In this final segment of our five-part series on the Legal Side of Park Ownership, we’re going to discuss some important tips on creating seller financed notes. Since one of the most attractive components to buying mobile home parks is the frequent availability of owner financing, this is a very important topic that we receive frequent questions on. Seller financing is what got us in the business to begin with, and it’s still a very important tool. But to do it successfully, there are some basic insider secrets that you need to know. We’re going to review these items and wrap up our five-part series with a discussion of what you need to know about seller notes and how to construct them
Episode 38: Tips On Creating Seller Notes Transcript
The best kind of financing for a mobile home park is seller financing. It's always been that way and it probably always will be. In fact, that's what got Dave and I excited about this industry to begin with 20 years ago. However, they're some things you need to know that we learned over the last 20 years regarding seller finance notes. That's why we're doing this, our fifth and final segment on the legal side of park ownership, all about seller notes. Now, let me start off by saying, I'm not a lawyer, I'm not an accountant, so the things I'm going to tell you today are based on things I've learned or observed, but I'm not giving you legal advice, because I'm not qualified to. I'm not a lawyer.
Let me also say on the front end that there's huge demand on the part of sellers to enter into seller notes today for one simple reason. Our interest rates today on savings are very, very low. The standard CD rate right now runs from 1 to 1.5%. However, a good seller finance note will pay the seller 5 to 6%, so it's pretty much up to a five for one. That's why there's so many folks out there that want to enter into seller notes. It just makes complete economic sense for them. It wasn't always that way. There was a time in America where CDs paid very high rates of interest and it was very hard to get seller notes, but that is not the way it is today and probably will remain that way for as far as the eye can see.
Now, one quick observation is, to the best of our knowledge, although it's so quirky no one really has a handle on it, it doesn't appear that SAFE Act or Dodd-Frank, the laws that took effect in America in 2008 and 2010 respectively, apply to sellers creating mortgages on mobile home parks, because those are commercial transactions. The SAFE Act and Dodd-Frank, to the best of our knowledge, is reserved only for transactions with the individual consumer and commercial transactions are exempt. Now, another front end observation, even though I'm not an attorney, but you probably should use an attorney when you're drafting your seller finance note. Here's why. Maybe you get along great with mom and pop you're buying from, and maybe you totally trust them, but it won't always be that way.
It's very possible that after closing something happens to mom, or pop, or both of them, and you no longer have that collective group that you trust to deal with. Now you're going to be stuck with the heirs to mom and pop. They may not be as friendly as mom and pop were. Number two, there may come a time when mom and pop aren't as friendly as they were. Possibly they'll have health issues, or something else will happen, and they may not be as easy on you as you thought they would be. You can't just write a note on the back of a napkin. You just can't do a note with a handshake deal. You have to have an actual written note that's no different than the note you will get at a bank.
Now, how do you do that on a reasonable budget? Well, here are some thoughts. Number one, you can typically find templates of seller notes online. Number two, you can typically get a seller note that's already approved by the state from the state mobile home association, but regardless of what you can obtain as far as raw material, don't think that's the finished product. Take that to an attorney before you close and make sure that that note has everything you need in it. Make sure you understand every bit of that note as far as the payment, the length of the note, the amortization. Make sure you have a very firm handle, because once closing is over and everyone's left the table, it's probably unlikely you'll ever get any of those amendments changed.
Now, let's go over some of the things we like to see in our notes and why we like to see them and why I think you would like to see them too. First item is a thing called the cure period. This is one thing that scares us more than almost anything else. That's the fact that in most states in the United States, if you make your payment just like you're supposed to and they don't receive it, they can call your note due in full, claiming you've defaulted. How horrifying is that to think you could do everything right, write the check, take it to the post office, put it in the mailbox, and you just assume it will get there, but you know it does not always happen? I myself have had over the span of my entire lifetime, on many occasion, things vanish that I put in the mail.
