Seller sent over his financials and my optimism quickly faded

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I have a 55 space park under contract in the Cincinnati MSA, and was waiting on the seller to send over the requested items prior to beginning DD. Based on his rent roll, gross rents are $16,100 per month, and $10,300 of that is lot rent. The $5,800 from the home rentals has been left out of my underwriting, and I’m not capitalizing that income. $10,300 x 12 x .60 (40% expense ratio) = $74,160, which is a valuation of $927,000 at an 8 Cap. I added in the value of the POH, which are mostly older so I’m not placing much value there at all, but there are 4 90’s double wides and a small commercial building, so I added $73k total to get to 1M.

The sellers tax returns show $134,860 for gross rents for 2019, which is lot rental and home rental combined. I multiplied that by 64% (monthly percentage of lot rent to total rent) to get the portion of that income that equates to the lot rental income only, which is $86,276.89. This is well below the $123,600 ($10,300 x 12) I had used in my underwriting. Obviously the number I used assumes perfect collections, and isn’t factoring in any vacant or collection issues, but that’s a big difference. The bank statements show 27-28 total debits each month for the prior two months, totaling $13k. This leads me to believe there several tenants not paying, or the owner is accepting cash from some and not depositing it.

Additionally, the park pays all the utilities to the tune of $41k per year, which is higher than I had accounted for as well. The next large expense is the repairs and maintenance, which is $32,974. This is directly related to the 22 park owned homes, and this is where I was looking for a little guidance on how to handle this expense in my underwriting. If these POH didn’t exist, this expense wouldn’t be there. If I can execute the plan to convert these over to TOH over the course of 1-2 years, that expense should be greatly reduced. However, my concern is right now, and making the best decision at this moment. Do I separate the lot rental and home rental operations, and apply the large R&M expense to the home rental portion in order to reconcile these expenses better?

Altogether, the seller has $98,000 in expenses, which is a 73% expense ratio. Needless to say, a better operator can get the expenses in line, sub-meter, bill-back, etc., but is the bank going to take that into account as I try to get this financed? I’m not very confident at this point that I can get financing here based on their tax returns. They are running a lot of expense through the park in order to help their cause as far as taxes go, but this seems to be big obstacle in my pursuit of bank financing.

Any advice or suggestions would be greatly appreciated. The upside here is that lot rents are $100+ under market, it’s in the Cincinnati MSA, the park currently pays ALL utilities, the zip code the park is in has $200k median home prices, a good school district, and the test ad ran got 50 hits in 2 days.

Thanks in advance for anyone who takes the time to read through this and offer their advice.

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I have purchased a few parks with the same situation you are facing. Both those deals were seller financed because the financials were not good enough that a bank would underwrite. As you said, the park can be turned around with expense reduction, passing through water/sewer cost, etc. and you capture that upside value. But getting bank financing for the purchase is unlikely.

You will need to plan on having capital to invest into the 22 homes. In my experience, you will have some of these renters move out or be evicted because they don’t want to follow the new rules you put in place and/or they have not been paying for quite some time and the prior owner never evicted or enforced collections. You’ll be spending money on repairs as they turn over.
If it were me, I’d apply with a few banks and if you get denied loan approval, use that as leverage to ask the seller to finance the sale for say, 5 years. If he’s serious about selling, then he should work with you. Hope it works out!
Robbie

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Appreciate the response. That’s good advice. I’ll continue to try to find a bank, and if I get some to actually underwrite the deal and reject it, I’ll use that to try to get the seller financing. I went for seller financing with my first offer, but the owner shot it down. And I have budgeted a pretty decent chunk for POH rehab and tenant turnover after the rent raise, thanks for that feedback as well.

The bank the owner banks with actually was open to financing it since he has 40+ years of continuous deposits with them, and they know the income it produces, but they told me they wouldn’t process my application unless I live in their footprint. I’m mobile and can relocate, but I’m not going to move to Ohio just to apply for a commercial loan, and then get rejected.

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It’s tough I know. Sounds like a very good market and ability to improve the park. So I hope you are able to work it out.

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This is not that uncommon but good thing you caught it, I have had the same issues even with MHP brokers your dd is the only thing that you can count on and don’t include the potential rent raise in the cap rate that is your profit to take and if was easy the seller would have done it already.

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Appreciate the input. In the case of 84 year old sellers, who haven’t raised rents in 6-8 years, I was counting on that initial lot rent bump in my underwriting as upside, but of course the goal is to have the numbers make sense as it currently sits.

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I agree, use the bank rejection to ask for seller finance. I actually had a small park under contract in Cincy earlier this year, but dropped it during DD after the apts included showed significant structural issues.

Feel free to shoot me an email at milesnoland859@gmail.com, and we can set up a call. I developed a large list of banks in Cincy while shopping the loan on this park, and have some contacts. I live in the Cincy MSA too, so perhaps I could help you out in some way. I own a park in WV, and have another contract in Ohio right now to buy. Good find, 50+ pads in the Cincy metro is tough to find. Talk soon!

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Hi. Good topic. Your upside is location,under market rent, expense reductions, and utility bill back. Down side is price and financing. I personally would pay a bit more for a property if a rent raise can happen in 60 days and you can get seller financing with reasonable terms. No deal is perfect. Weigh the pluses and minuses and see if the deal fits your goals. Good luck.

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Yes. The appraiser will use market rents and market expenses to do his calculations. That’s a big part of the appraisal: the relationship between purchase price and the income a skilled manager can generate from the asset.

However, financing can’t make a bad deal good. Just because sellers will finance doesn’t make this a sound purchase. If the bank won’t finance it, or the appraisal and inspections uncover other problems, renegotiate price, and be prepared to walk.

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That’s sound advice. If it ends up that a bank won’t finance it, and/or an appraisal comes in significantly lower, that’s probably telling me something. For now, I’ll stay optimistic, and keep pushing forward, but certainly won’t hesitate to walk away if necessary. Thanks for the reply.

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@afreeman did you close on this deal?

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Not yet. Out here in Ohio now doing the on-site due diligence, still moving forward.

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As an owner with numerous POH, I disagree with your assertion that the POH income should be discounted to zero. For example, my 2020 YTD gross income from POH rentals (excluding lot rent) for two of my parks in Michigan is $61,941. My total expenses YTD for those homes is $8,818.59 including everything (repairs, pest control, tenant turnover clean up, and the like). Most of the homes don’t have any mortgage cost associated with them as they were valued at virtually zero when I bought the parks and investing $2-3K each years ago made them rent ready. If you are trying to buy parks, most sellers won’t discount this income to zero either.