First-time park evaluation -- comments welcome


#1

Hello all,

I’ve been looking at parks for a few months now, but have always found something fairly quickly to make me drop the idea. This is the first park where I’ve gotten to the point where I’d like to put in an offer. I’d love feedback on how I’m going about the analysis.

Details:
• 55+ park in Massachusetts, not rent controlled (I’ve done a fair amount of research into parks in MA and read the AG’s report, and I’m ok accepting what it means to be a park owner in MA), asking price $1.2M
• 35 lots, all occupied, all TOH, history of high occupancy, $380 lot rent. History of raising lot rent $10-15/year
• all city utilities, water/sewer/trash paid by park
• 4 other 55+ parks within 3 miles, mostly nicer, all with similar lot rents and utility structure
• avg home price over $200k
• onsite manager getting free lot rent but nothing else to be eyes and ears and do some minor maintenance
• current owner has owned for 8-9 years

Here’s my reconstruction of the P&L

The law in Massachusetts allows tenants to have the right of first refusal on the terms of a signed deal, if they want to turn it into a co-op. This park went under contract late last year and the tenants tried to do a co-op, but backed out late and the original buyer backed out too. However, the tenants commissioned a third-party report that showed the following in deferred maintenance:

The report also made the following judgments on the state of the infrastructure:

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Comments on the findings of the report:
• The seller thinks replacing the water distribution system is ridiculous, and when he had leaks previously, was able to find them and fix them for far less. Instead he suggests crawling under each mobile home and listen for leaks with an acoustic detector, and if that doesn’t identify leaks as it has in the past, install 4 access pipes over the water mains and detect leaks using leak noise correlators. He estimates no cost to do acoustic detection, probably no more than $5k - $10k to repair, and perhaps $40k - $50k to install access pipes and utilize correlators if it comes to that with repair costs of $10k - $30K.
• The park is in a depression relative to surrounding land and has flooding issues after a hard rain. As much as a couple feet of standing water. The drainage improvement is to rectify that. It is in a FEMA flood zone, but there are no major water sources nearby. The repair estimate was done without engineering plans and seems to be a ballpark guess more than anything else.

So, my questions are:
• Does anything on my P&L seem wildly off? I believe there’s no mowing or landscaping required by the park, so I don’t have line items for those.
• On the findings of the report about needed capital improvements, the seller thinks there’s $24k in excess water expense caused by the leaks. He proposes doing what he lays out and then having the buyer reimburse him for what he spends. The seller has no intention of doing any of the other items mentioned. Is it unreasonable to ask the seller to foot the bill for the drainage, paving, and tree pruning?
• The seller mentioned having to spend $12k a few years ago to fix two major water leaks. My assumption here, combined with the third-party report and the seller’s reaction to it is that the infrastructure is going to require those kind of five figure infrastructure fixes on a regular basis going forward, and I should bake this either into an annual reserve build on the P&L or increase my required cap rate. Does that seem appropriate?

I tried to keep this posting as short as possible – I can give more details if helpful. Thanks to all.


#2

Where do you see a pathway to wealth in this deal?


#3

My initial goal is to acquire parks that will be fairly easy to run (few if any POH, for instance) where I can generate good cash on cash returns and an annuity-like cash flow stream. The math that I’ve penciled out, which includes asking the seller to fix the identified issues, gets me there on this park. So I view it as less as a pathway to wealth and more as a way to begin to generate an income stream outside of my regular job.


#4

Another question before I can comment on this; What’s the LTV are you are looking at when you talk to lenders?


#5

Proposed loan is 75% LTV, 5 year term, 25 year amortization, rate in the low 5% range, recourse.


#6

Well, I am certainly glad that there are people like you willing to take a slow walk to wealth since some day I hope to sell my properties to such.

Let’s look at the deal as I am able to understand it:

$90k NOI, $1.2M = 7.5% Cap Rate.

Say a 2% spread (I guess they will hit you with some points and fees that will close that spread a little) means you make about $18k/year on the money you borrow and some $22, 500 on your $300,000 down payment, giving you a total of $40,500. Let’s call that $40K since projections can not be made to the degree of accuracy that the $500 suggests we can.

