MOBILE HOME PARK FINANCING
MOBILE HOME PARK FINANCING – THE BASICS
Mobile Home Parks, like any other type of real estate, are most often purchased with some type of financing involved. Very few people pay in cash.
MOBILE HOME PARK FINANCING – INTEREST-ONLY VS. AMORTIZED
There are two basic ways to pay off your mortgage, Amortized and Interest-only. With an Amortized plan, your Monthly Payment includes not only the interest you owe for the month, but also a portion of the principal, which gets paid off in small increments each month, or more precisely paid down. A Fully Amortized Loan will pay itself off completely by the end of the term of the loan. Some loans are based on a 10-year Amortization schedule, for instance, but they are due in 5 years. So, each month you make a payment, you are paying down the principal based on an amortization schedule that would pay it off entirely in 10 years of payments, but the remaining balance becomes due in 5 years.
MOBILE HOME PARK FINANCING – WHAT IS AMORTIZATION?
Amortization is a formula that calculates the exact amount the monthly payment must be in order to pay off a given loan amount at a given interest rate. In the old days, bankers worked this out with good old fashion arithmetic, pencil and paper. Today we have real estate calculators that do it for us, just enter the Loan Amount, Interest Rate and Term (the length of the loan), push a button and presto it gives you the monthly payment. While the amount of the monthly payment remains constant throughout the life of the loan, early in the payment schedule, the principal portion of the loan payment is quite low, and you’re paying mostly interest. But as you slowly pay it down, there is less principal to pay interest on, so as the interest portion comes down, there is more monthly payment available to pay off principal. This follows a slow curve, with the interest being reduced with each monthly payment, while the amount being paid against the principal increases each month, paying down the outstanding balance by more and more each month. With the last and final payment (in a fully amortized loan), you’d be paying almost no interest, because the entire remaining balance upon which that interest is based is now less than the payment itself, which is in fact paid off in full with this final payment. Obviously, the shorter the term of the amortization (the number of years needed to pay it off), the higher the monthly payment, and hence the longer the amortization schedule, the lower the monthly payment.
MOBILE HOME PARK FINANCING: HOW DOES ‘INTEREST-ONLY’ WORK?
Interest-only loans are structured so that your monthly payment is made up of only the interest that is due on the loan for one month. No Principal is being paid off in an Interest-only payment. This makes for a much lower monthly payment. However, the loan amount never reduces, and when it becomes all due and payable (there is always a balloon payment with Interest-Only loans) you will have to pay off the entire original amount borrowed. Of course, unless there is a prepayment penalty of some kind, you can always pay off some principal if you wish, in addition to your interest-only payment, or pay it down in chunks. The point is that it’s your choice. Generally, banks do not make Interest-only loans. Seller financing however, is often set up on an Interest-Only basis. It’s also much simpler accounting and tax-wise for the seller.
MOBILE HOME PARK FINANCING: BANK- vs. SELLER-FINANCING
It’s generally advantageous to get the Seller of a Mobile Home Park that you are buying to carry the financing himself. First off, this saves you tons of Loan Fees. Second, the Seller may not demand as much personal financial information from you as a bank would. Third the seller’s primary goal is to sell his property, not to make money on a loan, so you may be able to negotiate a better rate and terms.
In today’s lending climate (2018), expect to put about 30% to 40% down. This means the loan is at 60% to 70% LTV (Loan-to-Value). These days, they are writing loans at around 5.5% to 6.5% interest, amortized over 15 to 25 years. But most have some sort of ‘transition’ that occurs 3 to 7 years out. It could be that the loan converts from a fixed to an adjustable at 5 years. Or that the interest rate may adjust one time at 3 years. Or that it becomes due, or subject to review and renegotiation at 7 years. It’s all up to the bank when they offer you the loan, and on what you’re willing to accept. More than likely, most banks will gladly rewrite your loan when it becomes due, provided you’ve got a good payment history with them, giving them a chance to adjust the rate, check on your credit worthiness again, and charge you more fees. Refinancing every 3 to 5 years is just going to become part of the commercial real estate business in the future. Some Variable Interest programs may have lower rates and longer calls. Either way, expect to pay around a 1-point (1% of the loan amount) Loan Origination Fee plus a boatload of other “garbage fees” including a commercial appraisal, which could itself cost $2,500 to $5,000.
