If you want to
buy an older community that is in need of repair, where do you start? What do you consider? To whom do you go to ask questions? What questions are important? What other resources do you have to
Recently, a woman wrote to ask me what she should do in considering the
purchase of an older community “that is in much need of repair.” She said the current owners were closing
the community down. Her concerns
were what resources she should consult prior to entering into negotiations, and
what legal ramifications there would be for the current residents.
answering that question, let’s start from the top of the potential purchase, and
look at a lot of the different areas that need your attention – and demand
answers before you can decide if you even want to purchase the community. In these times of uncertainty in the
stock market, real estate may be a safer place to put your money for an
investment, but it has to be a business decision, not an emotional one. When you look at all the options, the
numbers need to crunch properly in order for you to make the investment a wise
decision. Therefore, one of the
biggest resources you need to investigate is the ability of the property to meet
your investment demands given the financial position you are in.
First, before we even get into the property valuation and general
questions, let’s think about your intended returns. What percentage of return do you want to
get on your investment? How much of
the funds generated from your operation will you need to take either as a draw,
salary, or return of investment in order to live? How much of it can be left in the
community or reinvested in improvements?
Obviously you know the offering price of the community. Is it a fair price? After you make the required initial
investment, how much capital will you have remaining for future improvements or
operational shortfalls? What is the
financing structure? Is the loan
large enough for a commercial mortgage?
Or, will the current owner finance it for you after you make the down
considering the offering price of the community, how did you determine if it is
a fair price? There is a simple
mathematical formula that will help you, and will also enable you to determine
the appropriate selling price, determined by the rate of return you would like
to see on your operation. This
age-old formula is simply V=I/R.
Put into words, the Value of the community (V) equals the Income (I)
divided by the Rate of return (R).
put into plain English, in order to determine how much the community is worth to
you (V), you must first know the amount of net operating income it is generating
(I), then divide that by the rate of return you hope to receive (R). So, let’s use some real numbers and
start the process for you.
Income for the community (I) is actually the Net Operating Income
generated for a 12-month period.
You should be privy to a set of financial statements from the current
seller. Start with the amount of
money the community should be collecting each month if all the sites were full
and everyone was obligated to pay the normal rents. This number is normally called Gross
Potential Rents, although it is also commonly called Optimum Rents. From that, subtract the amount of
dollars lost each month by the vacant homesites, abandoned homes not paying
rent, and any community-owned homes that are not occupied. Add any other income received on a
regular basis – such as water and sewer reimbursements if the community is
submetered, pet fees, late fees, etc.
now have a number that is called the gross effective income. This represents the amount of money that
you should be able to count on actually putting into the bank each month to pay
the bills for normal operating expenses, the mortgage, and have a profit.
look at the normal monthly expenses, but not the mortgage. Consider utility bills, wages, property
taxes, office expenses, advertising, phone billings, maintenance supplies, legal
fees, vehicle expenses, permits for well or sewer treatment plant, licenses for
normal operations as well as sales (if that is being done or you want to do it),
insurance premiums and property taxes.
These are only a few of the major categories, but you can get the
you combine all of these anticipated expenses, and subtract the total from the
effective gross income figure, you arrive at the net operating income (I). This is the number you need to plug into
your original equation to help you determine the actual value of the
much do you want to make on your investment? What rate of cash on cash return do you
want to see? And what rate of
return from operations do you feel is fair? Generally speaking, the greater risk you
take, the higher rate of return you should receive. If the community has a high number of
community-owned rental homes, you are usually taking a greater risk, and should
have a higher rate of return. It
creates a double exposure for you.
You not only have to collect the site rent, but you also have to collect
the rent for the home. Plus, you
are subject to continual repairs on the home itself for damages in addition to
normal wear and tear.
you consider the rate of return you want for yourself, also look at some other
factors. If there is a stable
resident base, with good record of payment and not too much vacancy or
delinquency you have a much better chance of getting a positive return each
month, therefore your risk is lower.
That means the rate of return is lower. If it is a riskier situation in terms of
collecting rents (high vacancies, bad area of town, etc.) you have to work
harder to get the money into the bank each month, so therefore you should plan
on a higher rate of return.