So you are getting some 13% return on your $300k. Not bad, perhaps a very slow walk to those happy days in the future of palm trees and white sand beaches, but still not bad. I know this is not cash on cash, like you said in your reply but let’s go with this so as not to make me go to the amortization tables.

Now let’s look at the risk you are taking to get that 13% or so.

You a buying at a fairly low cap rate so there is not much chance you will be selling at a even lower cap rate in the future. But what if rates go up in 5 years when your loan balloons? Let’s say it goes up half a point. That most likely will push the lowest cap rate you could sell the property at would be 8%. Which means the bank would use that number to figure the valuation of the property and how much they would be willing to lend on it.

Let’s figure this – $90,000 NOI / 8% = $1,125,000 X 75% = $843,750.

This means with a .05% increase in interest rates your property may very will have lost $75,000 and you are going to have to dig into you pocket for something like $50k to refinance. [There is going to be some pay down of principle so you no longer owe the whole $90k but I don’t have time now to run the calculations on that - but it will not be much.]

What if rates go up a whole point and pushes you cap rate to 8.5%?

$90,000 NOI / 8.5% = $1,058,823 X 75% LTV = $794,000. Yikes! You made your $40k a year, but you lost $242,000 and have to come up with another $100,000 to keep from loosing everything.

These are actually positive projections of where you will be in interest rates a up a little from where they are now. It could well be that the bank may not be willing to lend a full 75% on the MHP and it may well be that investors having recently been schooled on the risks of leverage (unlike they have in years) demand higher cap rates than the one point move in interest rates = one point move in cap rates.

You should run the numbers with a sharper pencil than I have here to get a handle of the risks you are taking on. See what rent raises do for you. The problem I see with the deal is the short loan, the low cap rate and the lack of opportunity for growth in the stabilized park.

If, say, you had a 50 lot park with 15 vacant lots that would be a different issue. You could fill the lots, sell off the homes and push the value of the property giving you a safety margin. If rates go up, you could curse the FED like the rest of us would be doing, but you would not be in negative territory and perhaps be facing loosing everything if you don’t have the cash handy to help pay off the loan.

Please tell me where I am wrong if you find an error in my analysis.


#7

Despite your condescending intro and typo-riddled rant, you seemed to miss the easiest upside to the deal - the $35k of water!


#8

A quick clarification: asking price is $1.2M. I don’t intend to offer that.

And a quick correction: that $35k of water is actually water/sewer/trash paid by the park. It should be one line higher on the spreadsheet. I’ll try to correct that. But regardless, yes, submetering that is part of the opportunity. Fixing leaks on the water is the more immediate opportunity.


#9

So call it $28k or so of w/s at an 8 - that’s $350k. There’s your cushion. Ignore the 5 pages of Real Estate 101. I’ll spare you the arithmetic of what happens if your interest rate goes up… Hopefully you can do that math and understand the implications if you’re involved with real estate. Conservative (I think?) rent raises of $10 a year for 4 years post metering will add another $17k to bottom line, or $200k at an 8. Make sure to have a good sense of any deferred maintenance (although those 3rd party reports will intentionally often go overboard) but with public utilities it should be hard to blow yourself up, especially in a $200k+ median home market. And finally can run draconian sensitivities in excel of ranges of valuation assumptions vs. rates vs. debt paydown/equity in 5 years to see where you’ll be at different assumptions. Good luck. This actually sounds like it could be a decent starter park.


#10

I’ll add something in here since I see a bit of a problem with your P&L. Property management fees should definitely have a number. I would also say that you are missing payroll as well.

Regardless of how you are managing this, it’s unrealistic to have someone manage this park for free lot rent without your (or someone else’s) hand in it. So, you need to figure out who you are paying a salary to. A manager who will do more than collect rent… or you/ your management company/someone else’s management company who will most likely do more than you currently realize you’ll be doing. Those hours of bookkeeping, dealing with BS, speaking with and paying vendors are certainly more than $0 and not at all a part of your passive cash-on-cash return.

This is your first park so I just want to make you aware of that. It’s less painful to let that sink in now than it is 4-5 parks in when you’re trying to hire people and digging into your overstated cash-on-cash from yesteryear.

