My friend and I were looking through a group of very low end mobile homes in a rural setting. These homes were for sale dirt cheap but had great cash flow numbers to back them up. How great? On the order of 60% cash on cash return before expenses. I say before expenses because the guy who was selling the homes had no real records to speak of. Just a hand written rent role on the back of an envelope. It appeared to be the kind of thing he may have whipped up ten minutes before we got there so that he had something to show us.
It was clearly not enough to gather any sort of fiscal assessment.
The best I could do was to take a reasonable guess at what the expenses might be and interview a few tenants to see what they pay for. I wasn’t really interested in using these as rentals, but instead my idea was to start getting tenant buyers into the mobile homes. Instead of $200/month in rent, I could likely get $1000 down and $300 per month for someone who wanted to buy the home.
Since the buying mindset is different than the rental mindset, I could also make the new tenant buyer responsible for maintenance. Homeowners always take care of their own repairs, but renter will look for the landlords phone number at the first sign of a problem.
The opportunity, something you should always be looking for with a real estate investment, was that I thought I could increase the income and nearly eliminate the expenses by getting in “Buyers” instead of “Renters”
I then asked the seller how much money he was holding for security deposits. I use this seemingly innocuous question to verify how much income he is actually getting, as landlords typically set the security deposit at about one months rent. I also ask “so security deposit is usually one month’s rent then?” as a follow up question later on.
What he came back with surprised me:
“I just use the security deposit from the guy who moves in to pay off the guy who moves out.”
It was a great example of the old phrase robbing Peter to pay Paul. Of course, you can see the problem with this – what if you can’t find a new tenant?
It also told me that he was running his business really tight, or possibly had the habit of blowing any cash he got in his hands.
In my mind security deposits are funds that you should never touch, but instead set aside in a separate account. By spending the funds he was supposed to hold this guy was breaking a level of trust that could get him into trouble later.
If , for any reason , you find yourself dipping into the security deposit’s you are holding, it is a warning sign that your business, and possibly your moral fiber, is in trouble
We eventually passed on the group of mobile homes, mainly because there was too much deferred maintenance and they were a bit too far from where we like to operate, but the lesson has stayed with me.