Underwrite an MHP Offering as a Passive Investor
Has a sponsor pitched you a mobile home park (MHP) deal and you passed because you aren’t comfortable underwriting one?
In this article, we cover what to look out for with an MHP offering.
We want you to understand what a sponsor puts in front of you, such that you can make a ‘go / no-go’ decision.
Contents
• Strategic Goals
• Market - Geographic and Product
• Performance Metrics
• Financial Model
• Onsite Due Diligence
• Checklist
Strategic Goals
Before any presentation, make sure you define your investing goals.
This is overly reductive, but MHP investing goals boil down to twofactors:
1. Risk tolerance
2. Capital goals
Example 1
High risk tolerance and want to multiply capital? Look for sponsors who focus on small value-add parks in secondary and tertiary markets.
Example 2
Lower risk tolerance and want to preserve capital? Look for sponsors who focus on large stabilized parks in primary markets.
Market - Geographic and Product
Market is arguably the most important factor in MHP investing.
That said, we should clarify the term ‘market.’
We use market to refer to two interrelated terms:
1. Product Market
a. MHP Demand
2. Geographic Market
b. Metro Area
Product Market
By product market, we mean the demand for a product, i.e. balance of buyers and sellers.
Venture Capitalist Marc Andreesen summed it up perfectly in his classic article on product / market fit:
“When a great team meets a lousy market, the market wins…
When a lousy team meets a great market, the market wins.” – Marc Andreesen
The point here is this:
If there’s not a market for your product, a good team and good product will still lose.
However, if demand for your product is strong…
you have a shot at not losing your shirt.
In this case, our product market is affordable housing.
And demand for affordable housing is typically quite strong in most geographic markets.
For example, below is the shortfall of affordable housing units in the state of Tennessee for 2022:
The supply of affordable units cannot meet the demand for the product.
Geographic Market
Each geographic market has different affordable housing demand.
Generally speaking, bigger metros tend to have lower supply of housing in relation to the population, and a higher demand for the existing housing.
Conversely, more rural areas tend to have a higher supply in relation to the population, and thus a lower demand for housing.
Nashville, TN will have more affordable housing demand than Viola, TN
Whichever market your sponsor has chosen, it must be a market that exhibits a strong demand for affordable housing.
Every metro is case-by-case, but here’s what we tend to look for in geographic markets
- 2 bedroom apartments 2x lot rent
- Single family homes > $100k
- Metro area > 100k (bigger is better)
- Diverse employer base
If a market meets these criteria, most likely it’s a safe enough market to fill the homes and deter vacancy.
Below is a simplified chart showing the advantages and disadvantages of primary vs. tertiary / rural markets.
Geographic Market Advantage / Disadvantage Chart
Advantages
Disadvantages
Primary Market
Easier to increase rents
Higher exit prices
Easier to fill lotsages
Higher purchase price
More competition
More city restrictions
Primary Market
Lower purchase price
Higher Cash-on-Cash
Less Competition
Harder to trade
Harder to raise rents
Harder to fill lots
Generally speaking, primarymarkets are safer bets.
Performance Metrics
Just remember ‘horses for courses’…
I.e. Match your goal with the suitable performance metrics
If you’re already comfortable with performance metrics, please skip to the model section.
For a quick refresher, keep reading
Watch out for the Big Three Performance Metrics:
Equity Multiple (EMx)
If your goal is to multiply capital, then Equity Multiple will be your primary metric.
Equity Multiple measures total returns relative to invested capital.
Formula: Money Received / Money Invested = Equity Multiple
$100k / $50k = 2x Equity Multiple
Equity Multiple Limitations
Equity multiple doesn’t take into account cash flow during the hold period. This means the property could cash flow very little for most of the hold period until a capital event.
If you’re a value add / capital multiplication investor, this doesn’t concern you as much because you’re focused on multiplication – not day one cash flow.
Cash-on-Cash (CoC)
If your goal is steady returns and capital preservation, CoC is a better metric.
CoC measures periodic cash flow (Y1, Y2, etc.) against the total investment
It measures annual cash flow performance not long-term equity growth.
Formula: Annual Net Cash Flow / Invested Capital = Cash-on-Cash
Example:
$1,000 - Year 0 Invested
$1,200 - Year 1 Received
$200 - Year 1 Net Return
$200 / $1,000 = 20% Cash-on-Cash
CoC Limitations
CoC is a snapshot in time, so it’s myopic if you use it as one metric.