MOBILE HOME PARK FINANCING – LTV VS. DEBT COVERAGE
Many lenders who are trolling for business will offer Mobile Home Park Financing at “up to 80% LTV”. This often borders on false advertising as no one ever seems to do any better in the end than about 60% to 65% LTV. (What is LTV? The Loan-to-Value Ratio is the Loan Amount expressed as a percentage of the Sales Price.)
Commercial Lenders really don’t care all that much about LTV Ratios. What they do care very much about is the Debt Coverage Ratio (DCR). What this represents is how much cash flow, expressed as a percentage of the Gross Income, is left over after all the Operating Expenses and the Debt Service (mortgage payments) are paid. Of course, you need more Income than Expenses and Debt Service, so the percentage of Income will be higher than 100% (assuming the park makes a profit). This is called the Debt Coverage Ratio or DCR, and most banks want a DCR of 130% or better, also expressed as a DCR of 1.3, meaning the Income is 130% of the Expenses and Debt Service combined. So, in this example, 30% of the Gross Income must be left over after paying all the bills.
Mobile Home Park Financing
In this example, our Subject Property is being offered for $1,000,000, has a NOI of $100,000 (for a 10% Cap Rate) and an Annual Debt Service of $46,389 (see below).
WITH 40% CASH DOWN
60% Loan-to-Value (LTV)
Debt Service @ 6% 25yr Am
40% Down Payment
Gross Effective Income
– Operating Expenses
Net Operating Income (NOI)
– Debt Service
= Net Income
/ Gross Income
= % of Gross Income
Debt-Coverage Ratio (DCR)
/year (10% Cap)
When the economy was stronger, most Commercial Lenders wanted to see around a 1.25 or 125%. This would mean that the Net Operating Income (NOI) would have to be 125% of the Debt Service (Loan payments). In today’s market however, some lenders are insisting on more like 135% Debt Coverage (although 130% is possible). This ends up being the factor that most often sets the maximum amount the bank will lend on a given property, not the Loan-to-Value Ratio. Think about it: With Mobile Home Parks (MHPs), the value is based on Net Operating Income (NOI), and so the banks use the same yardstick to determine how much they will loan on it. If the Mobile Home Park doesn’t make any money, then even a 50% LTV might be too high.
But, EXAMPLE #1 above should pass most bank’s DCR guidelines of 135%. This is because we put 40% down. Notice how closely we squeaked by with just 7/10-of-a-percent to spare with a 60% LTV loan. I talk to buyers all the time trying to buy a park with 20% down, and are convinced they have a lender who will do it. The problem is that as soon as you increase the Loan amount (80% instead of 60% LTV) the Debt Service goes up, driving the Net Income down. If it was barely passing the 135% DCR-requirement at 60% LTV, what do you think it will do with a larger 80% LTV loan? Let’s take a look:
Mobile Home Park Financing
In this example, the same Subject Property is priced at $1,000,000 with the same NOI of $100,000 and 10% Cap Rate. But now, we’re going to try to do it with just 20% down.
WITH 20% CASH DOWN
80% LTV Loan
Debt Service @ 6% 25yr Am
– Debt Service
= Net Income
/ Gross Income
% of Gross Income
Debt-Coverage Ratio (DCR):
As you can see above, putting less cash down, and thus increasing the loan amount results in an accompanying increase in the Debt Service (note payments). This, in turn reduces the Net Income, which results in a lower Debt Coverage Ratio (DCR). In this case, it’s 10-points too low. A lender who requires a minimum 135% DCR wouldn’t make this loan. What they will do however, is to reduce the loan amount (and thus increase your cash down payment) in order to lower the Debt Service until the DCR comes into line. As we saw in EXAMPLE #1 above, that point is at about 60% LTV.
A WORD OF CAUTION ABOUT SOME LENDERS
This is significant. Because most of the commercial lenders we talk to claim to offer 80% LTV loans on MHPs, but they also have a 135% DCR-requirement. Techically speaking, these lenders can honestly tell you that they do 80% LTV loans, but in order for it to hit 135% DCR the Cap Tate would have to be exceptionally high. But in most normal cases, you’ll be stuck either having to come up with more cash, or walking away from the deal (and hopefully getting your deposit back). This very situation happened to me when I first started looking at MHPs and didn’t know any better. Fortunately I had skillfully crafted the wording in my Purchase Offer that got my deposit back without any problems.
