From the desk:Mobile Home Parks (Capital Scale)

Roll my three parks into a platform, or take cash? I can't price the units.

An operator running a roll-up wants my three parks. 214 lots total, all tenant-owned homes except 19, in-place NOI $712k. I'm in for $2.9M all in including the water plant rebuild I ate last year.

Cash offer is $8.4M, so a 8.5 cap on in-place. Their preferred structure is $3.4M cash at close and $5M in units of the platform LLC, five year lockup, no redemption right, pro rata distributions after a 7 percent preferred return to the fund investors who came in ahead of me.

Their pitch is that they trade the aggregate at a 5.75 to 6 cap because it's 4,000 plus lots with a management platform on it, so my $8.4M becomes something like $12M inside their portfolio and I ride that up. On paper I like it. I've done nothing but thin-margin flips and a few park buys and this is the first time somebody's offered me the spread instead of a price.

What I can't get comfortable with. I'm being handed units at a number they set, in an entity whose debt I haven't seen, behind a preferred I don't get, locked for five years, and the whole thesis is that the cap spread survives to their exit. If I take the $8.4M cash I clear roughly $5.5M pretax and I know exactly what I have.

The partial roll is what's on my desk. Take cash on two parks and roll the third? Or is that just the worst of both.

Answer

0stephen_ok9CO2CPRO6

The number that decides this is one you haven't been given, which is the platform's unit valuation policy. Somebody sets the price at which your $5M becomes units, and unless that document exists in writing and says how, you're accepting a mark from the person on the other side of the trade.

Ask for four things before you decide. The valuation methodology for issuing units, including who does it and at what frequency. The current capital stack of the platform, park by park, with loan maturities and whether any bridge debt matures inside your five year lock. The full preferred return language, specifically whether that 7 percent is cumulative and compounding, because if it is and the portfolio underperforms, the accrued pref sits ahead of your units and can eat your whole position at exit. And the dilution mechanics on future raises, meaning whether they can issue new units or new preferred at prices that reset your share without your consent.

On the cap spread. It's real. Portfolios of 4,000 lots with in-house management do trade tighter than a 214-lot cluster. But the spread accrues to whoever owns the platform equity, and your units only capture it if they're issued to you at the standalone price and marked at the portfolio price. If they issue you units at the aggregate valuation, you handed them your spread and took the risk.

A partial roll isn't the worst of both. It's how I'd do it if the answers come back thin, because it caps what you can lose to a mark you can't verify. Contributing property for LLC units has real tax consequences that depend on the entity and the debt allocation, so price that with your CPA before you sign anything.

6 replies

1raj_mehta14CapitalPRO6

Dumb question maybe, but why isn't a seller note the middle option here? You get paid over time, you're a creditor instead of behind a preferred, and if they blow up you have a lien on the parks you used to own. I don't understand why anyone takes illiquid equity in someone else's platform when they could take paper.

2Rena Expert

@vellum's point and @meridian's point are the same point from two sides. Your position in the capital stack determines what you're actually being paid, and the units put you at the bottom of it.

The assumption the whole rolled-equity case rests on is that the cap rate spread between a 214-lot cluster and a 4,000-lot platform persists at their exit, and that you get issued into it at the small-portfolio price. Institutional bid for manufactured housing has deepened over the past decade, which is what creates the spread, and the sector's structural characteristics support it, roughly 35 to 45 percent operating expense ratios against 50 to 65 for apartments plus turnover costs that a resident measures in thousands of dollars to move a home. Those characteristics are why the aggregate trades tighter. None of that guarantees the spread is there in year five, and none of it protects you from a cumulative preferred accruing ahead of you in a flat year.

On the $8.4M itself, 8.5 on in-place for 195 tenant-owned lots plus 19 park-owned is a market-shaped number rather than a gift. Test it by asking what they underwrote your rent to. If their model takes your lot rent up meaningfully in year one, they bought future NOI at your current cap, and the spread you're being invited to share is partly your own rent push.

A seller note changes the question to credit risk on the platform, which you can at least underwrite from the debt schedule. Whether a note, units, or cash is the right structure for you turns on tax and on the enforceability of the documents, and both need your own CPA and counsel.

3dpatel_reCS4A

Run the spread arithmetic before you weigh anything else.

$712k NOI at 8.5 is $8.4M. At 6.0 the same NOI is $11.9M. So the raw spread on your contribution is $3.5M. Your units are $5M of a $12M-ish value on your assets, which means you're rolling 42 percent of your own park value and taking, at most, 42 percent of the spread, call it $1.5M, over five years. That's roughly 7 percent a year on the rolled piece, before the 7 percent preferred to investors ahead of you, before platform fees, before any dilution.

So the honest comparison is $1.5M of upside over five years, subordinated and illiquid, against $5M in hand now that you could deploy at 8.5 caps yourself. If you can buy another park at an 8 cap with that $5M, the roll has to beat that plus liquidity, and I don't see it beating that unless they're issuing you units at the standalone cap. @meridian is right that this is the question.

One more thing your numbers hide. NOI $712k on 214 lots is $3,327 a lot, which suggests average lot rent somewhere around $430 to $460 with your expense ratio. If you're already at market, you don't have the value-add lever the platform is selling to its own investors, and they're buying stabilized cash flow from you at 8.5 and marking it at 6. Nice for them.

2bmoreno23AB1B

Half of this was new vocabulary to me. Is a roll-up just buying a bunch of small companies and selling them together for more than the sum, and the extra value comes from being big? Because if that's it, I don't understand where the extra value comes from other than buyers being willing to pay more for less work.

1jessreyes12AU1APRO8

@ember that's basically it, and the extra comes from a buyer at that size needing one transaction instead of twenty and getting professional management with it.

@flint the thing I'd want in writing, and I say this as the person who asks the obvious stuff, is whether the platform can call capital from you after you're in. Some of these unit structures include an obligation to fund pro rata on capex or debt paydowns, and if you decline, your units get crammed down. You'd be in a position where you sold three parks and can still be asked for money. Ask them straight and get the clause number.