Mobile Home Park Mastery: Episode 160

Understanding The Game Plan For Cash-Out Refinancing

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“Cash out” refinancing is extremely attractive to all investors, as it allows you to “recycle” your capital over and over to build a portfolio of properties. Or it also allows you to remove all risk from any certain deal and gives you cash to build a financial safety net. Whatever the goals may be, obtaining “cash out” is somewhat of an art form, and there are certain strategies required to achieve it. In this week’s Mobile Home Park Mastery podcast we’re going to discuss this game plan regarding “cash out” and what the deals look like that carry that potential.

Episode 160: Understanding The Game Plan For Cash-Out Refinancing Transcript

What is cash-out refinancing? That's when you go to a lender and the lender loans you the money and that loan gets you, not only the amount that you borrowed covering that, but also all your capital back that you put into the deal to begin with. And sometimes even capital beyond that. This is Frank Rolfe, The Mobile Home Park Mastery podcast series. Clearly, then we would all want to do cash-out refinancings. And that is true. It's one of the best models you have in the Mobile Home Park industry. However, let's talk with the more granular detail on how they actually work. And as you'll see, it's not as simple as you just saying, "I want to do cash-out refinancing." There are some hurdles you have to jump over. There's some basic metrics of deals that make them possible, to result in cash-out refinancing.

So, let's start off by saying, "Who does cash-out refinancing, who are the lenders who do that?" Well, there's really only two that I know of. One conduit lenders, these are called CMBS Commercial Mortgage Backed Securities. Yes, this is the group that crashed during 2007, which led to the great recession, but that was on home loans. This is different. This is on commercial properties and they haven't done that poorly over the years. So a conduit lender, they look at a deal and they will do 70% loan to value of the appraised value. And they don't care how much you have in it, because all they're looking at to get their money back is the deal itself. So, if they say that deal's worth $2 million and 70% of that's 1,400,000 they're going to say, there's no way we're going to lose any money on this, because worst case, if you default, we know we can sell it for at least 1,400.000 or more.

So, conduit lenders are the first variety. The second, Fannie Mae and Freddie Mac, also now known as Agency Debt, part of the government, the people who do all those home loans that you see all across America. Well, they now do Mobile Home Parks too. And they do it in a big way and they do the same formula, roughly 70% loan to value based on appraisal. Once again, they're not looking to you. This is all non-recourse lending. So, they don't really care a whole lot about you and your capabilities. What they're concerned is the property. They want to get an appraised value and they do roughly 70% of that. And whatever that number is, they don't care how much you paid for it, or how much debt you have remaining, or how much cash you're taking out of the deal. That's who does it, your regular banks don't do it.

Your regular banks have a little bit different viewpoint. They want you to have recourse debt. They want you to have skin in the game. They want to come after you, if for any reason the deal loses money. So, they just look at it completely differently and they don't like cash-out, because then you don't have any "skin in the game." So, they think that you're a dangerous type of a borrower. So, that's who does the lending. So, if that's who does the lending then, let's work backwards from there. What did those people want? Well, we know one thing, conduit lenders start at about a million dollars and up as far as how much they'll do a loan for, and the agency lenders, they're more in the world of $2 million and up. So, if you want to borrow a million and they're doing 70% loan to value, how big does the deal have to be?

Well, roughly about 1,500,000, right? About 1,500,000 would be about a million dollars of actual debt. So, what do we say, we want to do a cash-out refi ... It means we're going to buy a property that ultimately can appraise out at about 1,500,000. So, the loan is about a million dollars because that's the benchmark minimum for most conduit lenders. If you want to do Fannie Mae, Freddie Mac, you're probably going to have to go up a million dollars more than that. So, we're trying to please them. We got to fit their profile. Why? Because if I'm smaller than a million, conduit and agency won't do it and then banks aren't going to do it either. So, now I've already set in stone the metrics of how it works, but there's another side to it. I have to have a deal that I can increase in value at least 30% to actually get my cash out.

Let's model that for a minute. All right. So you buy this deal for a million dollars that doesn't qualify for conduit debt, because if you buy it for a million, 70% LTV would only give you a $700,000 mortgage, so your $300,000 short of hitting their metric. So, I got to get that thing up, right. Now if I increase the value of that million dollar deal by 30%, now I'm at 1,300,000, 70% of that, it's about 900, I'm getting pretty close. So you can see that typically I have to buy a deal that I can increase the value on pretty substantially. I'm going to have to get the value of that thing up based on the size of the deal, 30%, even 50%. So, I have to have deals that I can make a significant impact on the net income with. It can't just be a case where I'm going to raise the rent up five or $10 one time a year.

It will take me a long, long time doing that to increase value by 30% or more. So, what kind of properties give you that option to go up 30% or more? Well, typically the properties where you can, A, raise the rents ... I've talked a million times over the fact that Mobile Home Park lot rents throughout America are woefully low, ridiculously low, a thousand dollars a month, less than apartments, even though our product is better, which just makes no sense. So, raising rent, that's a big part, also filling lots. The demand for affordable housing has never been higher and there's so many financing programs from manufacturers today and so many homes to choose from, that surely you can find a way to combine that affordable housing into a home that you can stick on that vacant lot and sell or rent. So, that's another way you can increase your net income.

