Jerome Powell at the Fed has ushered in an era of interest rate instability that has not been experienced in over 40 years. This has created an environment in which traditional banking is not always the attractive solution to getting deals done. But what are the alternatives to sidestep traditional lending? That’s the focus of this Mobile Home Park Mastery podcast.
Episode 267: Options To Sidestep Conventional Banking Transcript
A totally incompetent administration has led us to the highest inflation in 40 years. As a result, Jerome Powell of the Fed has raised rates over two points in one of the fastest fashions we've ever seen, and suddenly, there's a lot of questions regarding banking. This is Frank Rolfe, the Mobile Home Park Mastery Podcast.
The question is, how can you side-step conventional banking at a time where interest rates are rising, bank loans are not as attractive, there's so much instability and concern in the market. What can you do to finance a mobile home park deal? Well, the good news is, there are quite a few formats that buyers have used for long periods of time to get around banking entirely. Now, when I got the mobile home park business back in the 1990s, the hardest thing you could humanly do on any mobile home park deal was to find a lender. They just didn't exist. Back in the '90s, everyone thought of trailer parks as a stupid investment to make, filled with horrible customers and banks just didn't even wanna touch it. So what did you do back then? Well, everyone developed skills to get deals done back in the '90s before bankers were really interested in this asset class, and a lot of those are still available today. People have just kind of forgotten about them because banking got so easy for so long.
So what are those techniques? Well, the first one is seller financing. My very first deal came from seller financing. $400,000, all the seller wanted was $10,000 down, 2.5%. I was more excited about the financing than I was about the mobile home park deal itself. The next five deals I did also all had seller financing. Now, why do sellers do seller financing? Well, they do seller financing because at the end of the day, sellers are just like everybody else. They're trying to get the best return on their dollar and they know that they can not get levels of interest that they can get on a seller note through conventional investments such as CDs, and they watch the stock market. It is a perpetual decline. It's down, what, 20% this year so far, and bonds are no better. So typically, when the seller carries the paper, they're carrying the paper simply because it benefits them. A lot of people think of some magical sales pitch that you give them to make them wanna do it. No, there's no magical sales pitch, the only sales pitch is the reality of the world. They go to their broker at AG Edwards, and they see how low almost everything pays them, and they would much rather have a safe and steady, say, 5% on a firstly secured note.
The great thing about seller financing is the ultimate sidestep of the banking industry. It has nothing to do with banking. There's no requirements. They don't do any credit checks on you. They don't care much about you other than the fact they like you. And the downpayment is hugely flexible. You can do a zero down deal. We've done 12 zero down deals, but it also comes in other denominations like 2.5%, 5%, 10%, 20%.
I would say your typical seller note is probably 20% down, but many sellers, if they bonded with you and like you and you have a good reason why you think you should go with a lower amount, they're typically open to that. Because the more money they put in play, the more money they have in the note, then the higher their monthly payment turns out to be. So seller financing is a great tool. It's always been available in our industry. Just a lot of people weren't pushing for it quite so hard because the banking was just kind of sort of easy. Now, there's a derivation of a seller note called a wrap note. Let's go over that for a moment.
So what is a wrap note? A wrap note is where mom and pop still have the last vestiges of their mortgage. So let's say you're buying the park for a million dollars, and they still got a mortgage on it of $300,000 or something, so you try to construct the deal where they keep that first lien in place and they establish a second lien. So mom and pop in this case don't have a first lien on the property like traditional seller financing, but instead they take a second position and that's called a wrap because you're wrapping around that first lien mortgage from the bank. Now, there are some problems with wrap notes.
It's not as easy as mom and pop often think because their underlying note often has to do on the sale clause. If they sell the property, that note must be paid off, you can't just leave it laying around and keep making payments on it because that's what is easy for you to do. No, the bank doesn't like that. So you've got to look at their underlying note and see what it says. Now, some of them do allow a wrap, but many of them do not. If you do a wrap on a note that does not allow a wrap, what could happen? Well, the bank could call it due and payable in full. And then who's gonna pay that? How will that work? If mom and pop seller don't have the cash and you don't have the cash, well, the park will go into default and you could lose your down payment. So be very, very careful when you look at a wrap note construction but that is a second alternative to traditional seller financing.