MOBILE HOME PARK FINANCING – HOW MUCH CAN YOU BORROW?
Lenders assume that most borrowers are either lying about the Income & Operating Expenses, or they have overestimated the former & underestimated the latter. Either way, they want to make certain that, no matter what, the income from the park is enough to cover all the expenses & the Loan payments, with a little extra left over. They may have to cut the loan amount back in to make the ratios work. And this is why Debt Coverage is more important than the Loan-to-Value Ratio, and why, the LTV is really irrelevant.
MOBILE HOME PARK FINANCING – DON’T BE MISLED
These days, the banks aren’t going to put themselves into jeopardy, if anything, they will err on the side of caution. That is the job of the bank’s underwriting department & they will cut your loan back, or impose seemingly impossible funding conditions mercilessly & without remorse. The Mortgage Broker however, is in the business of selling loans & many will say whatever it takes to get you to use their services. They understand that Debt Coverage will ultimately decide your fate, yet they will continually quote only LTV Ratios as a way to ‘hook’ borrowers. An 80% LTV Loan is pretty attractive to a buyer, especially when everyone else is quoting 60%. Many buyers will fall for the ploy & fork out $2,500 to $5,000 or more for an Appraisal, Credit Report & processing. You hand over the money & all your personal & the park’s financials & you spend the next 60 days hoping these guys will actually fund the loan that you were promised. Most often, things go somewhat worse. They will often ask for more & more stuff, then issue a “Conditional Loan Approval”, which is precisely that: an Approval with Conditions, or an Approval IF you so certain things. And often these Conditions are either impossible to meet, so expensive or impractical that they kill the deal. And most often after reviewing the data, they will cut the loan amount back, sometimes to the point of killing the deal. More to the point, it puts you in a very weak position and often the banks will renegotiate the terms in their favor. At this point you’re at risk of losing the deal, the money you’ve already given the lender for the appraisal, and maybe your earnest money deposit. It’s not a good position to be in.
MOBILE HOME PARK FINANCING – PROTECT YOURSELF
Of course, you should always have a good team of qualified professionals on your team, a good tax person, a good attorney you can trust, a good insurance person, and a good mortgage broker. Hopefully, if they’re doing their jobs, they will watch out for you and keep you out of trouble. But, you certainly want to do more than stay out of trouble, right? You want to make some serious money investing in Mobile Home Parks. For that you need a Mobile Home Park Expert. We have been involved in so many Mobile Home Park transactions, be they Sales, Purchases, Refinancing to pull money back out, Management, Ownership, or Turnaround, that we know how to avoid the pitfalls. Of course there is more to Mobile Home Park Financing than can be fully explained on this site, but here are a few pointers we can offer:
* SEEK SELLER FINANCING WHENEVER POSSIBLE
As silly as it sounds, this really is the best solution. Sellers are easier to work with (they’re motivated to sell their property), their terms are usually better, they don’t charge points & fees, and you will generally know right up front if they’ll make the loan or not.
* IF YOU MUST USE A LENDER, MAKE SURE THEY’RE GOOD
It seems obvious, but we can’t stress it enough. They will all tell you they’re good & that they can make the loan. How many Mobile Home Park loans have they FUNDED lately?
* KEEP YOUR LOAN CONTINGENCY OPEN
Most pre-printed Real Estate Board Offer Forms have a tiny box somewhere in their Financing section that, when checked will keep your Loan Contingency in place until the loan actually funds. If not checked, the standard loan contingency on most forms runs out in just 17 days from Acceptance, but you can write your own clause. Never forget: everything is negotiable during the Offer/Counter Offer-stage, so make sure you ask for the really important things. This is one of those things. If, for any reason the lender doesn’t make the loan at the last minute, or they approve it at terms that you are unwilling to accept, you want to have that loan contingency clause to fall back on, to make sure you get back your deposit, right up to the end.
* NEGOTIATE IT RIGHT THE FIRST TIME
We’ve written so many Purchase Agreements for Mobile Home Parks over the years, and owned so many ourselves, that we know what to ask for. It’s vital to ask for all the right stuff up front, while you have the most leverage. Everything you ask for later will cost you something.
DON’T TAKE ANY CHANCES – GET SOME HELP
Call me, Andy Tallone at (925) 323-2134 or email me. I’m more than happy to share whatever knowledge I have with you.