All Forum Posts by: Ben Reese

Some links

http://www.shearman.com/JOBS-Act-SEC-Proposes-Rules-Allowing-General-Solicitation-and-Advertising-in-Private-Placements-Under-Rule-506-of-Regulation-D-and-Rule-144A-09-05-2012/

http://www.compliancebuilding.com/2013/01/15/crowdfunding-and-the-ban-on-general-solicitation/

Yes PPM's are going to become easier to accomplish as the solicitation rules are to be relaxed under the JOBS Act. The SEC was to have the new rules out by now but I believe they have been dragging their feet while waiting for comment.

Under the new rules the big thing to watch out for is that the SEC has proposed putting the burden of determining the "accredited investor" status on the entity. Right now, its up to the investor to attest to his/her status. What they haven't ruled on is how an entity might determine the accredited status, but I imagine proof of funds, financial statements and W-2s would be a good start.

Michael,

As others have mentioned you are not likely to find HM for this so don't waste your time looking for it.

Instead offer the seller a decent down payment and see if he'll carry it. Explain to him what you are doing so he'll know that if you don't perform he'll get his house back improved... and he'll get to keep your down payment.

Negotiating: If he balks at this you can offer him offer more upfront while making the term of the loan reasonably short. Keep making the point that he'll have your down payment AND an improved house if you default.

Good luck!

Ben

Hi Bryan,

How many borrowers are in the entity and would there be both personal and corporate guarantees?

Ben

Reggie,

Forgive me if I get too basic here. In buying any rental always keep this in mind: It is only worth the net income it is able to generate. Consequently, a thorough verification of the gross income and expenses is critical. While such a verification is easy in theory, unfortunately many sellers will talk up the income and talk down the expenses.

The data you sent over does not look complete to me and it is difficult to tell if these are actual numbers or pro forma estimates. A rent-roll should show a monthly payment history so that you can see who is delinquent, what rents are in arrears, and which units are vacant. This will assist you in predicting future income. Ask the seller for 3 years of “actuals” for both the income and expenses. And ask him for the full rent-roll, not just a summary. As a crosscheck I always ask to see tax returns to confirm if they are consistent with the P&L. A lot of the time an owner won’t share the taxes, but it never hurts to ask.

Once you have a good history on the income and expenses it’s time to ask a few questions and make adjustments to the numbers so that you can predict the property’s performance. What is the condition of the building and its systems? Are there expenses looming such as deferred maintenance, old roofs, faulty, heaters plumbing and so on. You’ll also want to see if the property taxes will go up based upon the sales price. In some jurisdictions this can be a substantial bump.

When evaluating a complete P&L I make my own adjustments to the income estimate if I see obvious vacancy or turnover problems on the rent-roll. You can do this by coming up with an expected annual loss figure or you can just reduce the income by a expected loss percentage. And I adjust the expenses by removing items that are related to the seller's financing (unless I'm assuming it) such as Amortization and Interest. You'll also want to remove Depreciation if shown, as this is a "non-cash" expense item. Lastly, look at the expense history to see if the seller has expensed what was really a capital improvement. If he has, great, leave it in the expenses as a negotiating item while knowing that it is an expense that won't recur. Adjust the property taxes to reflect the new post-sale amount, add in a replacement reserve to cover things that wear out and you'll have a ballpark figure on what the actual cash expenses are expected to be. Your goal in this is to get an accurate estimate of the property's Net Operating Income (NOI) as this drives the property value based upon your desired return.

The return you are looking for is up to you. You'll hear the term "CAP Rate" which is simply the amount you are earning on your cost of the property. Market CAP Rates vary depending on the quality and type of property. As a buyer I generally want to buy a property so that it produces a 9% or better return. ( A "9 CAP" in other words). My basic return formula looks like this: (Gross Income -Adjusted Expenses) / (Purchase Price + Required Improvements) = Return on investment.

Shortened up: NOI/Cost=ROI

Assuming the building you are considering has no deferred maintenance and assuming the seller's Net Operating Income (NOI) figures are correct then to obtain a 9% return you would want to buy the property for $24,151/9% = $268,344.

If you choose to finance the property then the terms of your loan and the amount of your down payment will determine what your return on your invested cash or ‘Cash on Cash” return is. I can help you with that if you like.

Ben

Reggie,

If you are comfortable sharing the P&L and Rent Roll I can walk you thru how I would analyze it. Because the seller may have non-disclosure issues please de-identify the address and such.

Good luck!

Ben

Jonathan,

Under a Sandwich Lease you would have leased the property from the owner and then sublet it to a 3rd party. So if you "bought" it for $1 then this would not be a sandwich.

