{"id":42846,"date":"2013-06-10T10:33:55","date_gmt":"2013-06-10T16:33:55","guid":{"rendered":"https:\/\/www.biggerpockets.com\/renewsblog\/?p=42846"},"modified":"2024-02-17T15:52:51","modified_gmt":"2024-02-17T22:52:51","slug":"2013-06-10-financial-due-diligence-mobile-home-parks","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/2013-06-10-financial-due-diligence-mobile-home-parks","title":{"rendered":"The “Big 15” – Diving Deeper on Financial Due Diligence for Mobile Home Parks:"},"content":{"rendered":"

In\u00a0a recent article entitled Mobile Home Park Due Diligence Checklist<\/a>, I detailed the importance of a well-defined and executed due diligence plan.\u00a0\u00a0 Additionally, I covered the basics of due diligence and provided a checklist for the 3 areas of investigation: financial, physical and locale or environment.\u00a0\u00a0 This article provides a “deeper dive” into financial due diligence (FDD) which usually is the first area of focus and arguably, the most important.\u00a0 I’ll do this by reviewing each item from our checklist in a narrative that discusses what the buyer should ask from the seller, why the data is important and how it should be considered in building a P&L and evaluating the future performance of the investment.<\/p>\n

Current Rent Roll <\/strong>– Ask the seller for a rent-roll that includes the space number, name of resident, current rent and any additional monthly charges.\u00a0 In addition, ask the seller to indicate if the home is park owned, owner occupied or single or multi-section and the total number of occupants, the move-in date and provide any relevant notes about the resident.\u00a0 Using this data, the buyer should reconstruct the rent-roll in a spreadsheet which will serve as a starting point to building a projected P&L.\u00a0 Breakout the revenue by type and leave empty cells where more detail is required.\u00a0 Ask for a list of owners for the non-owner occupied homes to determine if one or two people own several of the homes.\u00a0\u00a0 How many park owned, non-owner occupied and rentals are in the community?\u00a0 If this total is 10, 20 or 30% of the homes in the park and the homes are older and of little value, the buyer should discount this revenue or increase the expected expenses to manage and eventually, replace these homes and tenants.\u00a0 What is the average number of occupants per home?\u00a0 If just 2, this places a far smaller burden on the park’s infrastructure than 3-4 occupants per home.\u00a0 What’s the annual turnover and trend?\u00a0 Parks with 10% turnover are more work than those with 3% and if the trend is up, the buyer should investigate and understand what’s driving the increase.\u00a0 Add up and confirm the number of spaces – don’t assume the space #s are sequential!<\/p>\n

3 Years of Profit & Loss Statements <\/strong>– Ask the seller to provide a year-to-date P&L by month and statements for 2 or 3 previous years. \u00a0 Hopefully the P&Ls breakout revenue by type including space rent, house\/rent payments and utilities by type (electric, gas, water, etc…)\u00a0 Take a few minutes to confirm the math and work through the logic and assumptions in the statements.\u00a0\u00a0\u00a0 Does the monthly and annual income in the P&L align with the data in the rent-roll and if not, where’s the difference?\u00a0 Are there any big changes in the revenue and expense by item from period to period and if so, why?\u00a0 Calculate the % of expenses vs. total revenue and are they about 40%, which is an industry benchmark for MHPs and if not, why?<\/p>\n

3 Years Capital Expenditures<\/strong> – Ask the seller to provide a list of capital expenditures for the past 3 years.\u00a0\u00a0 Many MHP owners expense everything in the current year while others capitalize their improvements.\u00a0 If your seller is the former, ask what significant upgrades or improvements they’ve made to the roads, utility systems, structures, etc, and where these appear in the profit and loss statements.\u00a0 Ask if the park has purchased, set-up and sold any homes and how these impacted the P&L.\u00a0 If your seller is the latter, closely review the list of improvements to gain a more complete picture of the total cost of ownership of the property.\u00a0 Ask the seller what they expect in additional improvements over the next several years and ensure these capital or operating expenses are included in the projected P&L.<\/p>\n

3 Years Tax Returns, 12 Months of Bank Statements <\/strong>– Provided by the seller and the purpose of which is to confirm the accuracy and completeness of the profit & loss statements.\u00a0\u00a0 The returns and statements provide triangulation points, which is the process of comparing data from multiple sources (reports, visual inspection, conversations, etc…) to determine if they are aligned.\u00a0 I’ve seen P&Ls showing $15K in monthly revenue but the total in the tax return was, well, significantly less!<\/p>\n

