Posted by ray@lcorn on December 03, 1999 at 12:08:05:
…I think the L/O is a great way to get into the deal and control the outcome of the other elements. I just hate to see you overvalue the thing as a way to get your foot in the door, then have to give up too much of the back end profit that was entirely due to your efforts.
Good luck!
ray
Experts: Please Critique this MH Park Offer - Posted by PeteH(NYC)
Posted by PeteH(NYC) on December 02, 1999 at 21:57:48:
Park: 49 pads, 12 vacant, tucked away off any main roads, well water & septic, lot rent $210, 80 acres to total property. (Approvals for 47 more sites, blah blah blah.)
Seller busy tending to family health problem is explanation for empty pads.
Asking $895K. (What!? Even at 25% expenses, that’s a 7.8% cap!!) Broker agrees it’s ambitious, but seller willing to hold some paper.
My proposed offer:
>>$600K for 20 acres that includes the 49 pads; $100K down, seller-held $500K mtg (8%, 20 yrs)
>>7-year option on remaining 60 acres at reasonable raw land price ($2500/acre?)
What am I overlooking? Should my biggest worry be absorption rate in a small town, even if I haul in Lonnie deals and offer “move-in-today” terms? Thanks for all help.
Thanks, Gents, for your Generous Help - Posted by PeteH(NYC)
Posted by PeteH(NYC) on December 03, 1999 at 17:16:59:
Ray & Ed:
Many excellent pointers for digging at; thanks for your indulgence. I’m going to continue to due my dili, and will post what I find out. Naïf that I am, I still think there’s something here.
Your pal.
More Details - Posted by PeteH(NYC)
Posted by PeteH(NYC) on December 03, 1999 at 09:44:37:
I need (and, gulp, appreciate) the constant beatings with the skeptic stick; still hard for me not to think there’s something here, though.
Gross Inc from 37 pads: $93,240
Expenses: $26,439 (28%)
N.O.I.: $64,801
Value @ 13% cap: $498,469
Plucking a figure out of the air for valuing the empty pads, say $6250 (less than half what I’m paying for the occupied spaces), I would add $75,000, giving a total value of ~$573K.
I’ve been through the park; the homes are all young and comfortably situated on spacious tree-lined lots – you could call the place bucolic if the birds would shut up long enough to let you speak.
Does it help any if my offer is to master lease the park for $4000/mo with a one-year option to buy at $575K? That way I’d have a year to test the waters and see what the operating expenses are really like while still running a positive cash flow of $1400/mo (yes, pro forma based on broker’s figures – but there’s some room for error here). My gut tells me the biggest risk here is not capital expenses from deteriorating infrastructure, but filling those other 12 pads in a less-populous part of the state.
Re: Experts: Please Critique this MH Park Offer - Posted by Ed Garcia
Posted by Ed Garcia on December 03, 1999 at 02:35:22:
Pete:
When doing a deal, you should always have a game plan.
On this one, I would like to know what yours is?
If you are buying it for CASH FLOW. This is not a good deal.
$210 x 37 rented sites = $7770 per mo. x 12 mo. = $93,240 per year.
Hit it for 45% expenses etc. That gives you a NOI of $51,282.
I agree with Brother Ray that it should be a cap rate of 15% (real world), let’s
not fall in love with the property, let’s crunch the numbers and let them speak for
their self. $51,282 divided by 15% cap = $341,880. There is your price for the 49 lots
or 20 acres.
Your price of 600k would give you a 8.5cap rate. Not a good deal for this kind of product,
In the area that it’s in. By the way, the reason I know it’s in a questionable area, is the
vacancy of 25%. We have more here, than just family illness or bad management.
Never under estimate the ability of the seller. Those 12 vacancies didn’t just happen over
night. especially with affordable living.
If your looking for UPSIDE, which is really where you feel the value of this deal is
to begin with. Then you had better do what brother Ray say’s, and that’s do your home work
as Ray indicated. Remember, YOU MAKE YOUR MONEY ON THE BUY.
