Potential Real estate deal - comments appreciated

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I comment here quite a bit on RE investment ideas that other people are trying to put together. A lot of the time I talk about how you can buy great income properties that offer a 10%+ cap rate and a 25%+ cash on cash return (ROI). Well, I just found just such a property, and I figured that I’d post the details here for education and public comment. Right now I’m in the very initial stages of this deal, and I’d like continue the thread to the conclusion of the deal, and hopefully the first month or two of operations if I buy the property so you guys can tell if it was a deal or a bust.

This deal was brought to me by another investor that I know. My friend knows a guy that knew the seller. My friend, like me, buys mobile home parks, but he focuses on larger properties than I do, so the tossed this one my way. I likely wouldn’t have been interested in it except that its only like 20 minutes from my house.

The property is a mixed use property. It has a 6-unit motel, 6 RV hookups, a 5-plex, and a 20 unit mobile home park. I heard that the seller is dying to sell the place. That piqued my interest obviously. So I gave the seller a call and got the scoop. He bought the property 8 years ago with cash. He spent some time renovating mobile homes, etc, but overall he was not interested to continue to run the place. He decided to lease-option the property to some random lady from his church with no RE experience. You can imagine what happened. He ended up taking the property back and then lease optioned it to another guy with no RE experience. That guy ended up being a drug addict and allowed the place to get into disrepair. Eventually the place closed completely, and was recently reopened by the seller.

The property is distressed. The mobile home portion of the property is worth basically nothing considering that 15 of the 20 mobile homes need to be hauled off and trashed, then replaced by new homes. However, there is a huge upside potential from bringing in new homes. The motel and 5-plex are actually in great condition. The property is in a bad area and will likely bring in mostly transient tenants. However, there is a factory about one mile away that employs 300 workers. There is also an airport about a mile away that employs lots of people.

Another problem is the fact that I’ve never owned a motel before and I don’t really know how they are best run. This is not insurmountable, but it is a consideration. On the other hand, how hard could it be to manage 6 motel rooms?

The seller wants $300,000 for the property. The 5-plex is rented at $2900 per month, and the motel rooms are currently all rented at $550 per month. I’m not really sure how to guess at expenses for the motel. I spent some time online trying to get some ballparks, and I found a range of 45-55%. I assumed 70% expenses for the motel, and 45% on the apartments. On the expenses, I’m making an educated guess.

Hotel = $3,300 – 70% = $990 NOI
Apts = $2,900 – 45% = $1,595 NOIT
Total NOI = $2,585, or $31,020 annually

Now, starting at $2,585, we can easily figure out if the price of $300,000 is within the ballpark of reasonable. Here are some purchase prices at various cap rates:

10.34% CR = $300,000 ; (31,020 x 10 = 10% CR)
12% CR = $258,499 ; (31,020 x 8.33 = 12% CR)
15% CR = $206,903 ; (31,020 x 6.67 = 15% CR)
20% CR = $155,100 ; (31,020 x 5 = 20% CR)

Right now I’m thinking that I’ll make three different offers that reflect my risk in the deal. I have to wait to get some financials before I make the offers, but here is the skeleton of what they’ll likely look like:

Offer 1: $155,100 cash (20% cap rate)
Offer 2: $206,903 (15% cap rate), $20,000 down, seller carries $186,212 at 6.8%, $1213 per month, 10 year balloon
Offer 3: $280,000 lease option (11.07% cap rate on purchase price). $10,000 option price, $1500/month, with $1000 per month credited toward purchase price.

The income numbers above don’t even consider ANY of the current MH park income (which amounts to about $1400/month currently). So basically, the numbers above would allow me to buy the property at a great price, make money from word go, and create quite a lot of upside by improving the MHP side of the operation. The MHP side could bring in another $2,000-$3,000 gross per month just on lot rent.

I’ve requested the following information from the seller:
Tax returns - 3 years
Annual profit and loss statements for 5 years
Two years of monthly P & Ls
Balance sheet for 3 years
Rent roll including term, deposit, payment history
Payroll register - all employee names, position, wage, entitled benefits (including free rents)

Appreciate any comments, ideas, questions. I’ll try to keep you guys posted, but maybe nobody cares…

[Tien]

There isn't really much to add in terms of advice, but I have a few questions.

I have zero experience with mobile home parks and motels. What kind of a motel is this? A month long motel rental? I don't really see any of these in my area.

How would you proceed to run the mobile home park area? Trash the homes, and then advertise to lease the land to people who own mobile homes?


What's the population of the area? Low income housing?


Your 3 offers are absolute steals. Overall this is a killer deal, the 5plex / motel income is already worth the price you're paying for the property and what you do with the mobile home is just icing on the cake. Awesome work.

[Tien]

Did you tie up this property yet?

I'd get over to the owner ASAP and work up some sort of purchase and sales subject to all the documents being furnished to your satisfaction.

I don't know why you are waiting for more documents to make your offers. I wouldn't.

Last question, is the motel self-managed?

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I have zero experience with mobile home parks and motels. What kind of a motel is this? A month long motel rental? I don't really see any of these in my area.