What happened to them? I don't know. Possibly they fell out of the bin, fell out of the truck on the way to the destination. Maybe those machines that sort the mail ripped it in half and they never knew who it went to or who to even return it to. I don't know, but if you don't have a cure period in your note in some states, the simple fact you did everything right is not going to protect you. If the seller does not receive the note on the prescribed date and there's no cure period, they can simply call the note as being in default, and immediately demand that you pay off the note in full, or come and take it away from you. You've got to make sure that you have a cure period.
The next big thought is something called the release price. Here's how this works. When you enter into that note with mom and pop, they're going to encumber under that lien not only the mobile home park, but other items as well, possibly park-owned homes, maybe a tractor or a riding lawnmower that came with the property, maybe some land that came with the property. Not all of these things you're going to want to keep for the next 10, 20, 30 years. If you want to sell them off, you've got to get a release price from mom and pop in order to do that. What is a release price? It's the price in which any item you want will be released from the collateral pool and free to sell. The most common of these, of course, are park-owned homes. Here's the big tip on this one. You want to do those release prices very early on the front end. That's when you want to do those.
You don't want to do those when you really need them, because when you need them, you'll be over a barrel, and the seller will sense that, and the price will go way up. If you've got 10 park-owned homes that come with the deal, and you really want to sell them off, and they're 1970s, and they're not very good homes, you might say to mom and pop, "Hey mom and pop, I might want to sell these homes some day. If I were to do that, could I pay you say, $1,000 or $2,000 a home to be released from the collateral pool?" They'll probably say, "Sure," because they'll think, "Yeah, he'll never do it. We thought about doing it one time and we never did either. We're just going to rent them and he'll just rent them." They just don't assume you're going to do it.
Or if there's the old mom and pop residence that they lived in for 40 years. It's an old frame house. It's right at the entrance. It is separately even deeded sometimes, subdivided, ready to go. You could sell it. Don't wait until four years later to ask them, "Can I sell it and how much on the release price?" Establish that on the front end. Say, "Hey, I might want to sell the old house some day." They'll think, "Yeah, he never will, so okay, fine. Sure, you want to sell the old house, just give us 20 grand and we'll release it from the collateral pool." I guarantee you if you go back to tell four years later, that same house will now require 60,000 or 80,000. Why? That's human nature. When you approach someone for that release price, an alarm goes off in their head saying, "Boy, they must need that release. They must've already sold that," and it will go up a lot higher.
I even had a case once where the guy wouldn't release it. He just wouldn't release it. I came to them, they had a mom and pop house, I never established a release price. It was early in my career, I had no idea I'd ever sell the house off, but I got a great offer on it, and I sold it, or I went into the process of selling it, and I went to mom and pop to get the release price, and they would not release it from the collateral pool. In the end, I had to go out and refinance the park and then right before I paid them off, they changed their mind again and said, "Oh, don't refinance this. We're sorry, we'll go ahead and release the house now." What a mess. I should've had the release price on the front end, I would've never had all those different problems.
The next item is called assumability. When you enter into that note, you like it. It's exciting to have a note on a property and to have escaped the entire banking process. You know who will be just as excited down the road? That's the person you sell it to. If that note is assumable, it will help you also when you go to sell the property, because rather than get a bank loan, they can now assume that note and their down payment is basically the money you get. Now, it doesn't always work, of course. If you've put a lot of effort, and were a very good shopper, and the park is worth a whole lot more now than you paid, it's unlikely anyone would like the leverage potential of that assumable note, because it might only be 50% of value and not the standard 80% or so.
However, in other instances it's a good thing to have and it always makes you feel happier from a liquidity standpoint, from an exit strategy perspective to have the option of assumability, so that's always a good thing. The next one is non-recourse. You always want seller notes to be non-recourse. Now, what the heck is non-recourse or it's corollary recourse? Here's how it works. If you enter into a mortgage, and you default on the mortgage, and the person who holds the mortgage forecloses on the property, and sells it at auction, and it's less than the amount of the mortgage, they have the right under a recourse provision to come after you personally for the difference. Now, it may not sound like much to you at the moment. You might say, "Well, how much could the recourse be? I'm buying this property good and I think if they sold it at auction and I have a 70% loan to value rate, that I can't be down that much."
Well, it can really be a calamity if there's a really hard time on the spectrum. Don't forget that Clint Murchison, the guy that owned the Dallas Cowboys in the olden days, lost the entire team because he had entered into a number of recourse loans on some commercial buildings. He didn't think it could go down that bad, but he had no idea the Texas savings and loan crash was waiting right around the corner. What do you want? You always want non-recourse debt. Non-recourse debt means that no matter what happens, the mortgage holder can never come against you personally. All they can do is keep your down payment and that is the safest and bestest way to set it up. When you have non-recourse debt, you know the absolute worst downside that can happen to you, and you can come to grips with that. When you have recourse debt, you can never really calculate exactly where you're at. If you worry all the time, like Dave and I do, it's not a very good lifestyle choice.
Finally, and this is a very important item here, so if you did not pay attention to any of the earlier ones, you might want to pay attention to this one because this just could save your life on a seller note if things go bad. It's basically buying an extension of the note, buying an option for the extension of a note. Here's how it works. Let's say mom and pop, they're 80 years old, 78 years old, they don't want to enter into a fully amortizing mortgage because they don't think they'll live 30 years. Well, you never know, they might. I've read articles on MSN about people living to 115, 120 years old in some parts of Europe. Nevertheless, the odds are it's not probably going to happen, so they're going to want to have a five year term or a 10 year term, but more than likely a shorter one, like a five year.
Now, here's what happens. None of us know the future of banking. I don't, you don't, nobody does. What happens in five years if the banking market is in complete turmoil? What if all the banks have just shut down? Look what happened in America in year 2008. A lot of banks just stopped making loans. Things were in a free fall, and they were too concerned, and they wouldn't do it. What do you do then? How do you finance the park? How do you pay off the note balloon? What do you do? Well, there is a lot you can do, but what you can do is to protect yourself against that eventuality. What you do is, you go to mom and pop and you agree to write into the agreement for the loan, the possibility of an extension. You have the right to buy the extension, the option to extend the note for another additional period of, let's say, three years, or even five years.
What you do is, you make a good faith gesture by paying down some of the principle. You preestablish that in the agreement. It might be $20,000 or $50,000. It's not a penalty. It goes against your outstanding principle. It's a good faith moment though, because you would not, if you were going to walk the deal, obviously put more money down. That's why you do that, is to convince mom and pop that you mean well and that you have good intentions. Then what happens is, you put down that money, and then the note continues on another specified period. Why is this so important? Well number one, it doesn't cost you a darn thing on the front end. You have the option to do this, but you don't have to exercise the option till the note comes due.
The big issue is, it's the ultimate fail safe insurance policy against absolute banking Armageddon. None of us really know where the banking world will be, but we do know the banking world has extreme cycles of up and down. You don't want to be caught in the down cycle with no way out. This gives you that very valuable way out to extend that seller note for enough of a period of time that perhaps banking will return and you can then get the loan. Now again, seller notes are the greatest thing on earth. My very first property, Glenn Haven, came with a really, really attractive seller note, and that's what really put me over the top in deciding to want to buy this thing that I know absolutely nothing about.
Same with Dave, all through our early career was peppered with nothing but seller notes, and we still do them today. It's one of the big assets of mobile home parks and you can only get them in mobile home parks typically, out of all the real estate sectors, because you're typically buying from mom and pops who own the properties free and clear. You cannot enter into a seller note, obviously, if you have an underlying mortgage. That's why it's such a very powerful tool to get into the business, but if you're going to do it, you got to do it right. Hopefully, these tips will help you get you down that path of doing it the correct way and I hope you've enjoyed this five-part segment of the legal side of park ownership. This is Frank Rolfe of Mobile Home Park Mastery Podcast and I'll be back again soon.