Question: Did you take title to the home/land and if so, was this OK'd by the lender? If you took title without lender approval then I would expect you would have some concern about the Due on Sale clause in the original mortgage docs. (I'm assuming MH financing has DOS provisions)

I'd like to hear other's thoughts on this but in the future, in order to avoid Due on Sale problems, you might lease/purchase the home from the seller for $1 plus an amount equal to the payments. You could then earn whatever spread the market supports by selling/leasing the home to your customer.

Hi Dion,

My partners and I are finishing up a year long workout of a 220 house pool in Milwaukee that we picked up from the FDIC. I will email you for a NDA.

Thanks,

Ben Reese

Hi Justin,

In the case of the park you are evaluating you actually have two operating businesses, one being lot rentals, the other mobile home rentals. It is important to make this distinction because the two businesses are different animals and have to be evaluated differently. This is because Mobile Homes (unlike lots) are not only depreciating assets with limited resale value, they also require additional maintenance and management expenses that MHP lots do not incur. Think of how little maintenance a MHP lot requires vs the heating systems, doors, roofs, porches, plumbing, paint, appliances, etc. of a rental. And from a management point of view remember that a trailer tenant can kick in the walls/door, steal the refrigerator and skip out in the middle of the night, whereas it is difficult and expensive for a lot tenant to move his/her trailer from your park. And because lots are valued solely on the income they produce, but trailers are sold in a market, the two must be evaluated by different metrics.

Now plenty of park owners will just love to try to sell you on the idea that their park & home combo is a steal at a 13 cap, and they do this by "capping" the income from the Park Owned Homes on top of the income from the lots. A little analysis will show why this is a bad deal (from your perspective) and why it is important to separate the income streams so that you can determine the value of the lots separate from the the value of the homes.

In your case you have 38 lots and 13 trailers. The lots rent are $140 and while the homes rent at 575, bear in mind that 140 of that 575 that is lot rent. The incremental rent on the homes $435.

Now a MHP is gong to have an expense ratio of around 25-40%. For the sake of analysis let's assume 35%, meaning you'll net 65% of your lot income. Your net income from the park will be: 38 Lots X $140 X 12mo X 65% = $41,496. At this NOI and a 10% CAP Rate the park (without the homes) is worth $414,960.

The 13 houses can be evaluated several ways. You could have them appraised or get a "blue book" value on them. You can also value them with a CAP Rate, but because the homes represent more work, maintenance, cost and trouble, because they're not holding their value, and because they are generally not financeable, you do not want to buy them at the same CAP Rate as you would the Park. Lets assume the expense ratio on the houses is 40% so that the houses generate a net income of: 13 X $435 X 12mo X 60% = 40,716. And for the sake of the argument, let's further assume you indeed decide to purchase these at the same 10% CAP rate as you are paying for the Park. Note that you'll pay $407,160 for these 13 homes. That's over $31,000 each. They're hardly worth that much brand new! Furthermore, you'll be hard pressed to find a bank who will finance these nor will you find a future buyer who'll pay you that 10 CAP for them. At a 20 CAP you'll still be paying over 15K per home... and this would be about the max I would even begin to consider offering for them unless they are very recent homes and in excellent condition.

If I were buying this deal I would first ask the seller if he/she would like to keep the homes and just sell the land. If that wasn't possible then I'd structure it with two separate LLC's, one purchasing the park and the other the homes. That way the park is a stand alone business entity that may be financeable with the bank (remember banks don't like POH's). As for the homes, consider selling them to the tenants on a land contract, or contract for deed. This makes the tenant/buyer more "sticky", gives them pride of ownership which improves the Park and it eliminates all the management/maintenance brain-damage of the home rental side of the business.

Your goal is not just to have a business that pays you a good rate of return, it needs to be one that can take advantage of financing while also being structured for future resale/trade. While the immediate returns might look OK, overpaying for the POH's will stymie you in the long run.

I uploaded a simple spreadsheet that will allow you to play with CAP Rates and Expense Ratios. To me it looks like this deal is worth about $600K. I might pay a little more if the seller carried.

Good Luck,

Ben

NANA,

Just a couple of additional thoughts: Regarding your Question # 6. This would be best posed to the non-recourse lender as what you are asking for is essentially a "cash out" refi. The IRA lender will have the answer to that.

Also please know that under IRS rules you can never put any of your own funds into the property or receive funds from it. While this may seem obvious on the surface, what it really means is that your tenant NEVER makes a check out to you personally. It also means that you can't buy a bucket of paint on your credit card or pay a contractor from your personal checkbook and then have the IRA reimburse you. More subtly it means that when you identify a property to purchase you must have the contract made in the name of your IRA and you should have your IRA custodian issue the earnest money check. Do not instead enter into the contact yourself and then assign it to your IRA. This is a common error and can lead to trouble.