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Its basically an older mom & pop type of operation. Basically just a little roadside motel. The seller has been renting it out for $155 per week or $550 per month. The rooms are all kitchenettes. The road its on is high traffic, but like I said, in a bad area of town. It was probably originally intended to cater more to nightly guests, but the deterioration of the area likely forced it into a more extended stay situation. Not really sure though.

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How would you proceed to run the mobile home park area? Trash the homes, and then advertise to lease the land to people who own mobile homes?

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I would salvage what homes I could and sell them. Whatever homes I trash will have to be replaced, and I'll have to foot the bill for bringing in new homes. These days nobody that is willing to live in a mobile home has the cash to buy one and have it hauled in. I'd buy, haul in, and resell them on a note.

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What's the population of the area? Low income housing?

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Its in a city of about 300,000. There is the possibility to replace homes and rent them out rather than selling them on notes. But frankly, that is too much management hastle, IMO, and the cash flow isn't that much better. However, I could get Section 8 approval on the homes and rent them that way. They'd stay full, thats for sure. Its a possiblity.

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Did you tie up this property yet?

I'd get over to the owner ASAP and work up some sort of purchase and sales subject to all the documents being furnished to your satisfaction.

I don't know why you are waiting for more documents to make your offers. I wouldn't.

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Yeah, I know, but something is making me hesitate. The deal seems a bit too good to be true which is why I want to see everything up front before making any kind of committment. The thing that I keep coming back to in my mind is that the property has been lease/optioned twice and neither person made it work. Somehow I just can't figure how that would be possible unless the payments on the least agreement were ridiculously high or something. I dunno, I just wanted something a bit more. I should probably just get it under contract. I know you're right.

Edit: Part of it is that I want to verify the motel income. All the rooms are full now, but I want to be sure that they're STAYING full all the time, or at least have a reasonable vacancy rate. Seller claims that the rooms are always full, but sellers tend to ....well....lets say exagerate. Since the motel income makes up so much of my gross, I wanna be sure that the income is correct.


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Last question, is the motel self-managed?

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There is a manager in place that oversees the entire property. She gets a free apartment and $600 per month. I don't know what kind of job she is doing, but the place seems like its kept up very well. The manager has a decent situation for herself, and I'm sure that she'll want to stay on. I haven't asked her yet though.

[Tien]

Well, I would probably be sitting with the seller either tomorrow or at the latest Saturday morning and pound out all the details.

Dying to sell is a good word and enough of a good word to proceed.

I'd iron out an agreement and make it subject to whatever the hell you want.


Have you spoken with the manager yet? I think this is the KEY person you need to speak to ASAP to find out whats going on. Also knocking on tenant's doors and talking to them directly is something I often do. You will be bound to find one honest tenant in there that will sing the entire story of the property.


Another thing. What's your exit strategy?

If he accepts cash, do you flip or keep?


I like the owner finance approach but why are you voluntarily giving him 6.9% interest? Since when does a motivated seller get to have 6.8% interest?

[Tien]

Normally when I make them take back a mortgage, I just assume not payments and no interest.

When they ask for payments I say "How much do you need a month?"

Then I'll negotiate that part down.

If they ask for interest, I'll say:

"Interest? Why do you need interest for? Are you a bank?"

"Do you want to sell or do you want to be a bank?"

"The most I can give you with interest is what a bank would give you, or else it isn't fair"


The fact that he leased this property out to a bunch of idiots TWICE makes me think this guy is not really savy and you can get a really good deal out of him.

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Another thing. What's your exit strategy?

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Yes, this is the biggest problem with the deal that I can see. I would buy this with the intention to hold it long term since it would be such a good money maker each month. The problem that I can see is that the area is such that any future investor that is serious will recognize the inherent tenancy issues with the property. I've got two sex shops accross the street and a strip club about 2 blocks down. Not really conducive to a family environment. Tenancy is likely to remain highly transient. Most of the time I like to buy mobile home parks that can be made into communities. Thats not an option for this property. Any serious investor will immediately see this problem.

Another problem is that I think that its going to be kinda tough to find a bank that is interested in financing the property given its mixed use. Plus, most serious investors will probably not like the mixed use anyway. These issues highly limit the pool of future buyers that will be interested in the property. This is a very difficult issue, and I'm still not really sure of the answer.

In sum, I know that I'll keep the property long term. I just don't know how I'm going to be able to sell it later on.

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If he accepts cash, do you flip or keep?

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I'd keep it for income. See above.

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I like the owner finance approach but why are you voluntarily giving him 6.9% interest? Since when does a motivated seller get to have 6.8% interest?

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mmm...good point, and normally I would agree. Actually, I considered this issue and decided to offer the interest in order to better differentiate the lease/option offer from the seller finance offer. All the offers are good, but the offer I want him to take is the lease option. I can make the most money with the least risk with the l/o deal. Would you disagree with my thinking?

[Tien]

Looks like you will be a slum lord. Always good deals in slum areas.....


What are the neighborhood problems? And shootings? Violence? Crime?


Considering the fact that he has been burned TWICE before by lease option buyers, it may or may not be a hard sell. The 2nd option is the owner finance option which I like the most since it would give me absolute control over the fate of this property and what happens down the line.

I normally don't like to have any strings attached to the previous property owner.

[Tien]

Either way, with the price you are buying these things at, meaning IF you get your price, it's a steal regardless of any offer / option you pick. It almost doesn't even matter.