Ed Garcia
Re: Experts: Please Critique this MH Park Offer - Posted by ray@lcorn
Posted by ray@lcorn on December 03, 1999 at 24:12:36:
Pete,
I’m not sure whether you are dealing with an owner looking for an appraisal or a seller who really wants out. You and I and everybody else in this business knows there is a big difference, but I sometimes get too carried away with “potential” and fail to evaluate the present. You may be falling in the same trap.
On a deal like this there are really only two things to consider: First, the present income and expenses. You didn’t mention any expense amounts, so I have to assume the worst, which is around 50% expenses. That could mean well problems, septic tanks that need pumped and a privately maintained road system. Unreasonable? I hope so. I can’t begin to derive an appropriate cap rate without that information and some knowledge of the market, but at best a small park of this size would rarely be valued under a 12% cap, and probably 13-15% would be more likely. Yes, absorption is important here, but only in the context of the big picture of evaluating all the pieces of the operation
Second, is the development project. I wonder why the additional 60 acres is approved for only 47 more lots? I would hightail it to the planning department and ferret out the exact conditions and requirements of the 47 “approved” lots. I would also hope that there is some overlooked factor that would let me yield at least twice as many lots. Is public sewer available at any price? Check with a local (small) engineering firm and get a ballpark price on the cost to develop the streets, water and sewer (septic) systems, and electric service for the site. Roads in my part of the country have to be paved, and the total development cost can get over $75 per foot of lineal street in a heartbeat. Absorption is a HUGE issue here, therefore much market research is called for to determine feasibility. Right off the top of my head, a small park with a 25% vacancy doesn’t indicate a real strong market, owner inattention or not. In a strong market they will literally knock the doors down to rent lots. What’s the population trend in the area? Income? Housing choices? Rental market? Employment rate? All these and more questions have to be answered to do the deal the smart way.
After you do some footwork on both the existing operation and the development project, I think you’ll find that $600T is a premium price for 37 performing lots. I can’t speak to what may be a reasonable raw land cost for the development portion of the property, but an easy way to find out would be to research the most recently constructed park in the area and see what was paid for the property pre-development. To compare, add or deduct for property features accordingly.
Every property has the potential to be a deal, but I suspect this owner may have to get a bit hungrier before it is one.
Good luck!
ray
Re: More Details - Posted by Ed Garcia
Posted by Ed Garcia on December 03, 1999 at 11:42:21:
Pete:
I like it when you say, your going by your gut feeling. Instincts are important when doing
a deal. However after saying that, they should be supported or based on facts.
When doing a deal, I always give the previous owner the benefit of a doubt that they can
properly manage a property, unless information shows me other wise. The reason for that,
is they have a lot of advantages on me. The first one being that they have been struggling
with the property that I think I’m going to come in and be a answer man on.
Un like Ray, I do not feel it necessary to see the previous financial information because usually
the seller is lying anyway. I like to go in and put my own numbers on it because I’m not influenced
by the sellers information. Their figures don’t always reflect what is really going on with a property.
When they disagree with my figures, I ask them to show me, and they usually can’t.
Now don’t get me wrong. I’m not saying that I don’t want to see their information, of course I do.
Because when they show you their figures, their saying they have nothing to hide, and that’s important.
When they don’t want to show you their figures, then you know something’s wrong in River City.
Were back to GAME PLAN.
It seem to me that you feel that the value of this deal is the upside potential, and that the existing income,
is just a vehicle to justify your purchase, until you can increase the income of the property.
Obviously by doing that, you increase the value of the property.
Ray in his first posting, gave you some steps to take, to make sure that this deal has the upside potential that you are suspect of. You don’t buy a property to see what happens. You buy a property with a GAME
PLAN to make things happen. If you don’t, you’ll get stuck in this deal and may not find another buyer
like you, who will buy on the IF COME MAYBE. They’ll want the Cap Rate that this property and area allows or more. That’s why Ray is sharing his concerns. He is going by his GUT FEELING.