Just because an investment boasts a high CoC, it might take several years for a return of capital.
To counteract this, look at CoC performance over several years PLUS Equity Multiple for a better picture.
Internal Rate of Return (IRR)
Zoom Out: unlessyou evaluate multiple projects and have a defined discount rate, youmost likely won’t need IRR.
This is not a deep dive into IRR (or NPV). This is just a functionaloverview of how to view IRR when looking at an offering.
However, sponsors include this in analyses so we’d be remiss if we didn’tcover it.
Main Takeaway : IRR measures yield
According to the CCIM definition “IRR is the rate of return each dollar in an investment earns while it is in the investment…
IRR gives investors the means to compare alternative investments with different hold periods and cash flow projections based on theiryield.”
That’s it.
If you want to understand how it works, there are literally thousands of online resources.
Conceptually, all we need to know here is that $1,000 received today is worth more than $1,000 received in five years.
Here’s an example:
Given the above, how would you compare these two investments?
The same amount was invested but the hold period and cash flows are wildly different.
How do we know which investment boasts a better yield?
Enter IRR.
It takes cash outflows, inflows, and hold periods, and tells us which investment earned more dollars per dollar invested over the period.
Even though investment two has a dramatically higher reversion figure, it still has a lower IRR because of the additional two years to receive those monies.
This is what people mean by the Time Value of Money.
We used the CCIM financial calculator for this, but you can just aseasily use Excel or find a pre-existing model.
We recommend using all three metrics when evaluating any deal.
Financial Model
This is not a deep-dive on how to create an underwriting model. That is beyond the scope of this article.
However, we’d like to arm you with enough knowledge when you analyze a proforma that a sponsor provides.
Remember This: Any underwriting model will be wrong…100% of the time ;).
No model can perfectly predict what will happen over the course of an investment.
That said, without one we’re blind to potential performance.
From a financial modeling perspective, MHP underwriting is similar to multifamily but nuanced enough where you can’t plug and play
An underwriting model has three layers:
Investment Cash Flows
Investment cash flows reflect the capital you put into the investment.
Think Equity and CapEx.
For MHPs, CapEx can be paved roads, playgrounds, mailboxes, etc.
Operating Cash Flows(Operating CF)
Operating Cash flows reflect ongoing revenue, expenses, and debt service.
The revenue portion ofMHP underwriting distinguishes it from other asset types.
What to Watch: MHP Revenue
Quick MHP Refresher:
MHPs have two types of homes:
- Tenant-Owned Homes (TOH)
- Park-Owned Homes (POH)
MHPs have two types of rent:
- Lot Rent (Rent the land)
- Home Rent (Rent the land PLUS the home)
TOHs = lot rent
POHs = home rent
Oftentimes, folks will underwrite with home rent instead of lot rent. We caution against this.
Here’s Why:
Let’s say you have the following scenario:
Shady Oaks MHP
100 lot MHP (50 TOH + 50 POH)
Lot rent = $300 / pad
Home rent = $600 / pad
50 TOH * $300 / pad * 12Months = $180k Annual Top Line Revenue
+
50POH * $600 / pad * 12 Months = $360k Annual Top Line Revenue
TOTALS
$540kAnnual Top Line Revenue
All good...but what happens if you sell all the POHs to the tenants?
You get this:
100 POH * $300 * 12 Months =$360k Annual Income
That cuts $180k of annual top line revenue which home rent previously provided.
Thisis a common strategy as it greatly reduces workload required to service the POHs.
However,it’s a problem if the model doesn’t take losing home rent into account.
Whatever the plan, make sure the sponsor takes this into account
What to Watch: Aggressive Growth Assumptions
Keep an eye on aggressive growth assumptions. This can be either in lot rent increases or infill velocity.
If the operator plans to take lot rents from $300 to $500 per lot in 1 year and infill 30 homes…
it could happen but it won’t be smooth sailing.
What to Watch: Operating Expenses
There are some rules of thumb for MHP expense ratios for stabilized parks.
Largeparks (150+ pads) can have incredibly low expense ratios – near 20%.
