Mobile Home Park Mastery: Episode 252

Understanding the Science of Cash-Out Refinancing

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One of the best methods to approach maximizing the performance of a mobile home park investment is to refinance it and do a “cash-out”, which means a return of some or all of your initial capital. But many people fail to grasp the science behind this alternative, and the thresholds required to make it a reality. In this Mobile Home Park Mastery podcast we’re going to facts from the myths regarding this financing trick.

Episode 252: Understanding the Science of Cash-Out Refinancing Transcript

We all know the concept of buying a Mobile Home Park at a low price and selling it at a high price, but there's another model in which you buy the low price, raise the value and then do a refinancing. This is Frank Rolfe, the Mobile Home Park Mastery Podcast. I wanted to explore the actual science behind doing a cash out refinancing versus some of the myths that float around from people as far as how that might work. So, what is a cash out refinancing? A cash out refinancing is when you buy a mobile home park, you increase the value of the park over time, typically through raising rents, filling vacant lots, pushing back water and sewer, and get the value up to a level in which you can then get another bank to refinance that deal, thereby recovering some or all of your initial capital you spent on buying the mobile home park. Well, it sounds all kinds of easy, right? Let's just buy the mobile home park, let's just put into effect our playbook of increasing rents and occupancy, and a cash-out refinancing is imminently attainable. But no, it's not quite that simple. Here's how it actually works.

For you to do a cash out refinancing on a mobile home park, you have to increase the value of the property roughly 50%, using a standard metric of 70% of loan-to-value, which is what most of the lenders who will do cash-out refinancing require. So it's not driving them to value just a small token, it's a very, very significant rise in value, that means you'll have to go in and buy a property, and through raising rent and increasing occupancy, drive up that value very substantially to roughly a 50% increase over what you paid. Now, if you buy a property that has a lot of turnaround potential, you're gonna go ahead and fill a lot of vacant lots and push rents up a lot, then it's not impossible by any stretch of the imagination, to hit that target. But the problem is that those types of properties, those heavy lifting turnarounds are rarely the ones that you can get that cash out refinancing loan on, because the kinds of lenders who do cash out refinancing are typically what are called conduit lenders or Fannie Mae, Freddie Mac, these are people who do parks that are much on the upper extreme of the condition and the size and the appearance of the regular park. So, you typically cannot do a cash out refinancing using a regular bank.

A regular bank might be a little more lenient on the terms as far as road condition, general property appearance, pride of ownership and those type of things, but the conduit lender and the Fannie Mae, Freddie Mac lender, well, they are a little bit more picky, and the kinds of properties that they like to tend to refinance are not the kind you can typically buy with that much upside to it. So if you're buying that four star mobile home park that's basically full market rent, the odds of you boosting up the value by 50% seem somewhat remote, so as a result, that's the real trick is, can you find a property worthy of a re-finance lenders time in the future, that you can boost the revenue and cut the costs enough to make the refinancing possible? 

Now, the other question is, is that really the best thing to do anyway? And that's the other part of the equation. When you buy a mobile home park, most people can view into the future, maybe 10 years into the future, we look at a market and we say, "This market either has potential or does not have potential, but they can't really tell for decades into the future. My crystal ball doesn't stretch quite that far. If you could drive around America, as I always do, I pass through certain areas of towns and certain towns themselves that have seen far better days. Sometimes, their peak moment in the history of that town might have been 1920 or 1930, or maybe 1950. And if you were viewing it into the future back then, well, you might have missed that one moment.

I drive through St. Louis, for example, and I see on the east side of town, high-rise hotels completely abandoned, the windows broken out. They were landmarks back in the 1930s and '40s and '50s, but then as St. Louis died over time, as did the fortune of those hotels, and no one could have ever seen it coming, no one ever knew that someday, that hotel would be in an area where it would just sit as an abandoned hulk. There was money that should've been made when it would have been sold back during the peak, but no, someone held on to it and said, "No, I'm not selling this asset, this asset is the kind you'd wanna own forever," as they watched the value drop and drop and drop until it reached complete abandonment. As a result, when you refinance an asset, what you're doing is you're extending your ownership of that asset out another goodly amount, typically at least a decade. So, that will take it typically from the asset you bought originally, to the end of that refinancing period, you may well own that thing for two decades, for 20 years. None of us can truly envision the future 20 years out.