A third way is pushing the water sewer cost back on the residents. It's good for everyone. It's good for the world ecology, it causes conservation. Studies have shown that when people pay their own water sewer, they drop their consumption by roughly 30%. That's certainly all part of our new green America. So, that's an area that we shouldn't forget. And another one is just basically lowering cost. And typically when you lower the cost in the Mobile Home Park, it's normally by replacing the manager whom is often massively overpaid with some of these mom and pop properties, to someone's more in line with industry expectations. Those are the big four. Now there's another item out there, which is a little more passive, a little more behind the scenes and that's making the property nicer. So, it will appraise for a higher amount, because the nicer you make it, the lower the CAP rate is on your appraisal.

How do you make it nicer? While you aesthetically make it more pleasing. Every park owner should be focusing on that. Make your entry nice, make your streets nice, make your homes nice. Even if you have to do the work, even if you have to paint the homes that look bad and paint over those rusted roofs, nevertheless, you need to be doing that work because that's one way to make them have a lower CAP rate. Another one is just to go ahead and change the ambiance of the entire park. Bring back pride of ownership, bring back sense of community, build amenities, where there's currently just land, put in some picnic tables and some grills and maybe a pavilion, maybe a playground. Do things to unite the tenants together, so they share a common purpose of making the park look nice. Everyone benefits when you do that.

Finally, do not allow anyone to drag down the overall quality of life for all the other residents. In many Mobile Home Parks, there is one or maybe two residents that cause all of the problems, all of the blight, all of the litter, all of the rules violations, wild parties all night, you're going to have to either get them to behave in a manner in which the rest of the community can have a high quality of life, or you'll have to get them out. Now, when you make that property nicer, what does it mean? It means the appraiser drives through and says, "Oh, this property is nice." And they give you a higher value. It also means the lender is also happy because they think, "Well, this is one that won't fail because this is a really nice community. And if it does fail, I still have that 20 or 30% down." Right?

So, you've got to find properties, where by virtue of you doing these things, raising rents, filling lots, cutting cost, pushing water sewer back on the residents where it rightfully belongs and making them seem nicer, that you can therefore increase the value to 30, 50%. But you know what? A lot of parks you can't. So when you look into buying a Mobile Home Park, if you're buying a park and of pretty much the CAP rate at the moment, you're not going to get there with tiny, tiny rent increases.

So, you've got to do something more. Search out those properties, if you really want to do cash-out refinancing, that meet the metrics I'm describing. Think of it from a lender's perspective and work backwards. What markets do lenders want to be in? What attributes of a Mobile Home Park do lenders want to see? For example, they want to see typically, paved roads with parking pads. Does this park have pave roads with parking pads? Try and find assets that lenders are happy doing cash-out refinancing on because they don't scare them. Remember that lenders have a unique role in life. There's an old saying before you can have return on capital, you have to have return of capital. That means the bank sees until they get their loan back, a lot of risk. Banks don't like risk. They get paid the same interest rate, whether you're risky or you're not.

So, they are always going to hedge their bets and go for the safe property that gives them peace of mind. Deliver that to them, help them, make the property look exactly like what the lender wants to see. And then work as hard as you can to get that value up to roughly 30, 40, 50% more than you paid and make sure when you do get that, it's a high enough value that the loan itself will hit their benchmark minimums. What are my best case stories of refinancing and cash-out refinancing? I have many, I have someone who attended the bootcamp and not long thereafter, bought a park, very inexpensively from mom and pop that had all the right attributes. Turned the thing around. And in no less than three years refinanced out $700,000 beyond what they had in it. There's many stories like that, but there's other stories of people who want to do cash-out refinance and didn't understand the basic game plan.

Didn't understand that to do it, they'd have to tap into conduit debt or Fannie Mae, Freddie Mac, Agency Debt. Instead, they thought they would do it through bank lending and they found they couldn't get it done. So again, cash-out refinancing is an excellent, excellent plan for any Mobile Home Park owner, we think it's probably one of the best in the entire industry, but it does have its limitations. You have to understand those limitations on the front end of your deal, to see if it truly can qualify when it's done.

If you follow that metric, if you follow that narrative, you will not be disappointed because you'll know exactly what the mission is and exactly how you are doing in accomplishing that. You can say, "Well, based on prevailing CAP rates, my property is now worth this. At 70%, let's see, where do I end up until you end up in that magic level that you can find lenders who agree and will backstop your concept and your property will qualify for what they're trying to do. So, really cash-out refinancing is an art form, but it's really more like a strategy as well. Definitely, there's math involved in doing it, but it's one of the best models there is in the Mobile Home Park investment business. This is Frank Rolfe, The Mobile Home Park Mastery podcast. Hope you enjoyed this. Talk to you again soon.