debt. And the reason of course is that if you don't repay your debt under a nonrecourse loan, the lender cannot come after you for the deficiency. But in recourse debt, if there should be any loss on the amount of the loan, the lender can come after you personally to obtain payment for the amount that was lost. So there's no argument, and no one can ever make an argument that recourse is superior to nonrecourse. But we have to really look at recourse because in many situations, recourse is the only type of debt you can obtain.

And then the question becomes, is it worth doing a deal if you have to do recourse debt with it? So let's examine that. First, a recourse deal is better than no deal at all. Some of the best mobile home park deals you may ever do may start off as recourse loans, and that's simply because most of the lenders in between seller financing and conduit and Fannie and Freddie debt only make loans utilizing recourse. So if you were to say, "Well, I refuse to ever sign any loan document that has recourse in it," then you may not be able to buy a mobile home park or it may take you a really long time to find one. Because if you're buying something that's under a million or so in size, dollar size, and there's no seller financing available, then you'll have to choose. You can either sign on to the recourse loan or you just can't sign on to any closing documents at all 'cause you can't get the deal bought.

Also, you have to remember that when you start out in the mobile home park business, recourse is fairly common. Most buyers graduate from recourse into nonrecourse, but their early deals tend to be smaller. So as a result, they're more often faced with having to do recourse borrowings because they don't have access yet, their deals are not big enough to get conduit or agency debt. And it's a perfectly natural way to get into the industry, is to start out smaller, grow larger over time, and that increases your loan options. But early on, it may well be that recourse is part of your journey into nonrecourse debt. Nonrecourse lenders prefer people who have had earlier experience in other deals and bank deals. In fact, it may be your recourse debt, the experience you've had, borrowing and making timely payments, may help you then gravitate into nonrecourse debt later.

But let's really drill down on the risk for a moment. Now, typically, when you buy a mobile home park from a bank, you're gonna put 20% to 30% down. Banks like to make loans that are typically 70% to 80% loan to value. That's a pretty good chunk of change to put down on the property if you really think about it. If you're buying a deal that's half a million dollars, the bank will make you put somewhere between probably a $100,000 and $150,000 down on that. And that means your remaining balance that you'll owe will be somewhere between $350,000 and $400,000. So are you gonna really buy something that will decline in value lower than that? Are you really gonna buy a mobile home park that's only gonna be worth after you buy it 70% of what you paid, and even at 70% you haven't reached a level or threshold where you'd have any real recourse 'cause that would pay off annuity in full.

So we're really talking about an even more significant decline. If you put down 30%, the thing would have to decline by 35% or 40% to really have any material amount of recourse at risk. And how exactly would that happen? Now, there's only two ways I know of that you could have the property dip in value that greatly. One would be if you're a horrible operator, you can't collect the rent, you can't pay the bills properly, and you just let the property go down the drain. And the other would be if you have some kind of interest rate fluctuation. Now, we've all seen that interest rates fluctuation because it occurred starting in Q1 of 2022. We saw Jerome Powell at the Fed take interest rates up from nearly zero, 0.25 all the way up to about 5.5. So he went up about five points in the span of time that most people anticipated rates would never go up more than a quarter, a half a point.

He sure showed everyone a lesson there. He proved to the world that he could raise the rates faster than anyone has in a half a century. Not really sure it's an accomplishment to be proud of, but nevertheless, that was the course that the Fed has taken. Hasn't turned out that well in the end, if you look at the stats, hasn't really done a lot to battle inflation or do many things. It's really resulted in a viciously expensive housing market that has made home buying now nearly impossible for millions of Americans. But nevertheless, that's the choice we made. And in so doing, when you take the interest rates up like that, it's possible that the valuation of your property would then decline substantially because cap rates tend to follow interest rates. However, it's unlikely they're gonna go up anymore. So if you were buying a property today, you're probably looking instead at rates going down rather than up.

I cannot even fathom under what conditions the rates would go up higher. I know people will say, "Well, the Fed will have to fight rates even higher if inflation won't slow." Well, inflation's not going to slow because Ronald Reagan proved you can only reduce inflation by basically promoting oil and gas production because so much of American inflation is based on higher gas prices. You can look it up on Wikipedia. So if we assume that inflation will be here for a while, the bigger issue and the bigger threat I think would simply be we're a nation with $35 trillion in debt and growing. If you apply a 5% interest rate to the $35 trillion, you end up with about $2 trillion a year of interest. And here's the problem. Our entire intake in the federal government is only around $4 trillion. So if we're stuck paying 5% as opposed to 0.25%, we'll have to give up a few things.

We'll either have to abandon the military altogether, lay them all off, shut the bases down, sell off the tanks for spare parts, or we'd have to eliminate completely social security, Medicare and Medicaid. Neither seems very likely. So the only other scenario is to get those rates down and get them down pretty quickly. And more than likely, the Fed right now is watching for the opportunities to do so. So if that were to occur, if rates start to decline, it would be very, very difficult unless you were a terrible operator, to suddenly have the value of that property to descend down lower such that you would have recourse.

Now, have I seen it before? Yes, I have. I'm old enough to have been through many, many recessions. I was around during the days of Jimmy Carter, Ronald Reagan. I was around for the 1987, 88 Texas Savings and Loan Crash, dot com, Great Recession. I feel like I've seen them all, won't be that shocked by the next one that comes up. And I've seen values decline in recessions, but not in recessions for the mobile home park industry because we're a weird animal. We're contrarian. When times get bad, we get stronger. One of the best periods for mobile home parks, in fact, was the Great Recession. Rents went up a lot because people needed affordable housing badly, and in supply and demand world, that's the right position you want to be in. So I don't really see the economy leading to drops in valuations, and I don't really see going forward interest rates playing a part of it.

So the bottom line is, if you feel confident in your management ability, you should be okay with a 70% to 80% loan to value position. That should be something that you can definitely handle. Now, can you mitigate those risks? Yes, sure you can. Every good operator should look at all of the risks in their business, mobile home parks are no different, and decide a plan B and a plan Z for any contingency. Often in the mobile home park business that plan B, that plan C is to rely on pushing rents upward, increasing occupancy and minimizing cost. And in typically doing that, you can cure almost all ills. But nevertheless, you need to have a plan. And that plan will give you even greater confidence in the fact that you can have recourse debt and be okay. Now, another alternative would be simply to never do recourse debt by converting lenders who do recourse into nonrecourse.

And to do that, often you'd have to ask the lender at what amount down payment would you do nonrecourse? Even banks that say, "Well, we don't do nonrecourse." You say, "What if I put half down?" And they then say, "Well, of course we'll do that then." It's just not an offer they frequently get, so it isn't normally part of the discussion. But most of your banks will do nonrecourse debt at a certain amount down, and that amount down often is around 50%. So if you say, "Well, I don't like recourse debt, but I realize I'll have to deal with banks because my deal isn't large enough to get into conduit and Fannie, Freddie," well, then there's a solution. Maybe you go with an even lower loan to value to get that job done.

The bottom line to it all is we need to take a real realistic look at recourse. Of course, it sounds terrifying when you say, "Well, this loan has recourse attached to it," but is there really ever going to be something that you have to tap into or is it more just a fear that we all have that could be conquered if we really put some strategic thought to it?

This is Frank Rolfe, the Mobile Home Park Mastery Podcast. Hope you enjoyed this. Talk to you again soon.