M-H-Conversion-Primer-Part-I

M-H-Conversion-Primer-Part-I

For residents to purchase the park in which they live; and for park owners to sell their park to residents, a number of methods must be considered. We’ll discuss the first of these here:

Mutual Benefit Non-Profit Purchase

During the 1980’s, the process of converting a mobile home park to resident-owned was assisted by the passage of a number of statutory revisions and innovations. One of the earliest of these innovations was a provision which allows the residents to organize a corporation composed solely of the park residents. That corporation could then offer to buy the mobile home park from the owner, and if successful ended up owning the park in the name of the corporation.

Prior to the 1980’s when these legislative accomodations were enacted, if more than a certain number of persons owning shares in a corporation accomplished the purchase, it was considered a subdivision and required extensive administrative effort to qualify the purchase.

The statutes, regardless of the number of members or shareholders set forth a relatively simple procedure which only required a “permit” from the California Department of Corporations. The process allows a faster conversion and enables residents to organize and purchase in a time frame more akin to that which can be accomplished by the typical investor.

The actual buyer of the park is a corporation, or similar entity. That entity (“HOA”) owns the park once the purchase is completed. The members of the HOA do not own the park nor their space; rather they simply hold some form of membership and an occupancy agreement with the HOA for the space they occupy. No one is guaranteed a specific space and all persons should be treated equally as members.

Under the laws that were passed to facilitate this form of resident ownership, the memberships or shares were originally intended to be full value shares. By this I mean that the total value of the corporate purchase is divided by the total number of potential members and that is the share or membership price. An example is a 100 space park, purchased by a resident-formed HOA for a total cost of $5,000,000. The value and cost of each individual membership is therefore $50,000.

Not all persons are able to afford the total price for each membership so various purchase terms are generally arranged. Additionally, it is very unusual to have 100% participation in the purchase by all residents. To accomplish the park purchase, you might have some members who are able to pay all cash for their share (i.e., $50,000 cash); yet others may only be able to afford to put down a down-payment, or only a portion of the total membership value, and are required to finance the balance. An example (following the above) is a resident who can only afford to pay $10,000 cash towards their purchase. That resident must then finance the remaining balance of $40,000. The corporation generally “lends” the resident the unpaid balance of their membership price, and holds the membership share (and lease) as security for the repayment of the individual’s loan. There are outside lenders who are willing to make loans on the membership share as well, and a typical purchase may involve some combination of HOA loans as well as outside lenders to make up the cash necessary for the park purchase down payment.

To accomplish the purchase, the HOA entity usually borrows a significant portion of the funds needed to acquire the park from an institution (bank, commercial mortgage lender, investors), and is thereby able to make these individual loans. That institution holds a lien on the entire park. In some cases, there may be multiple lien holders, including the prior owner/seller of the park. The balance of the total price (down payment) comes from the cash paid by buyers who are able to pay the full membership price in cash, or who borrowed the funds using their home as collateral. As mentioned previously, the residents may also seek to finance their membership through outside sources. Those source generally include lenders participating in the FHA Title I loan program, or private investors.

The preferred method for handling the park operational costs is to create a homeowners dues calculated to cover the common area maintenance, reserves and where not all were members an increment of debt service. Everyone pays the same HOA dues. Those who borrowed from the corporation pay on that as a separate loan. Additionally, if the homeowner financed all or a part of their membership interest from an outside lender, they would be responsible for making that payment directly.

Typically a lending institution will allow the residents in such a purchase scenario to borrow up to 70% (in some cases, up to 80%) of the value of the park, based upon a bone fide bank appraisal. Bank appraisals often use a capitalization of income approach to valuation. This means that the net operating income is divided by some rate, and that determines the value. For example, when all of the required expenses for a year, less any loan costs, are compared to the income of the park, any positive balance for the year is then divided by a “CAP” rate and the result is the real value of the park. The banks generally use a CAP rate between .08 and .11, so if you have a park with a Net Operating Income (NOI) of $400,000 per year, the value at an “8” CAP rate would be $5,000,000. In addition to the use of a CAP rate, there are other valuation techniques but the net earnings are usually the closest to the real value, and therefore the approach generally used by most lenders.

If the residents were able to borrow 70 percent of that amount, the down payment would, of course, be $1,500,000 plus any costs associated with the purchase and loan and qualifying the corporation.

If the corporation borrowed $3,500,000 at 8% for 30 years, a monthly payment would be $25,681 per month, or $308,172 annually. In addition to having sufficient income to make the payments on the loan, lenders generally require that the net operating income exceed the loan payment amount by anywhere from 10% to 20% per month. This requirement for additional income above-and-beyond the amount required to make the loan payments is often referred to as a “Debt Coverage Ratio”.

In this hypothetical case, we have assumed net operating income of $400,000 from 100 spaces and can assume expenses are roughly 30% of the total income. That leaves net annual income before debt service of $280,000. If we assume the residents are paying rent of $476.20 per month pre-conversion, the required net operating income is achievable by actually lowering the monthly rents to $367.24, but a lender requiring a 1.2 debt service ratio would require rents of $400.62 per month to cover the debt service requirement. The lower the debt service ratio, the less the required rents to cover that ratio.

Using our same 100 space park and roughly $50,000.00 per space as the park direct cost portion of the price and an additional increment of loan fees, conversion costs, etc., you may need to charge an additional $5,000 per space or a total of $55,000 for each member’s share price.

For those with cash this may be easily accomplished, for those who have to borrow all or a portion of the money it could be difficult, since any such loans on memberships or homes are personal loans the rates are usually higher and the terms of the loan less than real property. Also there may be loan costs and fees of a fairly large amount.

Thus in our example we would require 37 residents paying all cash to raise the $55,000 per space for the down payment and conversions costs, which totals $2,000,000.00. The remainder of the members could borrow from the corporation or you could have a mix of all cash buyers and part cash part plus a loan from the corporation, but no matter what, you will need to raise $2,000,000.00 cash to close the purchase, or roughly $20,000 from each resident in the park, and not all could come up with that amount.

That is a relatively large burden and although there may be some state, county or city funds available, the residents must be able to address an increase in housing costs and raise cash to purchase the park in bulk.

Some persons recommend that the memberships be issued at less than full value for a variety of reasons; the predominant of which appears to be disguising the total costs. It is much better to properly allocate the purchase price to the total potential membership. When you are finished all members own a pro rata share of the corporation and are equal members. Thus the cost per share should be the same regardless of how a member finances his or her share.

At times members pay a lower share price, but borrow money and lend it to the corporation. That can work, but it tends to create confusion and sense of difference between the “have and have nots.” It is also unrealistic; as members may not feel they have a significant investment.

As you can readily determine, there are pros and cons to the types of purchase. The major points are as follows:

  1. High cost input required up front – by those who are members (smaller number equals higher input per person).
  2. No ready market to finance shares/memberships – now or over time for resales.
  3. House is still person’s property and financed as such.
  4. Someone also has to pay the conversion and purchase costs, which can be substantial.
  5. Rapid purchase if financing available to close escrow.
  6. Ideal for small parks as the cost to accomplish is less than condo or full subdivision.
  7. No individual ownership of the park or any part of park.
  8. Same real property tax relief as subdivision or condo.
  9. Doubtful that interest on purchase price is deductible for income tax purpose.

We’ll continue in the next installment to examine the variety of ways in which residents can accomplish ownership of their community, and acheive self-determination. Please continue to check back for the latest information.

Gerald R. Gibbs, President, The Gibbs Law Firm, APC

About The Gibbs Law Firm, APC

The Gibbs Law Firm, APC has represented clients in all aspects of Real Estate and Business Transactions for more than 33 years from its office in San Clemente. Gerald R. Gibbs, and his son David Gibbs have a combined 48 years experience representing mobile home park owners and residents in a variety of legal matters, specializing in the sale of parks to its residents. Mr. Gibbs is generally acknowledged as one of the pioneers in the field of mobile home park conversions and subdivision, having represented Cities and other local jurisdictions, park owners, nonprofit entities, resident groups, and having testified in court and before legislative and administrative bodies on the subject of mobile home parks and conversion. Mr. Gibbs has worked with other industry leaders on shaping the legislation governing park conversions. For more information about this transaction or about the firm, please call David L. Gibbs at (949) 492-3350.

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