Interest rates are up nearly double from all-time lows, and even though mobile home parks have a very low loan default rate, distressed deals still hit the market on a regular basis. In this Mobile Home Park Mastery podcast we're going to explore the correct way to approach buying failing deals.
Episode 459: The Distressed Deal Playbook Transcript
It's absolutely true that mobile home park deals rarely fail. We have the lowest default rate of any form of American real estate. While apartments right now are doing terrible as far as distress, roughly about 8% are in loan default, if not more. In our industry, it's less than 1%. But less than 1% is still greater than 0%, so we still have distressed deals from time to time in the mobile home park industry. This is Frank Rolfe, the Mobile Home Park Mastery Podcast. We're gonna talk about distress deals, where they come from, how to pursue them, things to avoid.
So what causes a mobile home park to go into distress? Well, lots of different things can happen. Fundamentally, it means you're not paying the mortgage. But why are you not paying the mortgage on that mobile home park? You intended to do it when you bought it. Well, often it's just a fact of non-performance. People missed their goals of raising rents or filling lots. But there's other things behind the scenes other than just economic issues that can cause a park to go into distress. You can have things like the permit expired and no one ever bothered to check it out in due diligence. Or maybe it expired because the current owner, well, they didn't know or remember to renew it.
Also, you could have private utilities that are broken and you can't get those fixed. That can cause for real problem. Maybe you're having issues, tying back to the private utilities, of the EPA fining the park or shutting the park down because it's not running properly. Or maybe the borrower themselves got in trouble on something entirely different, nothing to do with the mobile home park. Maybe they bought a really fancy multi-billion dollar mansion and then defaulted on that. Now they're no longer creditworthy and they can't get the loan renewed, which is called a term default. But for any number of these reasons, it's always possible at any given moment for some mobile home parks to get crosswise with the bank, to go into default.
So then what do you do when you find a deal that's in default? Well, the first thing you could do is you could simply buy the note from the bank and not buy the asset, just the note, and then foreclose on the note. Now, you'll get a huge discount if you offer that, but here's the problem. All that borrower has to do is to declare bankruptcy or file a lawsuit and they could tie that park up in court for years and years. I've spoken many times about the fact that the American legal system is completely dysfunctional, doesn't really work. So as a result, you buy the note and sure, it's non-performing and sure, you can foreclose on it, but in the American legal system, common sense has left the building decades ago. It's very possible, even though the person is not paying their mortgage payment, never will, has no intention, they can still tie it up. And that's why most people won't buy the notes on mobile home parks that are in default.
But here's a trick on how you could. If you can get that borrower to sign a deed-in-lieu of foreclosure, passing the park on to you, that absolves you from having to go into foreclosure. And you might say, "Well, why would they do that?" Well, you have to give them something for that. And typically what you give them is you erase their personal recourse. A lot of lenders on a case like that where the borrower is in default, they can go after them for any loss personally. And you would think they would say, "Well, gosh, we'll drop that recourse thing if that's what it takes to get the park given back to us in deed-in-lieu." Many lenders won't do that, though. They figure that to be immoral or against their customs and traditions, and they won't do that.
But that's one way you could try and go about a deal is to buy the note, put it under contract, then to go to the borrower, try to get a deed-in-lieu. Another way is to buy them at auction. They come up on different auction sites, auctions.com, things like that. And then you're bidding against others. The problem when you buy it at an auction is you have to put down 10% the day you win and the other 90% within 30 days. It's really hard to get a loan on anything completed and in the bank within 30 days. Another thing you can do on a distressed deal with a bank is just try and assume the note. So see if the bank would do a zero-down deal, swapping a note that's in default for a new borrower and a note that's not in default. And sometimes that can work. We've done things like that before.
And then finally you can buy it the old-fashioned way, the traditional way, typically from a broker who has the listing from the lender of the deal that's in default, and then try and buy it the old way with a due diligence period and a financing contingency and all that great stuff. Now, what do you watch out for on a distressed deal? Well, the big thing to watch out for is things you can't fix. If you're in the turnaround business like most of us are, you gotta buy things you can turn around. And there's some things you can't fix. For example, you can't fix a complete absence of demand. Possibly that buyer did not do a test ad or any market research and bought a mobile home park in an area where nobody wants to live. And therefore you will not do any better than they will at filling those vacant lots. Or maybe the deal has got too many Lonnie dealers in it and the Lonnie dealers are threatening to pull out and so the buyer has given up hope. Or maybe they've already started suspending payments.