Now, another thing you can do with a mobile home park that side steps banking entirely is to do a master lease with option. Now, what's a master lease with option? Well, a master lease with option is a situation which you lease the property in total. You're collecting all the revenue, you pay out all the bills. And then you make a payment to the potential seller into the future. And in the whole time you are doing this maneuver, you also have the right to buy the property at a pre-established price.
Now, would anyone do that? Well, there are some sellers out there that their main goal is simply to get completely out of the operations of the park. They're tired of it. They have health reasons. They just wanna basically retire and do something completely different. So the master lease with an option accommodates that feature but it gives you the time to improve the property to make it more valuable and potentially obtain the financing. Now master lease with options typically are structured in periods of maybe three years or five years with the assumption it will take you that long to obtain the debt to actually make the sale. But what the good news is that's gonna go ahead and also buy you time for all of this banking instability to technically probably end.
So the goal would be... Let's say if you did a master lease with an option where the option gives you five years from taking over the park to actually purchasing it, the goal would be that interest rates then decline and re-stabilize before that fifth year. And that doesn't additionally count the fact that you can often go in and raise rents and cut costs and improve the looks of the property during that period even to make it more bankable.
Now master lease with an option has traditionally been revolving around mobile home parks that have been very poorly managed and that you can't come up with the value that hits what mom and pop paid for it or the number that they have in their mind but you may see more of it being done just during these times of banking instability as a shock absorber to buy people time until the banking industry returns back to normalcy.
Now another option you can do is to do basically just buy the park for cash and not have a loan. Now this is a very, very risky option. Let me explain why that is true. When you buy a park for all cash, what happens is your rate of return, your cash on cash return is the same as the cap rate. Because in real estate, to make money, you typically have to employ leverage. That's why most people, when they buy a mobile home park or really any income property try to put a debt on it to the tune of 70% or 80% loan to value. Because it's the spread between that interest rate and the cap rate that creates the higher returns. If you want to have a 20% cash on cash return, the standard formula is you need to lever the property with a three-point spread between the cap rate and the interest rate. That's a normal play book for that. However, you take that tool completely off the table when you buy something for cash. So now instead of getting a 20% cash on cash return from a three-point spread, all you get is the cap rate. So if you bought the park at a 7% cap rate, then that's the total amount you'll get on your cash.
The other problem is when you employ so much cash on a single park, you have look at the opportunity cost of all the other parks you might have purchased if you use that money for down payments using conventional financing. Finally, when you buy things for all cash, you don't know what's gonna pop up during diligence and the financing contingency when you go to get a regular loan, what things will pop up that might scuttle the loan. When you do a traditional deal and there's a bank involved, then it gets scrutinized in the front end before you buy the property, and if something popped up, if there was a roadblock, a pot hole, something so dire that the bank can't go forward, you can then cancel the deal. But you can't when you already bought it for cash.
Now, if you buy it for cash, you could always go back in and re-finance it. That could re-establish the leverage and that tool and so on and so forth. But nevertheless, buying for cash is not as great as many people think. Now, it's a very useful tool, typically when you're buying something at an auction. That's when you see it very prevalent to buy it for all cash because it's very, very hard in an auction format to get a loan fast enough to buy something. But if you can't get debt on a deal and it's a great deal and it's one you think should be bought, and you have the capital or capital partners to make that possible, that would be another way to side-step banking.
Finally, you can always, on any mobile home park that's a decent deal, do a deal assignment. What happens is you tie the property up on an and/or signed contract and that allows you to assign it to any entity you like basically at closing. Now the typically reason most contracts have and/or assigns is because you will set up an LLC prior to buying the mobile home park and transfer it into that LLC. But it doesn't really stop you from transferring into any LLC, including the LLC of somebody else. Deal assignments typically sell for somewhere around 5% to 10% of the face value of the contract, which is a very large sum when you consider how big many mobile home park deals are. It's another way to completely sidestep banking and really sidestep financing all together.
There's no money required as a down payment, no other issues at all because you're not going to ever be in the banking business. Your whole goal in that model is simply to find properties that are worthy of buying and tie them up into a good price, and then find someone who wants to buy the assignment. The bottom line is a mobile home parks, probably more than any other real estate sector are ripe with options to allow you to sidestep traditional banking, if that's your goal. And the way things are going right now between the administration and interest rates, sidestepping banking may not be a bad idea until things return to normalcy. This is Frank Rolfe of the Mobile Home Park Mastery Podcast. I hope you enjoyed this. Talk to you again soon.