Re: Which of 2 MHP’s do I buy?? Help! - Posted by ray@lcorn
Posted by ray@lcorn on December 29, 2002 at 20:24:26:
Brian,
The missing piece here is financing. What type of debt structure are you going to use on either of the parks?
I can make some assumptions and show you one way to look at the deals.
The first assumption is the biggest… that the NOI on each deal is correct. Be sure to verify the income and expenses.
Next is the finance piece. For simplicity’s sake, let’s just say you’re getting twenty year financing on either deal at 8%, at an 80% loan to cost (LTC) ratio. However I do this with the caveat that changing the debt terms can greatly change the returns. You may do better on rate, but probably not on amortization term. The 80% LTC is fairly aggressive, and you may get hit with a 75% LTC, but can counter on the second deal if the seller will take a 5%-10% second.
It’s a given that your minimum equity will be the proceeds of the 1031 since you have to trade equal or greater in debt and equity. That provides the 20% down on the first deal. However I don’t know how much debt you had on the relinquished property, and that could affect whether or not these deals meet the 1031 requirements.
On the first deal, you can close with the 1031 proceeds alone. Rounding the equity to $100T, that leaves a $400T loan. At the above terms, the debt service is $40,149. Deduct that from the NOI of $65,300, and it leaves $25,151 (25%) as a pre-tax return on your investment prior to the investment in deferred maintenance and turnaround costs (vacancies). My guess is that while it will pencil to a 25% pre-tax return, it won’t be anywhere near that for the first couple of years. (Depending on how fast you initiate the turnaround, the return could even be negative the first year. This is okay if it is planned for.) Also, you’re signing on for a lot of work to upgrade the park. The potential spaces are another deal of their own, and I won’t try to account for them here now. Long term, I think this deal could be the proverbial goose with golden eggs for someone who has the time and temperment to develop it to it’s potential.
The second deal is likely going to take most of your extra cash as well as the 1031 proceeds. Assuming you can get the financing done with $200T down, the debt service will be $80,298. Subtract that from the NOI and it leaves $35,390, or about 18% pre-tax on the $200T investment assuming no deferred maintenance or problems with the property systems. The nice part is it is on autopilot. While the upside will be limited to the increased value as with normal rent increases, the work is relatively easy. That’s not a bad return at all for a stable property.
So it comes down to either deal looking like a good investment. The question becomes what your goals and desires are. If you’re looking for a good supplement to your full-time career but a hands off investment, then you may go with number two. If you’re looking for an eventual no-job scenario and want to be in real estate full time, then the first deal may be the better ticket.
The most accurate way of determining the best of several competing deals over the long haul is to run a complete Internal Rate of Return (IRR) calculation for the entire holding period, accounting for capital investment, income taxes and the eventual sale price. That is too complex to go into with the time I have tonight, but if you’ll search the archives you’ll find a number of posts on the subject. Even IRR has limitations (and one fault) though, and cannot answer the basic question of what your long term goals are. Only you can do that.
Thanks for the post, and let us know what you decide!
Best of luck,
ray