Accounts Receivable\u00a0<\/strong>– Ask the seller to provide current and historical accounts receivable reports.\u00a0 The goal here is to understand the size and scope of the collection issue and which tenants are involved.\u00a0 If 10% or more of the tenants are several months behind and their homes are of little value, it could be very expensive to remedy this situation.\u00a0 Not only will the buyer have a loss of rents, they will incur significant legal fees and eventually, need to pay to have the expired homes removed from the property.\u00a0 Some sellers will attempt to hide this problem so triangulate the data and if offered, pay little to nothing for the old accounts receivable.<\/p>\n

List of Park Owned, Lease to Own & Rentals Homes <\/strong>– Every buyer has their own method to achieving a return on investment and for some, this includes financing and renting homes.\u00a0 For us, we only buy homes to fill a space or ensure it’s not moved out of the park.\u00a0 We buy parks where 90%+ of the homes are owner occupied and a high “pride of ownership” level exists in the community.\u00a0 If we buy a MHP with park owned homes, we want them to be included in the sale and transfer to the buyer at close.\u00a0 The purchase price should be adjusted to include the wholesale value of the homes with a price reduction for any previously capitalized rent or house payments (the lender will follow this practice with their underwriting and the buyer should as well!)\u00a0\u00a0 As for rentals (AKA, Lonnie Deals,) they are grandfathered but we prohibit them in our rules and regulations.\u00a0 We encourage investors who purchase homes to repair and resell with lease\/rent to own financing but do not permit “straight-up” or covert rental activity.<\/p>\n

Copy of Insurance Policies<\/strong> – The purpose of this item is to determine if the park is currently under or over insured and if the pricing on the policies is competitive.\u00a0\u00a0 Ask the seller for copies of all policies including property, liability, flood, worker’s compensation, etc… \u00a0\u00a0 Give the information to a reputable MHP insurance broker and let them analyze the data and provide a summary of projected costs, coverages and policies.\u00a0 Check to see if the property is in a flood zone or if some other insurance is required to comply with state or county laws.\u00a0 If the costs can be reduced, great and if the park is under insured, it’s better to know now than later!<\/p>\n

3 Years Property Tax Bills<\/strong> – The buyer should review the property tax bill to familiarize themselves with each of the taxes and how they are calculated.\u00a0 The goal is to avoid some huge surprise increase in tax that could significantly reduce net operating income (like a $1K annual assessment for each sewer connection, ouch!)\u00a0 Visit the county assessor’s office and inquire about new, pending or “under-consideration” assessments for water, sewer, schools or other services in the next few years.\u00a0 Confirm the total taxes due in subsequent years based on the expected purchase price of the property.<\/p>\n

Spreadsheet Detailing Utility Charges, Calculations and Bills\u00a0<\/strong>– Ideally, utility services for the property would be provided by the local utility district and direct billed to each tenant.\u00a0 In this scenario, the utility company is responsible for the services up to the meter or property line and billing and collections. \u00a0 At the other end of the spectrum, the services are private (well and septic) and gas and electricity are master metered.\u00a0 In this case, the park owns and has the responsibility to manage, maintain and provide the services as well as bill and collect from the tenant.\u00a0 Ask the seller for a spreadsheet detailing who owns and pays the utilities including water, sewer, gas, electric, trash, cable, etc\u2026\u00a0 For all utilities charged to the tenant by the park, ask the seller to detail how the bills are calculated (formulas) and provide meter readings (if applicable) and actual charges and copies of all utility bills for the past 12 months.\u00a0\u00a0\u00a0 There are several reasons to look at this information. First, it’s to help the buyer understand the financial liability of owning a property with private and master metered utilities.\u00a0 Physical leaks, old meters, inefficient billing systems and poor collections efforts all represent lost revenue to the MHP owner (not to mention the liability of managing and maintaining the utilities and infrastructure and staying in compliance with the EPA and county and state agencies!)\u00a0 In addition, the impact of these “leaks” spirals up with each passing year and the never-ending increases in utility costs.\u00a0 On the plus side, if some of the utility charges are currently paid by the park, passing them through is often more acceptable to the tenants than rent increases.\u00a0 Finally, take a minute to recalculate the underwriting provided by the broker (NOI, CAP rates, expenses as a % of income and price) without the public utility reimbursements and related expenses.<\/p>\n

