Imagine a hole in the ground ten feet deep, with pointed stakes at the bottom. That’s something you see in movies, but it’s also to be found in the mobile home park industry. In this Mobile Home Park Mastery podcast we’re going to identify what these traps are, and how to avoid them.
Episode 464: Traps To Avoid Transcript
If you've ever had mice in your house, you've probably set a trap for them. And if you watch a lot of action movies, you'll see people even build traps for humans. They'll dig a big hole in the ground. They'll put pointy stakes at the bottom of it, hoping that you step and fall into that hole. And traps are never a pleasant thing, whether you're a mouse or a human, and we all want to avoid them at all costs, but not everyone knows what the traps are in the mobile home park industry. This is Frank Rolfe, the Mobile Home Park Mastery Podcast. We're going to talk about what some of the traps are in our industry, and additionally, if we can identify those, maybe help you avoid them.
One trap, and this is a trap that many park operators don't know until they get involved in it, is bringing in new homes to fill vacant lots, only to find that you can't get customers approved to buy the new homes, and you end up in the rental business. Now, we all know that renting mobile homes is a terrible idea.
We've been talking about the fact that renting homes is the worst thing you can do as an operator now for about 30 years. And most people have embraced this idea, and they've done it just through trial and error. They've done it themselves and found it was a horrible money-losing catastrophe and sold the homes off. So really, pretty much all park owners today want to fill their vacant lots with homes that they can sell as opposed to rent.
But the problem is that ever since COVID happened, new home prices have effectively doubled. And when you bring a new home into a lot, you're going to have to find a customer who earns probably far more than your customers make in order to qualify for the loan. And if you can't find someone who can qualify, then that home will ultimately become a rental home in your desperation to get some form of income in it. So you're actually going backwards.
You're not getting out of the rental home business. In fact, you're accelerating your rental home business, and that's not where you want to be. How do you avoid the trap? Bring in used homes. Used homes cost about half the price of new homes, which means half the payment, and that means probably around half the income necessary to qualify for the loan.
Now, here's another trap. Sometimes you go and buy a mobile home park, and mom and pop agree to carry the paper. They'll give you a seller note, but they only want to give you one for a couple years, three years. Here's the problem with that. The problem is you're going to close on that, you're going to put up your capital, and you have three years to go out and get a new loan on that property, or you'll default and the seller will take the property back away from you, and you'll lose your down payment.
Here's the issue. You're probably not going to be able to get a replacement loan in three years. Why do I say that? It takes about a year to get a loan refinanced with any degree of safety, but then they're going to want to see whatever your NOI is evidenced by that performance for at least a year or two, and that means you have no time to turn the property around.
If your concept was to fill vacant lots and cut costs and raise rents, unless you can get that done in the first week since you bought it, you're going to run out of time. And when you run out of time, you'll enter into what's called term default, and that means mom and pop can take the property away from you.
How do you avoid this pitfall? Don't do those short-term seller notes. You have to have at least five years, or I would not even consider that a note. Ten is a whole lot better, and if they won't go longer than five, see if you can have the ability to buy a two-year extension on that thing just to get you to seven years in the event that you need it.
Now, here's another trap that some park buyers get into. They go to the city to get a certificate of zoning. They talk to the inspector. Yet, there's hostility. It may even be the city says, "Well, you can't bring any homes into those vacant lots." And yet they close anyway, thinking that, "Oh, well, it'll be a while before I bring in my first home. By then, I'm sure the city will be happier with me, and they're going to go ahead and give me my permit that I want." That is a bad trap to fall into.
Suing a city can be extremely expensive, and there's no guarantee you will even win. How do you avoid this trap? You've got to get these kinds of things ironed out before you own the property. During due diligence, if the city is saying they can't use the vacant lots, you need to hold off on buying until you can get this resolved.
It's one thing if the city is going to block you from adding to the occupancy before you own the park, because then it's not counting against you. But if you close on that park, the seller is out of the picture, and suddenly all the legal fees are going to come back on you if you can even get the thing done.
Same story when there's a cloud on title. If there's a cloud on title, I don't care what it is, you need to make sure that the seller fixes that before closing. I don't care how minor it is. Even if mom and pop are willing to carry the paper on it, here's what's going to happen. When you go to refinance it down the road, you won't be able to get a loan because there's a cloud on the title.
What's the fix? They have to get it fixed before you close. There's no other way you can work that and come away as a winner. Same with survey issues. Sometimes you're going to see survey issues on properties, things like homes going beyond the boundaries, and those things can often get resolved fairly amiably and sometimes quickly by going to the neighbor and paying them to be able to extend into their property, or sometimes buying the little piece of property it extends into, or you might be able to pull the home forward and get it off the neighbor. But these kinds of survey issues, which are no big deal when you're buying the park and the seller's carrying the paper, become a big deal later when you go to refinance.
So any survey issues, get them fixed. And you're going to find there's some survey issues you can't fix. For example, let's say there's a road easement that goes diagonally through the property. We've seen that before. What are you going to do if they show up one day to start building that road? You have no legal right to stop it. Your park is destroyed. Sophisticated lenders and buyers are going to understand and appreciate this, and therefore, they're not going to give you a loan or buy it.
So even if mom and pop will carry the paper and they'll close with those survey issues intact, you can't do it. It's a trap. You're going to buy the property and will not be able to sell it or refinance it. Now, here's another one that hardly anyone in America who's not in the industry knows is a terrible trap, and that's when there's too many Lonnie deals in the park, all owned by one individual. What's a Lonnie deal? They call it a Lonnie deal because a guy once wrote a book called "Deals on Wheels" by Lonnie Scruggs, talking about the wonders of making money by buying and renting mobile homes.
And what happens is, let's just say you had a 100-space mobile home park. Every tenant has only 1% of your occupancy. If they run off, what happens? You fall from 100% occupancy to 99. But let's say you've got a Lonnie dealer that owns 20 of the homes in that mobile home park and rents them out. If he pulls out, you drop from 100% occupancy to 80%, thereby probably defaulting on your loan.
So what's the solution? You can't buy parks that have too many Lonnie deals with one individual. The industry norm is typically about 5%. So in a 100-space park, you could have a Lonnie guy doing rentals on maybe five of the homes and possibly still get a loan on it, but not these situations you see frequently in the industry where sometimes one guy owns half of all the homes.
You can't buy parks like that. Now, can you solve it? If you were to go to the guy and reach a deal where you buy the homes at closing, I guess that would help. Or maybe if you run the numbers such that if he pulls them all out, your numbers still work, but that's going to make it very hard to underwrite that deal.
Another trap is simply buying a park in a state that has pending rent control, where you feel very seriously that rent control is right on the horizon. Because the problem with rent control isn't just that you can't raise rents. An equally big problem is if they enact rent control, the value of all the mobile home parks in that entire state goes down, because people don't like owning parks under the cloud of rent control. You've seen that happen most recently in the state of New York, where they enacted rent control, caught everyone off guard, and next thing you know, values decreased. We've also seen that in Washington and Oregon.
So you need to stay clear of rent control. That's the best way to avoid that trap. And then finally, one of the big traps that it takes everyone a while to learn is if you just have a bad gut instinct on a park, then don't buy it. I put out some traps for a mouse recently. I had one down in the basement. I knew it was there. I saw it out of the corner of my eye one day. I put the traps down there. But this mouse was very smart.
It knew how to avoid the traps. It knew when it smelled the cheese not to go in there. