Re: Including Rental Income In MHP valuation. - Posted by ray@lcorn
Posted by ray@lcorn on October 06, 2003 at 21:08:59:
Calling me out, huh! Okay pardner, let?s get to it! (smile)
I think we’re on two paths up the same mountain here. You’ve heard me state many times that different investors can arrive at widely differing valuations for the same property, and all of their answers are right. No argument there.
And before I go any further, let me concede one point. I’ve noted in several posts on the MH board that you (by name if I recall) and others have done very well with MH rentals in small parks with hands-on management. But there is a difference between writing a book for general application and using a specific owner and a specific park as a general rule.
I know you well enough to bet that any MH tenant that does not toe the line in your park will soon find himself living out of the truck he rode in on. I’ll bet your rental home tenants are required to keep their lot clean, the grass mowed and the trash out of site. No cars as yard art, no deck rail clotheslines or spare tire planters (unless they?re whitewashed? (smile)). I would also imagine you don’t spend much time in court with delinquent tenants. If they’re late, I’ll bet you’re on their doorstep the next morning. Unfortunately, that is not the typical case. However, true is true and fair is fair. There are those owners like you that take a personal interest in the property, and take the time and effort to maintain the asset even better than a land lease park.
So the point I will concede is that the line in my book should not read ?there is NO scenario in which a rental mobile home is an asset to a mobile home park?? Obviously there is such a scenario, rare as though it might be. Dangnabbit, I should know better than to talk in absolutes. You have my word that in the second edition I will change that line to say ?Unless you are going to run a park like a former police officer would, stay away from rental homes.? How?s that?
However you raise some points that I think need clarification. One of those is asset classification. I have no issue with a mobile home being classified an asset. Of course it is, but it is a different class of asset than real estate. My comments about rental homes in parks pertain to the park’s value as a real estate asset (absolutes aside), and whether a rental home (generally) adds to that value. I think we take different paths to the same conclusion.
By your own definition, you concede that the MH takes more work to maintain and rent than do spaces. I think you would also agree that a MH (without it’s own land) is an asset that depreciates in value. The reason it depreciates is that it has a relatively short life and is easily damaged with even normal use. (Why else would NADA print a book of MH values that decline with age and condition?) Land on the other hand, appreciates in value. With some basic assumptions about maintaining the infrastructure, the land will appreciate along with the income it produces. We both realize and account for the fact that a MH carries more risk, effort and operating costs than the dirt, right?
If I understand correctly, you’re estimating the extra expense of maintenance and management (including a charge for your time), vacancy and collection loss, personal property taxes, utility costs and refurb costs at tenant turnover time against the total income of the park, then using a real estate cap rate for valuation? My way suggests a flat dollar value (read cheap) on the MH, and counting only the lot rent portion of the rental income to the park. (By the way… I didn’t make that up. The Appraisal Institute uses the same formula.)
The reason I do that is because I don’t think it is accurate to value the income from a short-life, depreciating asset at the same rate as an asset that appreciates with a very long life. You take the position that if the MH produces more income where it is (in the park) then the income stream is what is important, and the lifespan doesn’t matter since you’re taking good care of the asset. So isn’t the only thing we really disagree(?) about is the quality (life) of the asset that produces the income? In valuing the income stream, I discount the income attributed to the short-life asset, and assign it only salvage value in addition to the value of the real estate. You decrease the income from both the short-life and the long-life asset, but use the same rate to value both.
Both methods discount the cash flow, but your way will tend to underestimate the real total expenses of the rental MH in the future, (because you are ignoring the life and disposition cost) and hence bring a higher valuation. My way will likely underestimate the current net income the rental home is producing in recognition of the disposition cost, and yield a lower valuation because I assign more weight to the long term asset.
On a small park the difference would likely be negligible, or even a wash. But the bigger the park, the wider the margin of difference between those methodologies. That’s where it is dangerous to mix the asset classes. In a park no bigger than 50 units, significant income produced from rental homes can skew a valuation in the hundreds of thousands of dollars. That?s a big boo-boo about the intrinsic value of the real estate, and what I was warning against. Here’s why…
In your specific instance of a small park and a very hands-on owner, yes, a rental home can benefit your cash flow. But in order to translate that increased cash flow to higher resale value, when you get ready to sell you will likely have to find a buyer that has the same inclination and philosophy. That reduces your number of interested buyers at sale time, so the price is less likely to be realized. All market factors being equal, the land lease park will sell quicker and at a lower cap rate than one with rental homes. That’s the basis for my take on rental homes in general.
That’s not to say a market does not exist for the small park with rentals, but the value depends more on the sophistication and inclination of the buyer, doesn’t it? And if the buyer doesn?t realize what he is in for with increased maintenance and management, then they will likely not realize the same performance as you did, will they?
I wrote ?DealMaker?s Guide? to help buyers value and acquire small parks, and I still see the distinction is an important one. You took what I taught and adapted it to your own talents, pocketbook and circumstances. I applaud you for that, because that is exactly what you should do with any knowledge offered. But it’s dangerous to make broad generalizations from a sample size of one. For a typical investor buying a typical park, I would still give the same general advice about rental homes. Your own description of managing rental homes recognizes the changes in the equations of operation, valuation and disposition. Those changes have a cost, like it or not.
Now that said, let me turn both of us inside out. I?ve also said I hoped the day didn?t come I had a buyer that had read my book. If I’m selling a park with rental homes, I don’t discount the numbers the way either you or I are talking about. Last fall we sold a small park at an 8% cap on projected income, with a projected rent increase and five rental homes included in the income. No discounts, no split expense statement. And before you ask, no, I didn’t give the buyer a copy of my book!
Hope all is going well,
p.s. Thanks for getting my attention. I haven?t been over here in a while and have missed y?all.