“rate of return” you want to see from the property has an inverse relationship
to the actual value or selling price you should be willing to pay for the
community. As you will see when you
begin plugging numbers into the above formula, the higher rate of return you
want, the lower the selling price (or value) of the community
continue with the formula. Now that
you have reached the point where you have the net operating income (I) and you
can estimate the rate of return (R) you want to see from the community, before
you actually do the division, you must annualize the numbers. That means simply multiplying the
anticipated net operating income (I) times 12 since there are 12 months in a
year. That gives you an annual
Divide the annual anticipated income by the rate of return you would like
to see. That gives you the value
(V) or the selling price that you have to pay in order to realize that amount of
are some of the variables we have not discussed? If the community does not qualify for a
commercial mortgage, or if you don’t qualify for one and the seller agrees to
finance it for you, then that alters the value of the community. First of all, if you can’t get it
financed through commercial methods, you couldn’t purchase it. So, if the seller steps into this
position for you (or for his own personal financial gain) then you pay for that
added value created in the community.
That alters the selling price upward from the numbers you reached by
using the mathematical formula.
Secondly, another huge variable is environment. And, yes, while the environmental
testing is a concern to eliminate the possibility of any underground
contamination for which you may be liable in the future, for the present time,
let’s think of the present environment in terms of acceptability. How accepted is the community in the
municipality? How accepted is
manufactured housing as a structure in that area? How do the elected officials and other
municipal officers feel about manufactured home communities, and this one in
at the zoning. How is it
zoned? Is it in an area of high
construction? It the land currently
being for a manufactured home community used for the highest and best value of
that parcel? Consider opinions of
those who make the laws in your area.
Understand why the current owner is contemplating closing the
community. Is he out of compliance
with government-required services, such as well water or a sewer treatment
plant? Is encroaching development
going to soon mandate tap-in to municipal water and sewer? If so, what are the costs? And, what is the additional cost of
removing the current sewer treatment plant, if there is one?
size are the homesites? If there
are vacant ones, how will you fill them in that market? What are the setback requirements? Is there a market for the size homes
that you can place in this community?
How stable is the resident base? How old are the homes? What would it take in terms of dollars
and time to redevelop a sense of resident pride in the community and their
homes? How can you improve the
appearance of the homes in order to attract new residents?
What repairs need to be done to the infrastructure? How will you pay for it? What type of permits and inspections
will need to be done? What will be
the additional value to the community when the repairs are made? Or, will it still be an older community
waiting for the axe to fall and a change in zoning to wipe it out?
What are the state statutes governing the landlord/tenant situation
in this state? If the community is
closed, what is the requirement for notice to the resident? For payment to help with
relocation? For purchase of the
home? What else are you as landlord
required to do?
Probably the best place to start is with the health department, or
the agency that is responsible for inspecting the operation of the
community. Ask to see any
outstanding violations and the time lines for repairs. Talk with them about their opinion of
the community. See if they believe
you can turn it around and improve it.
If their attitude is totally negative, and they are in control of making
decisions about issuing permits you need, you may have a really hard, uphill
If, however, they are just tired of the infractions, the
violations, and would love to see it cleaned up - - then ask for
suggestions. Be open to their ideas
and what they propose for improvements.
Look at the costs.
Review the marketing in the area papers. How much does housing cost of a
prospective resident were to consider living elsewhere? How does the cost of an apartment
compare with the average home payment plus site rent in your community? What about the average cost of
homeownership? Also look into
How will your new residents finance their homes? Is there a local or regional bank who is
in favor of manufactured housing that is willing to carry retail installment
contracts on homes? Who do the
retailers use? And, talk to the
retailers about the community. Are
they aware of it? Do they or would
they recommend their customers to it?
What would have to be done, in their opinion, in order to make it into
the type of community they would be proud to recommend?
If there are no retailers in the area, or none who would support
the community with infill, devise a strategy to fill it. Where will you get homes? How will you set them up? How will you sell them? Will you finance them yourself? How much of your capital do you want to
tie up in housing stock? Also
realize that owning or financing homes leads to repossessions from time to time,
and that generally means paying someone to fix the damages so they can be
It may also be a good idea to talk with the residents. Why do they live there? What would they like to see done to the
community? How long do they plan on
staying? What would it take for
them to refer people to the community to help increase the occupancy? What do they like best?
Buying a community is a big step; a big investment. Buying an older community is an even
bigger step and not only because it is usually a bigger investment in terms of
time and energy, but also because it is a bigger harbinger of the dreaded
unknown. Sometimes even the best
research, the greatest due diligence, cannot uncover all the maladies of a
particular community. They only
come to light after you have signed all the paperwork.
As with any investment, for taking a greater risk, you deserve a
greater share of the reward. Run
the numbers, ask the questions, then make a decision. Don’t buy a dream unless you have
unlimited resources. Buy a
business. Plan on a profitable
return for yourself and the residents.
Ultimately, it will also create a win-win situation for the municipality
and the industry as a whole.