For me, the choice is easy. I’d rather long for a park I don’t own than own a park that’s costing me money. But how do you make sure you don’t end up owning a park you don’t want? There are a number of smart steps in the buying process, and solid underwriting is one of the most important.
The trick to mobile home investment underwriting is simple: get real with yourself about how the park should be running, and then determine your acquisition price and future operating budget from that information. In my experience with underwriting, investing, brokerage, acquisitions, asset management, and dispositions, I’ve seen or created hundreds and hundreds of financial statements and operating budgets, and every one of them has been different.
It makes sense that every mobile home park is different, because no two properties will optimally operate the same way. It certainly requires experience to sort out the differences between parks, but, more importantly, it also requires the discipline to consider all the significant factors before you invest.
Not all of these 10 underwriting mistakes commonly made in mobile home investments may apply to every park, but every one of them can have a big impact on value and cash flow if they’re not considered in your spreadsheet.
1. Not Discounting Park-Owned Home (POH) Rental Income
Rental units increase management and maintenance costs. Our business is not renting homes. We’re in the business of renting lots. When I see rental income included in top line revenue, I discount it significantly.
For example, if an owner has included eight park-owned homes that rent out for $525/month x 12 months, the top line revenue would be $50,400 for those homes. I would underwrite $31,200 of revenue for those same eight spaces as if they were getting lot rent of $325/month x 12 months. Depending on your business model, you may disagree with this one, but most mobile home park owners don’t want to be in the rental business.
2. Including Late Fees or NSF Check Revenue
I never give value to late fees or NSF check fee revenue. A park I recently underwrote showed $5,800 in late and NSF fees. At a 7.0 cap, that’s a value of over $82,000 of the purchase price. If the park is being managed properly, there should be next to no late fees or NSF fees. Pull that income out before you write your offer.
3. Including Note Sale Income
Including note sale income in the NOI of a park is a huge mistake. A package of mobile home loan notes generating $10,000 in interest per year should not add $142,857 (assuming a 7.0 cap) to the park’s value. Loan notes should either be included within the purchase price or be negotiated outside the park purchase.
4. Failing to Build in a Vacancy Factor
Let’s face it; no mobile home park runs perfectly. Inevitably, there are dips in a park’s income. Lots sit empty between home owners. Residents abandon their homes. Homes get destroyed. It’s smart to factor some wiggle room into your top line revenue to account for these possibilities. Depending on the park, I’ll include a vacancy factor of at least 2-4% of gross income. Even though that’s a relatively small percentage, it will impact bottom line NOI.
5. Forgetting About the Manager’s Home
Typically, an on-site mobile home park manager or manager/maintenance team will be given a free POH to live in during their employment. If the seller is showing income for that space, or if you have built into your operating budget that the space will eventually generate income, you’ll end up short on cash flow and will have inflated the value of the park. Again, a manager’s pad that would otherwise bring in $325/month x 12 months at a 7.0 cap would account for $55,714 in lost value, or a loss of $3,900 in top line revenue.
6. Incorrectly Handling Payroll & Burden
There are a number of different ways to pay your on-site team, and most of them are incorrect. In most cases, the on-site team should be classified as an employee of the park. The IRS defines it best here. This means you should be paying your employees with a salary.
A salary paid correctly through a payroll company (we love Gusto, by the way) will include a number of federal and state taxes that the employee is responsible for paying. The burden cost can range from 12-20% of the employee’s gross salary. This percentage depends greatly on state and local regulations. Assuming a manager’s salary of $30,000 per year, the additional burden could show up on your expenses as $3,600-$6,000 of additional cost you weren’t planning for.
7. Overlooking Property Tax Basis Reset
This is a big underwriting mistake that can drastically impact future cash flow. Depending on the state and county where your mobile home park is located, your property taxes will be calculated differently. Regardless of the location, your property taxes will go up year over year 99% of the time.
I typically assume a 3-5% increase every year. Here in Arizona, the property tax dollar amount is based on the assessed value of your property (among other factors). The mistake investors make is not recognizing that the assessed value can be reset upon a property sale. This can have a huge impact if it’s been a decade since the current owner purchased the property.
Depending on your state and county, your property tax bill could go up significantly after a basis reset. If you underwrite last year’s tax bill into future yearly operating budgets, you could be at risk. Research the method used to calculate your property taxes, and understand how the tax basis could change upon a property sale.
8. Failure to Budget for Capital Improvements
Repair and maintenance line items will be obvious when you review a financial statement, and any smart mobile home park investor will budget for these in the future. What I see left out of financial statements and future budgets time and time again, however, is a capital improvement reserve line item.
We take pride in our communities, so improving and maintaining our parks is critical to our business plan. Roads need sealcoating at regular intervals. Roofs need replacing. Pools need re-plastering. These are big ticket items you need to be planning for. If you haven’t planned for these types of improvements, where will the money come from to get them done?
I create a 15-year capital improvement budget for every property we own. This helps me to understand how much these big-ticket items can cost and when I should expect them to hit my operating statement. Every month, I hold back money from cash flow to ensure that we stay ahead of maintenance, that we are always improving our parks, and that we are prepared for big-ticket issues when they arise.
9. Not Understanding TPT Tax (Rental Tax on Mobile Homes)
This tax requires a bit of research to understand. It is simply a tax on the rental income you receive on your POH rentals or your lot rent. Here in Arizona, not all cities require you to pay it, and most every city that does impose the tax has a different rate.
In general, the tax can range from 1-3% of gross revenue. If the tax doesn’t show up as both income and an expense (that offset one another) on the park’s financial statement, it either isn’t required that the park pay it, or the owner has left it off. Check with the local municipality to find out which is the case.
10. Inefficiently Dealing with On-Site Manager Utilities
Finding a good on-site manager can be a big challenge. As with any business, attracting top talent to manage a mobile home park requires that you incentivize them to join your team. Often, a free home or a competitive salary isn’t enough. Sometimes including utilities in the manager’s employment package is necessary to get the manager for the job.
There are a number of ways to structure utility compensation with a manager, but my favorite is to provide a utility stipend as part of their pay structure. Depending on the situation, that stipend could be approximately $300 a month. Regardless of how much it is, I keep it to a flat rate.
I like the stipend because it’s an amount that won’t fluctuate every month, making it easy to budget for. It also keeps the manager from cranking down the air conditioning to 68 degrees in July. If this is something you need to include in a manager’s employment package, don’t forget to add that $3,600/year line item on your operational budget.
Mobile home investments can be a fantastic opportunity, but making any of these underwriting mistakes can end up saddling you with a burden instead of a successful investment.