So as a result, there is some degree of risk when you refinance the asset, 'cause you're basically re-upping your original hunch. You said initially, "Oh, I think I can get this far, this far along on the deal and I'll be okay." But what about that next decade? Does that still work for you? So as a result, what happens often on the refinancing is you go with the best of intentions and say, "Oh well, I'm gonna buy this park, I'm gonna try and raise rents and cut costs and push back water sewer. And down at the very end of the movie, I'll go in there and I'll sell it." And then maybe you say, "Well, wait a minute, maybe I'll refinance it." The difference is when you go to sell it, you would have been locked on to your original target of a 10-year hold. Maybe you sell out in year seven, year eight, year nine. But if I go in to refinance it at that moment, now I'm going another decade, because those conduit loans and those agency, Fannie, Freddie loans, those things are 10 years in duration. And don't be thinking you can...

"Well, then I'll re-fi and sell soon thereafter," you have giant defeasance typically to pay. It's a penalty that you pay on those types of loads if you want to have any form of prepayment. So no, you probably won't. You're probably gonna hold that thing another decade. So then why do people refinance anyway, if it sounds so very difficult? Well, if you own an asset and you love that asset, I know a family, for example, that owns a mobile home park up near Aspen, Colorado, and they like to go in there and refinance that thing continually every 10 years. And why not? That property is in a perfect position, and there's very little risk that anything will ever happen to Aspen to make it any less desirable. So they see it kind of as a family, generational wealth-building tool. To refinance it, hold it another 10 years, refinance it again, hold it. And of course, they can do perpetual rent boost as they go, to make all kinds of sense of it. But that's a very, very unique asset. So when it comes to refinancing, it's very important to remember, you've gotta have just the right asset and just the right commitment to that asset, and just the right amount of value enhancement to make the whole thing tie together. It's not so simple as to say, "Well, I'm going to buy this mobile home park, I'm going to do a few items to groom the income, and then I'll do a cash out refinance."

It doesn't work that way. It only works that way if that asset is attainable as a conduit or Fannie, Freddie loan, which means it'll have to have paved streets and a nice pride of ownership, no hitches, all the homes looking very nice, skirted, well-manicured, the correct size and dollar value, the correct location, because lenders are picky when it comes to location. You have to have the right infrastructure, you have to have the right density, all the various items that fall into good park buying. But you gotta have all those elements together and still be able to enhance the value by at least 50%. Then, you have to make that commitment to go that extra decade. So when you add all those facts together, it doesn't quite live up to the myths. Now, it does work very, very well for some people to refinance the assets, but that's not to say that every mobile home park out there is best-suited to be refinanced, many of them would be much smarter off to simply be sold. So refinancing, while an excellent tool, is just a tool. It's one of many. A more dominant tool in the tool box is probably just selling the property off. It reduces your risk as far as guessing the future of what the property may be. It's definitely a whole lot easier, and in many cases, it's the only option you have.

Because unless that property is one with the sufficient quality to get that conduit or Fannie Mae, Freddie Mac loan, then there's no way you can do a cash out anyway. Typical bank lenders won't do cash out refinancing. And there's one more item to consider, and that's recourse. If I do a cash out refinancing with non-recourse debt, well, then that seems pretty smart. I've taken a lot of money off the table, but if I can only refinance into recourse debt, well, what have I really done? I haven't sequestered any money off the table whatsoever, I still owe all of it back, so I haven't really accomplished a whole lot, I've simply created perhaps even more risk for myself. So, refinancing is a great thing, but it's all important that anyone in the industry who's looking at doing a refinancing of a property understand the limitations, understands the risk and understands when that tool is of value. This is Frank Rolfe from Mobile Home Park Mastery Podcast. Hope you enjoyed this. Talk to you again soon.