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Buying A MHCommunity ? What to Look For?
Thu 10/14/04 09:47:42 am
by CHRISSY JACKSON

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 consider?

 

        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. 

 

        In 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 payment?

 

        When 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).

 

        Or, 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.

       

        You 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. 

 

        Next, 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 idea.

 

        When 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 community.

 

        How 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.

 

        When 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.

 

        This “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 becomes.

        Let’s 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 anticipated income.

 

        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 return.

 

        What 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 particular?

 

        Look 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? 

 

        What 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 battle.

 

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 condominium ownership.

 

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 resold.

 

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.

Chrissy Jackson, ACM, PHC, has been involved in Community Management for over 16 years. She managed communities from 200 sites in size up to over 800 sites. Chrissy also provides property management and sales training to state association conventions and private companies. She is also recognized as a nationally published author with several publications currently on the market. More about Chrissy at www.chrissy-jackson.com


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