Ed Garcia
I wish you hadn’t said that! - Posted by ray@lcorn
Posted by ray@lcorn on December 03, 1999 at 10:09:41:
Pete,
If I understand correctly that you are basing this valuation on pro forma numbers, may I ask why? Are actual performance numbers not available? If not, why not? And why would you add value for empty spaces? I’m not following this reasoning at all.
ray
Re: Experts: Please Critique this MH Park Offer - Posted by Pat
Posted by Pat on December 03, 1999 at 08:28:03:
Ed,
Could you explain to me “cap rate”? What does it mean, what does it show us in a business context, how do I figure it, etc. Maybe some examples that will show me what it can do for me in the real estate business? Thank you in advance for answering such a basic question!
Pat
Re: I’ll stay out of it, you guys are doing just fine… - Posted by Ed Garcia
Posted by Ed Garcia on December 03, 1999 at 12:20:27:
I’ll stay out of it, you guys are doing just fine.
When I posted my last answer I got an important phone call in the middle of
my posting. I was on the phone for about 15 minutes and then resumed the
completion of the post.
When I check the board, I saw by that time, you guys were in a dialog and had
gone past the points I was making. I just didn’t want you to think I was on a
different sheet of music.
Go for it,
Ed Garcia
Re: I wish you hadn’t said that! - Posted by PeteH(NYC)
Posted by PeteH(NYC) on December 03, 1999 at 10:22:49:
Ray –
I’m calling them pro forma because they’re the figures the broker provided, not because they’re predictions for future worth. My presumption is that any figures would be verified in due diligence prior to close. You don’t really get to look at a guy’s books before submitting an offer or L.O.I., do you?
Re: Experts: Please Critique this MH Park Offer - Posted by Ed Garcia
Posted by Ed Garcia on December 03, 1999 at 09:01:52:
Pat:
You take your NOI which stands for (Net Operating Income).
Devide it by the Cap Rate you desire.
This helps you decide the value of the property based on the income.
Example:
You have a property that nets you $2500. a month after expenses.
You then multiply $2500. times 12 months = $30,000.
Lets say you want a 8 cap rate.
You then take $30,000. devide it by .08 = 375,000.
At an 8 cap the value of your property is $375,000.
Pat, now here is a more detailed explination.
Why do you in invest in income-producing real estate? Perhaps you are
looking cash flow. Possibly you anticipate some tax benefits. Almost
certainly, you expect to realize a capital gain, selling the property
at some future time for a profit.
Your projection of the future worth of the property, therefore, can be
a vital element in your investment decision.
INFLATION
A fairly simple approach to this issue is the use of an inflation
rate. You bought the property today for X dollars. You make a
conservative estimate as to the rate of inflation, apply that rate to
your original cost and improvements and come up with presumed future
value.
The use of inflation as a predictor of future value typically makes
sense when the desirability of the subject property is based on
something other than its rental income. For example, consider a
single-user property such as a small retail building on a main
thoroughfare. The owner of a business operating as a tenant in such a
location is probably willing to spend more for the building than an
investor would pay. In general, rate of inflation as a predictor of
future value may be appropriate when comparable sales work well as a
measure of present value (i.e., "Commercial buildings on Main Street
are selling for $200 per square foot by next year they will be up to
$225.").
CAPITALIZATION
With most other types of income-producing real estate, what you paid
for the property is not likely to make much of an impression on a new
buyer. Witness the rapid run-up and even faster collapse of prices in
the late’s. The typical investor will be interested in the income
that the property can generate now and into the future. He or she is
not buying a building so much an income stream.
That investor is most likely to use capitalization of income as the
method of estimating value. You have probably heard this referred to
as a “Cap Rate” method. It assumes that an investment property’s
value bears a direct relation to the property’s ability to throw off
net income.
