I have about 20 years of full time landlording under my belt – not saying I’m a big time player – I’m not, but I have been around the block a few times and have had much more success than failure.
I’ve owned just about everything except MHPs, but for a long time now I have been eyeing them with envy. Looking in from the outside, they look like they have the best features that real estate investing has to offer, but without any of the big drawbacks.
What I see as attractive about MHPs as opposed to apartment buildings, is you are in the land leasing business and not so much in the major headache business of constantly repairing your units. People just don’t treat things that they rent as well as things that they own (and I’ve noticed most low income tenants don’t even treat what they own all that well.)
So when I read the 10/20 Investment System book (one of the best RE investing books I have read – thanks for writing it guys) I thought the lesson learned of not having any park own homes wise.
But now it seems selling off park owned homes and bring in homes and selling them off does not work anymore because of SAFE. This puts you back into the business of constantly paying for and cleaning up the path of destruction that low income renters often leave behind them.
I understand that you make the non-capital maintenance issues the responsibility of the tenants, but in my experience most will never do it and you will be stuck with the mess and destruction when they move out.
Am I wrong about this? Does SAFE change everything? I am very interested in your thoughts.
SAFE changes nothing. The only thing it changes is the business model in which you put a tenant in a home. If you want to fill a lot, you have to bring in a home – that’s a fact. To put someone into the home, you have to have a monthly amount they can afford (normally around $495 to $595 per month). So do you call that monthly payment rent or mortgage? The business model is identical – the tenant either pays rent or runs off. The only concept that changes is repair and maintenance on the home. You can do a triple net rental, and the tenant pays 100% of the repair costs. Or you can do one in which the tenant pays all of the small items (ours is set at a $100 and under level) and the park owner pays all the big ticket items (like AC, etc.) There are some interesting side effects we are finding under this plan. One is that we get things fixed in the house before they fester into giant losses. As an example, if the water heater bottom rusts out (which is more than a $100 repair) then the tenant immediately calls us and we replace it before it destroys all the floors and walls (and potentially grows black mold). Under the tenant pays all repair model, the tenant, in this case, would do nothing since he can’t afford it, and the $500 fix becomes $5,000+. The other big benefit has been in tenant retention. People seem to stay longer and pay rent more timely when they have heat, AC, and a roof that holds back the rain. Every time we keep a tenant in the house and not suffer a “churn” we save thousands on the cost to renovate, market and get a new tenant in the house.
Here’s the biggest issue – which has nothing to do with SAFE – and that’s the out-of-control problems in foreclosure today. On a rental, I can get the tenant out on a non-payment eviction in probably 30 to 45 days; no muss, no fuss. In a foreclosure, you’re talking thousands in legal bills potentially, and not getting the tenant out for 6 months or more (if the judge is a stickler). Even if SAFE ended today, WE WOULD NEVER GO BACK TO SELLING AND CARRYING PAPER. That business model, in our opinion, is dead, thanks to the the changes in case law on the process as a result of “robo-signing” and other carryovers from the sub-prime mortgage melt-down in single family homes.
We have been strictly renting for quite a while now, and it’s working fine. But then again, we always were theoretically, but we just had a different label on it. Getting people in houses at $495 or so per month is the important step, not who ends up owning the home a decade into the future.
If I read your response correctly, due to regulatory issues you’ve had to move more to a renter of park owned homes versus strcitly a land lease model. With your NNN lease, or large cap repair version lease, do you still find you’re breaking even on the home rent and making your actual return from the lot rent, or have you found that you are actually able to acheive a margin from the home rental? If you are able to acheive a margin from the home rental portion, roughly what %?
We value every home at what we have in it, and the goal is to recoup that investment. That being said, our model is to break even on the home portion – not including lot rent – and retire that investment internally over a period of years. In some markets, that’s not too difficult, as the tenants pay on time, don’t run off, and keep the property in good repair (example: Wisconsin, Colorado and northern Illinois). In other markets, the tenants do not perform as well (such as Oklahoma) and we have to fight to break even. However, it all works out because we always have the lot rent to fall back on. Unless we bring in a home, our net income from a vacant lot is zero. If we bring in a home – even thought it’s not part of the budget – we get a nice buffer of lot rent of, on average, about $250 per month. This is the key difference between doing what we do and being a Lonnie dealer. The Lonnie dealer has no safety cushion – he has to pay a monthly lot rent and survive on what’s left over. The park owner has the lot rent as cushion, and the value of the occupied lot as additional cushion and incentive to bring in a home. This unfair advantage is why we only do Lonnie deals in parks that we own. Do we make much profit on the homes themselves? Not really – that’s not our goal. We only care about the lot being occupied. But if you want to look at good, historical analysis of the home-only business model’s profitability (or lack thereof), consult the financial statements of ARC from the days when they were public, as they separated out the homes from the lots, and showed on a large scale how that model performs (hint: it wasn’t very good).
You’re correct about RTO, but the original question also addressed the concept of selling the home and carrying the paper on the sale with a small down payment (the classic “Lonnie” deal). That’s the construction that requires foreclosure when the tenant does not pay.
We are finding no greater defaults under a rental system with limited repair exposure, than we did with either RTO or carrying paper. But I cannot emphasize enough that the actual results will be hugely contingent on where your park is located and the quality of customer that you have.
We are shooting for a payback on investment in around 3 to 10 years, not including the lot rent portion of the payment (if you add that in, then the length falls by almost half). 10 years is reserved for brand new homes.
Our budget for each park is based on the value of an occupied lot. For example, if the lot rent is $250 per month, and the park pays the water and sewer, then our maximum home budget is $250 x 12 x .6 x 10 = $18,000, which would mean that we’re only going to buy repo’s for that park. We do this so that,if we had to give the home away for $1 we’d still be OK financially. We’ve been using that as a top-end governor for years. However, we do have some room in that number if the home is being used to aesthetically enhance the park (such as placing a brand new home at the entrance).
If I understand correctly, the reason for purchasing the home is to improve the value of the park and not to improve cash on cash returns. Relating to your above example, any cost below $18k is a net return upon sale of the park. The negative aspect seems to be the lack of return during the break even period. 3 to 10 years of zero return on investment is pretty tough. If you had numerous lots to fill, that could tie up a lot of capital for a zero rate of return.
It does not need to be zero – you can actually pay out a decent rate of return and be O.K. But the real money is in the park and not the homes. It always has been and it always will be.