In the CMBS “conduit” loan industry, non-performing apartment loans are up to 75% of the raw volume of defaults. While office foreclosures are massive at around $50 million to $100 million per loan, apartment loans average around $15 million so that, despite the sheer volume of apartment distress, office still makes up the bulk of CMBS debt losses. But what’s unusual is the contributing reason that these apartment loans are going into default. It’s not only collections problems, but what loan servicers are finding is that there are a huge number of apartment tenants having committed fraud in their applications. And it’s something getting very little media attention right now.
What is “tenant fraud”?
“Tenant fraud” are those occasions where the applicant for residency uses a fake ID or fake pay stubs in order to qualify under the apartment complex’s screening process. Apparently, the rise of AI and the internet has helped instruct would-be fraudsters in the methods to fake these things, as well as the quality of the forgeries. Good-natured apartment managers are not prepared to spot deep-fakes, and apartment owners are not set up to go through “mortgage-quality” screenings or their cost.
How is this impacting the apartment industry?
Due to many apartment residents not being financially qualified to rent units, the multi-family industry is currently in a collections crisis with only about 83% of rents being collected on-time nationally. But with the woke-inspired legal system, that has been waging war on landlords since the Biden administration, it’s estimated that a typical apartment eviction costs the landlord between $10,000 and $25,000 in legal fees, unit damage, and lost rent. This is hitting Class A apartments more than any other multi-family sector, as these units are not only more expensive, but the average high-end renter is simply more savvy on how to cheat at a high level.
How have mobile home parks escaped this problem?
It’s the basic construction of the mobile home park business model that eliminates the “tenant fraud” threat. While there is a tiny microcosm of the “trailer park” industry that likes to own and rent mobile homes, by far the majority is built on the “parking lot” model in which only the land is rented to tenants and the park owner has absolutely no responsibility for the homes they live in. Around 80% of mobile home park residents own their homes either outright or with small remaining mortgages – this group has no reason to use fraud as they have zero applications to fill out ever. Of the remaining 20%, these residents were not vetted using the same application system that apartments use but, instead, the more gritty and detailed mortgage underwriting system. That’s because the only way a tenant a gets in a home is by obtaining a mortgage with a sophisticated group such as Performance Equity Partners or 21st Mortgage that look deeper than a pay stub.
What will be the impact of all this apartment debt distress on the mobile home park industry?
Apartments suffer from over-building while mobile home parks do not – due to strict zoning laws that have not allowed new “trailer parks” in a half-century. And if mobile home parks weren’t already beating the multi-family business model as far as rates of return and the ability to increase rents and occupancy, this latest wrinkle on the apartment collections crisis should make even more investors begin to examine the “trailer park” sector of real estate. But that’s only the beginning. With increased debt failure, it will not be long before lenders such as Fannie/Freddie, as well as CMBS, begin to look more favorably on mobile home parks than they do towards apartments. I can envision a future in which the interest rates and terms on parks will be superior to multi-family and that means that parks will also enjoy lower cap rates, which equates to higher values.
Conclusion
The apartment industry has been getting in trouble for a while now. Massive overbuilding has caused widespread occupancy struggles as well as declining rents in some markets. And the new collections scandal due to widespread “tenant fraud” is simply the latest installment in the fall from grace of what used to be perhaps the most desirable real estate sector. Meanwhile, the lowly “trailer park” continues to climb the ladder of stability and desirability when all around it (office, retail, lodging, self-storage, etc.) has proven to be less than hoped for. Who would have imagined such an underdog victory only a decade ago?