Mathematically, a property’s simple capitalization rate is the ratio
between its net operating income (NOI) and its present value:
Cap. Rate =NOI/Present Value
Net operating income is the gross scheduled income less vacancy and
credit loss and less operating expenses. Mortgage payments and
depreciation are not considered operating expenses, so the NOI is
essentially the net income that you might realize if you bought the
property for all cash. If you purchase a property for $100,000 and
have a NOI of $10,000, then your simple capitalization rate is 10%.
To use capitalization to predict value requires just a transposition
of the formula:
Present Value =NOI/Cap. Rate
The projected value in any given year (i.e., the “present value” in
that year) is equal to the expected NOI divided by the investor’s
required capitalization rate.
To use capitalization rate as a predictor of future value, in short,
is to use this logic: "I am buying this property with the expectation
that its net operating income will represent a return on my
investment. It is reasonable to assume that whoever buys the property
from me in the future will have a similar expectation. That new
investor will probably be willing to purchase the property at a price
that allows it to yield his or her desired rate of return (i.e.,
capitalization rate)."
If you project that the property will yield a NOI of $27,000, and that
a new buyer will require a 9% rate of return (capitalization rate),
then you will estimate a resale price of $300,000.
You must never forget that, while the algebra involved here is simple,
the judgments you need to make in order to achieve an accurate
prediction of value are more complex. Your assumptions as to future
years’ income and expenses have to be realistic.
The same is true of your estimate of a new buyer’s required cap
rate. Look at the investment from the new buyer’s point of view and
remember that there are other opportunities competing for his dollar.
Would you buy an office building with a projected cap rate of 9% if
you could buy a bond that yields 8%? What if mutual funds are rocking
and rolling at 15% and more? To attract a buyer, your property may
need to be priced so that its cap rate is competitive. The higher the
cap rate, the lower the price. In our example above, the property with
the $27,000 NOI capitalized at 12% would be worth only $225,000.
Our discussion here has been limited to simple capitalization rates.
If you would like to delve deeper into this topic (for example,
mortgage-equity cap rates), an appraiser’s text on income-property
valuation should be your next step.
For more information, go to http://www.realdata-inc.com
Copyright 1996, RealData ©, Inc.
Reprinted with permission of the author.
Ed Garcia
Re: I wish you hadn’t said that! - Posted by ray@lcorn
Posted by ray@lcorn on December 03, 1999 at 11:08:15:
Pete,
I understand now. I didn’t realize that you were dealing with a broker. Be aware that a favorite ploy used by brokers is to get a buyer interested based on pro forma numbers, then leave it up to the buyer to disprove them. If they talk you into a contract on that basis then the deal becomes even more difficult to negotiate because the table has been set with the expectation of the price in the contract. That sets the stage for a pretty uncomfortable meeting when the numbers don’t match up, which they won’t, because if they did they would be showing the real numbers rather than a pro forma.
To answer your question, I will normally not even consider a deal, much less make an offer, without having the real numbers. Pro Forma is fine for projection purposes, but for valuation and negotiation of a contract I’m just not going to waste my time on “what-if” scenarios. I want to see “what-is”, because that is what I am willing to pay for. I don’t expect to see the books before the contract, though I will ask everytime… all they can say is no, but it is not too much to ask to see summary financials, subject to verification in due diligence. Then you have something to base a realistic valuation on. Using pro forma numbers for valuation is akin to paying the present owner for the work I must do to bring the property up to the projected level of performance. Why should he be paid for work he SHOULD have done, but didn’t? Every property has the potential to be more than it is, but it takes work and resources to realize that potential. MY work and MY resources… not the present owners. And in my book I am entitled to the return for that work and the use of my resources.
Bottom line, in all but the most unique situations, without real numbers I’m not going to do a contract, LOI or return more than the first few phone calls. But that’s just me, and I’m told I’m getting pretty crotchety!
ray
Clarification - Posted by PeteH(NYC)
Posted by PeteH(NYC) on December 03, 1999 at 11:00:52:
The figures are seller-provided 1998 actuals; I haven’t spoken to him personally and so am trying to be as accurate as possible in describing their reliability before I’ve examined the books.
