Same market, two parks: 6.5 percent cap on city utilities or 8.75 on a private water plant

Question

Two parks came across the same week from two brokers, twenty minutes apart in the same county. I'm nowhere near buying either, I'm trying to understand the spread.

Park A, 52 lots, city water and city sewer, individually metered in tenant names, all tenant-owned homes. Asking price puts it at a 6.5 percent cap on numbers I mostly believe.

Park B, 61 lots, private well with a small treatment building and a lagoon system for sewer. Same lot rent, similar home quality, five park-owned homes. Asking works out to 8.75 percent on the seller's numbers, and the seller's numbers include $0 for operator licensing and $2,400 a year for testing.

The spread is 225 basis points. On roughly $190k of net income that's a price difference of about a million dollars, which is a lot of money to pay for not owning a well.

Case for paying up on A: the utility is somebody else's capital problem, the exit buyer pool is much bigger, and lenders and institutional buyers are calmer about it. Case for B: you're getting paid 225 basis points to run a plant, the operating cost is knowable if you actually price it, and a private system means the city can't hand you a $300 a lot connection assessment. Private plants also mean you control the water and you're not exposed to a municipal rate hike passed through to residents.

What I don't know is whether 225 is the right number for that swap or whether the market prices it at 400 in a bad year. Where do you come out?

marcus_hale41 · Answer

I've done due diligence on both shapes and I voted for the third option, because the discount is only real if you know what the plant costs to replace, not what it costs to run.

Running costs on a small well and lagoon system are boring and knowable. A licensed operator on contract, testing on whatever schedule the state requires, power, chemicals, pump repairs. In the deals I've seen that has landed somewhere between $18,000 and $40,000 a year for a park that size, so the seller's $2,400 is fiction and the licensing line at $0 tells you he's either doing it himself under a license or he isn't in compliance. Find out which, because the answer changes what you're buying.

The number that decides it is the replacement figure. A new well with treatment can run several hundred thousand, and a lagoon that fails its permit limits can turn into a mandated connection to city sewer, which is the one outcome that eats the entire discount and then some. So I want three things before I price it: the last five years of compliance reports and any notices of violation from the state agency, a licensed engineer's opinion on remaining life for the well, pumps and the lagoon liner, and whether the city or district has a plan or a moratorium on extending service to that parcel.

With clean reports and twenty years of life, 225 basis points is fair to generous. With one notice of violation in the file, I'd want 400 and an escrow, and the compliance and permitting rules here vary by state and sometimes by county health department, so confirm the specifics with an environmental attorney in that state rather than with the broker.

jordan_ellis2 · Answer

The five park-owned homes on Park B are what jump out at me here, since the cap rate is probably counting lot rent plus home rent in one line. If you strip the home rent out and cap only the lot income, the 8.75 gets smaller before you've said a word about the well. @canton, does that usually show up in how these are marketed, or was I just handed a bad rent roll once?

Same market, two parks: 6.5 percent cap on city utilities or 8.75 on a private water plant

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