I would also say that legal and R&M are a little light and you are also missing reserves of no less than $50 per lot per year. You wouldn’t necessarily take those above the line but those reserves should not be flowing to your pocket at the end of the evaluation.

On quick math, I have you not much over a $100,000 NOI after sub metering. If $380 represents market rents, then you can likely assume roughly 2% NOI growth through conservative rent increases in the future years. Depending on debt, it’s probably not a terrible deal. However, my concern for you would be getting quality debt due to size and your cost of capital issue due to the upfront repairs you may need to make. Equity is usually more expensive in the capital stack so the more of it you have, the better the deal needs to be. This one’s a bit tight without the upfront commitment of large amounts of capital in my opinion.

I don’t see anything terribly compelling with it. If it were me, I’d push the limits on price knowing there’s another one with similar returns that will likely fall into your lap within a month or two from now if you are actively looking.


#11

Don’t know what set you off on such a tissy. A guy posts on a forum asking for help with analyzing his first deal and I give him a reasoned response and even put in the effort to walk him (and others who might be new to this) through some calculations that show the possible dangers of the combination of; a 2% spread between mortgage rates and cap rates; a high LTV; a five year balloon – and that is a “rant.”

Oookay.

I believe he said the owner guessed the amount of water leaks was $24k, not $35k, and it sounded kind of iffy (was that a typo, oh god I hope not) to me that all of it could be fixed. Too many hopeful and speculative qualifiers in there so I left it out. The issue of bill back was brought up only after I posted. But at any rate, it is the loan and the point spread are the main issues that I was bring attention to. Perhaps it will work out fine, but I see nothing wrong with encouraging someone asking for help to do some simple calculations to understand the risks with such a loan and the factors that aggravate and mitigate them. And I see nothing wrong with showing how to do it, albeit on a basic level. BTW, I have had a number of people thank me for going through the math in some of my posts, as simple as it may be.

As I reread it, I can see how you could read my intro as being condescending but it has been a concern of mine lately that as I close in on getting my parks to their potential that no one out there will want to buy them unless I leave some meat on the bone. Perhaps I am wrong but it seems to me that there is growing interest in MHP ownership and I believe Frank’s boot camps and boosterism are the driving forces behind that. He promotes a value added approach of investing and it seems that is what everyone (including me) is going for – raise rents, fill vacant lots, tighten up expenses, and bingo, 10-20-10, sell and repeat. When PJS said his goal was just to get some investment income to supplement his job’s income and he was willing to take on MHP ownership to do so, well, just wow, that is the first time I have seen that on the board and I am glad to see that market exists. It reminds me of the old idea of buying some rental houses and letting the tenants pay off the mortgage. It is slow, but it works. It is not appropriate for everyone take on turnaround projects. I suppose most people have bigger things going in in life then cleaning up MHPs and going for the fast buck.


#12

Thanks all. No offense taken @Randy_CA, I appreciate your views. Interesting to hear that I seem to be unusual in my goals. I’d of course love to buy a park that has a lot of income and expense opportunities to do the 10/20 model, but I’m ok with a get rich slow model, too.

Thanks to both @mhp and @CharlesD for your comments. The potential capex required scares me, especially as it sounds like I wouldn’t be able to finance it, so yes my required return on equity dictates a lower offer price to account for that. I’ll also change values for legal/R&M/management in the P&L. For managing a park like this, what would be typical compensation in addition to the free lot rent?


#13

Great information and reading.

I see a big insurance problem though. The pro-forma insurance cost reflects a reasonable rate for general liability insurance only. However, because the park is located within a 100 year flood zone (did I read that correctly), you have significant risk of a flood loss. If that happens and many of your 35 tenant owned homes are flooded, expect they won’t be insured and will be abandoned, and the governing entity may well not allow you to replace those homes (you may be able to force that issue, but cities are usually looking for an excuse to get rid of lower value housing and parks in particular).

If you purchase loss of income coverage including flood as a covered peril, you’ll likely pay an additional $12k per year as there are so few insurance companies that will provide it at any cost. Many lenders will require you to purchase this insurance. And you can bet that when you sell the park, potential buyers are going to add that risk and cost to their valuation calculations.


#14

Thanks for highlighting Kurt. I’m doing more investigation into the flood designation and what it means in practical terms.