Re: Experts: Please Critique this MH Park Offer - Posted by Pat in Columbus
Posted by Pat in Columbus on December 03, 1999 at 16:03:03:
WOW…thanks Ed. I really appreciate your time and effort in educating me on the subject. Like Kim, I never pass up your posts. Even if I have only recently discovered this site, your expertise shows through quickly. Thanks again.
Pat
Re: Experts: Please Critique this MH Park Offer - Posted by Kim K–AZ
Posted by Kim K–AZ on December 03, 1999 at 10:27:07:
Thanks Ed for the postings. Your “nuts & Bolts” info. with concise examples is why I never pass your postings. Thanks again for sharing of your precious time and expertise. Sharing…tis the season.
Oops! - Posted by ray@lcorn
Posted by ray@lcorn on December 03, 1999 at 11:13:19:
Pete,
I didn’t see your clarification before I posted the above. What I said about valuation on proforma numbers still goes, but obviuosly you can ignore the advice about not going to contract or LOI. BTW, I would recommend getting as much of the due diligence info as possible with a LOI, then use it to better craft the contract. I hate doing contracts and then having to try to amend fifteen clauses because of what I find in due diligence.
I still think you’re over valuing the park. The vacant lots do not have a value over and above the income being generated by the property as a whole.
ray
Re: Experts: Please Critique this MH Park Offer - Posted by Howard TN
Posted by Howard TN on December 03, 1999 at 17:02:19:
Ed
Thanks for the explaination of CAPS. I was going to ask the same question that Pat did. I’ve printed this and will keep it on file for future refs.
Again, thanks
Howard TN
No Value for Vacant Lots? - Posted by PeteH(NYC)
Posted by PeteH(NYC) on December 03, 1999 at 11:26:46:
Ray–
I’m not sure why not – don’t investors sometimes buy actual vacant lots? Wouldn’t you value them on the income they’re predicted to provide?
I guess it’s hard for me to get away from the expectation that I can put homes on, and collect rents from, those 12 lots inside a year. To me, the 12 vacancies represent not necessarily an undisclosed problem but the chance to buy at a discount and quickly hike the cash flow.
(I hope I’m not being argumentative – mostly I’m just confused. I do appreciate your responsiveness.)
Peter
Re: No Value for Vacant Lots? - Posted by ray@lcorn
Posted by ray@lcorn on December 03, 1999 at 11:47:04:
Pete,
You’re not being argumentative at all… just questioning and that is as it should be. Never take another’s opinion for your own without understanding it completely.
Your point makes mine! It is true that you can create value with the twelve vacant lots. It is also true that investors do sometimes buy vacant lots in the case where the property has been properly structured to allow for individual lot ownership. (That process I might add is a bit more complicated than just writing a deed, but we’ll leave that for another discussion.)
But what is also true is that for you to realize the inherent value of those vacant lots takes your effort and your resources, one of which is your time. Why would you want to pay the present owner for value based on your effort and your resources?
What we are buying in any income property whether mobile home park, apartments, shopping center or anything else, is an income stream. The PRESENT income stream. Cap rates, comps, and replacement cost are all just ways of quantifying the risk and effort (cost) required to maintain the income stream. The income stream created by the present owner is what it is, and it has a value. Our job is to come to a realistic estimation of the value of HIS income stream. What we do with the income stream after buying it is part of our return on, and return of, our investment. By giving the present owner the benefit of an income stream that does not exist except by our efforts, whether it be vacant lots or vacant apartments or vacant retail space, is tantamount to giving away our return on and return of investment.
You are correct in looking at the lots to buy at a discount and quickly hike the cash flow, but understand that if you pay the owner for the future value rather than the present value, you are reducing your return.
Hope that makes sense. If not, let me know and I’ll try again.
ray