Medium parks (150 - 30 pads) typically vary between 50% - 20%
Smaller parks (<30 pads) can have higher expense ratios near 50% because of the reduced NOI.
Given so many factors play into expenses, this is more art than science.
All that said, keep these benchmarks in mind when looking at an offering.
Debt Service
From an investor perspective, your main concern will be a healthy DSCR relative to the business plan.
Lenders typically want to see a minimum of 1.2 - 1.25, and we should do the same.
If the sponsor has been able to line up financing with a bank, it’s a good sign.
It means either the park demonstrates a strong cash flow history OR the sponsor has worked with the lender in the past and performed well.
Both scenarios bode well for investors.
Reversion Cash Flows
Typically the sponsor will use the income approach to reach a reversion value.
However…MHPs contain a nuance to watch out for.
Income Approach Refresher:
Formula: NOI / Exit Cap Rate = Estimated Reversion Value
For MHPs we recommend to take the Annual LotRent NOI of the following 12 months after exit and divide by an exit cap rate (Ex.7%).
The temptation for sponsors is to pump up the NOI with Gross Potential Rent OR include Home Rent to increase the NOI, and thus drive up the sales price.
We’ll illustrate with the Shady Oaks example above
Reversion Value Without Home Rent (Correct)
100 Lots * $300 / Pad * 12Months = $300k Rental Revenue
$300k Rental Revenue * 35% Expense Ratio = $195k NOI
$195kNOI / 7% Exit Cap Rate = $2.78M Reversion Value
Reversion Value With HomeRent (Wrong)
(50 TOH * $300 / pad + 50 POH* $600 / pad) * 12 Months = $540k Rental Revenue
$540k Rental Revenue * 35% Expense Ratio = $351K NOI
$351kNOI / 7% Cap Rate = $5.01M Reversion Value
That’s a massive $2.23m difference!!
The park could very well sell for that price, but that’s the rosiest assumption.
What to Watch: make sure sponsors only use Lot Rent NOI
Onsite Due Diligence
All parks have problems, it’s just a matter what kinds you can live with.
The point of due diligence is to find out what kind of problems come with the deal.
The cost to fix these problems will affect the capital expenditure budget and potential purchase price.
Some problems we can live with…and some require a capital call.
Some light renovations and new skirting – not a big deal.
Adding Skirting to a Home
Completely replacing yoursewer infrastructure – a very big deal.
Infrastructure Replacement Source: Burlington Record
From your perspective, you want to know the sponsor conducted proper due diligence, found the problems, and plans to address them.
Checklist
Underwriting is a massive topic that is beyond the scope of this article.
However, these points should give you enough tools for you to make your own ‘go / no-go’ decision.
The next time you look at an offering, test the sponsor with these questions:
MHP Offering Checklist Questions
Is this hold period realistic based on the proposed work?
Given the work and purchase price, do the performance metrics seem achievable?
Is the DSCR safe enough throughout the hold?
Does this match your strategy?
- Ex: Cash flow or equity multiplication?
Is the expense ratio realistic for the park size?
Are growth assumptions overly aggressive?
Are you satisfied with how quickly you get your money back?
- Ex. Year 3 refinance to return capital and then sale at end of hold.
Does the deal earn enough to wait through the entire hold period?
- Ex. 7 Year Hold
Is the rental demand really this high in this geographic market?
- Ex: Did they do test ads?
Did they adequately include enough CapEx budget to reach stabilization?
- Is $3k for a septic replacement really enough?
Can this geographic market really match their modeled income projections?
- Ex: $200 per lot rent increase in a city of 1,000 people?
How realistic is this exit cap rate for this size park in this particular geographic market?
- Ex: Is a 3 cap in the middle of nowhere realistic?
Is there an adequate margin of safety or does everything need to go right to meet projected returns?
These are just examples, but it should give you a good starting point the next time a sponsor sends you an offering.
No Offer of Securities—Disclosure of Interests. Under no circumstances should any material at this site be used or considered as an offer to sell or a solicitation of any offer to buy an interest in any investment. Any such offer or solicitation will be made only by means of the Confidential Private Offering Memorandum relating to the particular investment. Access to information about the investments are limited to investors who either qualify as accredited investors within the meaning of the Securities Act of 1933, as amended, or those investors who generally are sophisticated in financial matters, such that they are capable of evaluating the merits and risks of prospective investments.