Current Staffing<\/strong> – Ask the seller to provide a list of everyone who works for the park including the manager, maintenance people, bookkeeper, etc…\u00a0\u00a0 In addition, ask the seller to provide the details as to how these folks are paid, job descriptions, copies of employment contracts, reviews or any other relevant information pertaining to their relationship with the park.\u00a0 The purpose of this is to understand the park’s obligations and determine if the staffing and compensation levels are above or below average (purchased a park several years ago and immediately eliminated an assistant manager saving $10K per year!)<\/p>\n

Copies of Contracts<\/strong> –\u00a0Ask the seller for copies of any contracts that will transfer to the buyer including outsourced propane services, laundry equipment, trash, phone, billing services, leases, etc\u2026\u00a0 The goal here is to determine if any of the contracts should be terminated with the transfer of ownership and if there’s an opportunity to adjust the level of services and potentially decrease costs (we eliminated an unused dumpster at one park that saved $5K per year!)<\/strong><\/p>\n

Rent Increases<\/strong> – Ask the seller to provide a history of rent and pass-through increases including dates and amounts over the past 3+ years.\u00a0 The buyer, if they plan significant revenue bumps in the first couple of years, should take recent increases (and the local political climate) into consideration.\u00a0 “Too much, too soon” can set all sorts of things in motion including petitions, regulatory scrutiny, visits by city or county officials, newspaper articles, rent control initiatives, etc…<\/p>\n

Rules, Leases & Local Laws <\/strong>– Ask the seller for a copy of the rules and regulations, leases and the standard “package” given to a prospective homeowner including the application, disclosures, move-in documents, etc…\u00a0 In addition, ask the seller for copies or access to the tenant files to complete an audit and determine which tenants have signed leases and rules\u00a0 on file.\u00a0 The buyer should engage an attorney who specializes in mobile home parks to understand what’s required (based on the lease, rules and locals laws) to do the following: raise rents, pass through utility costs, reduce services, evict a tenant for cause, evict a tenant without cause, change the rules, restrict rental homes in the park, increase the standards for lot and home maintenance, restrict the age, size or type of mobile homes allowed in the community, etc…\u00a0 In other words, the buyer should be certain that whatever plans they have to upgrade the park, increase revenues and decrease expenses can be implemented from a legal perspective.<\/p>\n

Contact Information for all Vendors<\/strong> – Ask the seller for a complete list of everyone who has provided professional services to the park including lawyers, accountants, engineers, insurance brokers, inspectors, appraisers, realtors\/brokers, etc\u2026\u00a0 The buyer should email or phone each of these people and introduce themselves, explain they are considering a purchase of the park and express a desire to continue the relationship after the close.\u00a0\u00a0 The buyer will likely meet with some of these folks during the due diligence process to triangulate data provided by the seller or another source.\u00a0\u00a0 A cup of coffee and a “get to know you” conversation might reveal some information of value to the buyer in their evaluation of the property.<\/p>\n

Projected P&L <\/strong>– It’s time to bring all the data and analysis together and coalesce this into a profit and loss projection.\u00a0 Using the reconstructed rent-roll as a starting point, project space rent income for the next 12 months and then over the balance of the hold period.\u00a0 Make adjustments for vacancy (especially in the first year if a “house cleaning” is required) and rent increases.\u00a0 Add additional columns to the rent-roll for house payments\/rents, public utilities reimbursements, private utility income, other pass-through income, laundry income, etc…\u00a0 Carry the annual totals into the revenue section of the projected P&L.\u00a0 On the expense side, plug-in the current year actuals as a baseline and make adjustments for increases (property taxes) and decreases (management, maintenance, insurance, etc…)\u00a0\u00a0 If there’s a loan, calculate total mortgage payments, breaking out interest and principal totals by year.\u00a0 Finally, calculate the usual financial metrics including: debt coverage, loan to value, capitalization at purchase and resale, gross rent multiplier, cash on cash, IRR, etc…\u00a0\u00a0 Using these spreadsheets and by making adjustments to the assumptions and variables, the buyer can arrive at educated and hopefully, highly accurate projections about the future performance of the property over the expected hold time.<\/p>\n

Wow, that’s a lot of information and certainly much more than was contained in our Mobile Home Park Due Diligence Checklist<\/a> article a few weeks ago.\u00a0 I have a renewed appreciation for the art of due diligence!\u00a0 Stay tuned for my next article which focuses on the physical aspects of mobile home park due diligence including utilities, roads, trees, structures, etc…\u00a0 If you have a comment or question, please reply below.\u00a0 If this post could be of value to someone you know, please Tweet, Like, Share or g+!<\/p>\n

Photo: SalFalko<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

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