You can't really fix that unless you buy it so cheap that you just assume the Lonnie dealer will pull all of their homes out. Maybe you've got failing private utilities you just can't fix. Maybe you've got an old lagoon that's failing, but they won't let you put in a packaging plant and you can't connect to city sewer. Things like that do happen. Maybe you've got litigation with the city on the fact that the park shouldn't even be there. It's not legal, it doesn't have any permits. Again, not really something that you can fix. So always watch out on these deals that are failing. Approach them with the question, is it possible to fix it? Because some of these things simply can't be fixed. But yet there are some distressed deals out there that have things that you definitely can fix. One of our favorites is what's called term default.
Now, a term default deal is one in which the borrower was unable at the expiration of the note to find a replacement lender. And in some instances, it's not the park's fault. The park is fine. The park is plenty full and making money. But the borrower has lost their creditworthiness through some other thing they did and destroyed themselves, declared personal bankruptcy, and now they can't get the loan because they can't co-sign because the bank does not believe that they're creditworthy. And those are called term defaults. Those are some of the best deals you can get. And then a lot of times you see parks that are failing because they got a lot of rentals, and that's something you can fix. Convert those rentals into privately owned, even to the point if you have to give the homes away.
Those kinds of deals, typically you can construct them to work if you just put some creativity to it. Or maybe the problem is that the park has just got a whole lot of little things broken to it. Aesthetic issues, management issues, water leaks, those type of things. Again, these are all things that individually we can divide and conquer. We can fix those water leaks, we can fire that manager, we can go in and get all of those dead trees cleaned up and the mowing fixed and everything like that. Or maybe the problem is the rents are just too low. Again, if you're in a state without rent control, I can fix that, I can push those rents. We typically try and restrict them to no more than $50 annually going up, but still at that rate, if you bought a park at a 300 rent, the market is at 500, it has to be at 450 to really support itself, you can make that happen in only a few years. So if you can get it properly financed, that might be possible.
Also, if you got vacant lots and a ton of vacant lots, based on how you structure it, how creative you're able to sell it, it might be something where, if the demand is there, if you have access to the homes, you can bring in and sell a lot of homes. We've bought parks that were more than 50% vacant in the past and got them filled. We got them all the way up to stabilized occupancy and beyond. So those are things you can do. But there are some things you also have to consider when you're thinking about buying deals in distress. You have to remember that the deal is in distress, and because it is in distress, it scares a lot of bankers. Same is true with restaurants. There's an old rule in real estate that you never want to probably put a restaurant in a space where another restaurant has failed because public perception is it's, "Oh, that's a failure. That's a failure spot. It's a cursed spot." And when you deal in default mobile home parks, the first problem you'll have from most of your lenders is, "Oh my gosh, not that thing. That thing is in default." It scares people to death.
Also remember that when you're out there buying parks in distress, it is a fairly competitive business because everyone senses, like vultures circling, they can get a real deal on it. So it can be fairly competitive. Unlike traditional parks where people are just trying to get a win-win deal done, sometimes on this stuff that's in default, people really surge on those kinds of deals. They swarm those kinds of deals, and that can make it a little harder. Also, you gotta be creative on distress deals because you're gonna have to sometimes pitch crazy ideas to the seller, to the bank, to get one that will stick. So you can't be shy about making those crazy ideas. That's a whole part of creativity, is having an open mind about it all.
Also, don't forget you have this whole issue of liquidity because there may be a lot of big CapEx things needed to fix that park. For example, going back to: the lagoon is failing, packaging plant is failing. Those things can easily cost a million dollars or more. How are you gonna pay for that? But most importantly, you gotta follow your gut instinct, maybe more on distress deals than any other type. The old human fight-or-flight mentality will keep you out of trouble on a regular basis. And on distress deals more than maybe any other, you have to go with your hunches, your educated guess that you derive just out of being a successful adult. This is Frank Rolfe with the Mobile Home Park Mastery podcast. Hope you enjoyed this. Talk to you again soon.