Warning: When The Seller’s Promises, P&L And Tax Returns Don’t Align By Frank Rolfe

After having reviewed hundreds of mobile home parks in due diligence, you eventually realize that many park owners tend to have three different sets of books: 1) their Profit & Loss statements 2) their tax returns and 3) what they tell you the financial performance has been. And while it's uncommon to find all of these being equal, there are some cases in which they are lightyears out of alignment. And that can be a warning sign flashing "danger ahead".

The potential reasons behind the lack of alignment

Nobody is perfect, so it' not a reason for uproar when the numbers are slightly askew. But where things get dangerous is when the numbers are off by huge margins. For example, let's say that the seller tells you on the phone that the park makes $100,000 per year of net income. But then, when you get their Profit & Loss Statement it only shows a net income of $60,000, and then their tax return (if you can get it) shows only $30,000 net income. Which do you believe? Well, it would seem to make sense that the report the seller is least likely to "cheat" on would be the one that has the greatest penalty, and that's the tax return. But, if that's the case, then you'd have to run the numbers and purchase price based on only $30,000 of net income. Sometimes there are legitimate reasons for the numbers to be out of alignment including:

• Not taking into account depreciation or cap-x items that would not really be a reflection of true net income.
• The seller talking about "going forward" performance based on a recent rent increase, for example, while the P&L and tax return is based on "looking back" numbers.

But the truth is that large differences are often a sign of something worse than simply accounting.

What it suggests about the property's potential

When the mobile home park has essentially three different performance numbers, it definitely will cause big problems. Of course, the big concern when the numbers don't match is the impact on the true value of the property. As income properties, mobile home parks are defined by their true net income, and even 10% hits to that impression can mean proportional jolts to the price. And many of these alignment problems yield far greater than 10% adjustments. It can often a huge deflator of excitement on the part of the buyer, who suddenly realizes the initial numbers given by the seller overstated the property's current performance and future attainment, as well. It's certainly never a good thing.

How this will impact the deal

One of the huge potential pitfalls of the revelation that the numbers don't match is the impact on financing. Banks are not risk takers – they have no reason to do so. They have no equity in the property nor do they share in the upside. All the bank can hope for is return of its principal plus interest. As a result, many banks will be immediately concerned when the numbers don't align. They additionally have worries that the seller is not being forthcoming and, as a result, other items (such as the rent roll) are also being misrepresented. This can spiral into a situation where you can't get the type of debt you were hoping for and this alone may render the deal not of your liking.

How to solve this issue

The first thing you should do when the numbers don't align is to immediately notify the seller of this issue. Some sellers are hoping you won't catch it and, as time goes by, they begin to assume that they have sidestepped the issue. Instead, you need to immediately call and/or email them and say "hey, your actual performance numbers don't match what you told me." And then you need to figure out what you are willing to pay after this revelation. It's almost certainly going to result in a renegotiation of the price. But even then, you still will need to build a narrative of why they don't match to alert the bank. And, of course, it may also mean that the seller will have to carry the financing as large number aberrations will probably scare away many banks.

But don't over-react on small misses

"Perfection" is rarely a part of the "trailer park" vocabulary and it is not uncommon to have minor difference in the alignment of these numbers. Do not despair! If the seller says the park made $100,000 last year and the P&L and/or tax return says $98,000 that's not going to sink the ship. You still need to understand why there is a discrepancy but it's not going to probably require renegotiation or kill your ability to find a loan.

Conclusion

Just like your car, alignment problems are pretty common when it comes to mobile home park financials. And, just like your car, the magnitude of the issue can range from catastrophic handling ability to issues so small you can't even notice them without a computer. Just stay vigilant and make sure that you watch for these issues and address them promptly.

By Frank Rolfe

Frank Rolfe has been an investor in mobile home parks for almost 30 years, and has owned and operated hundreds of mobile home parks during that time. He is currently ranked, with his partner Dave Reynolds, as the 5th largest mobile home park owner in the U.S., with around 20,000 lots spread out over 25 states. Along the way, Frank began writing about the industry, and his books, coupled with those of his partner Dave Reynolds, evolved into a course and boot camp on mobile home park investing that has become the leader in this niche of commercial real estate.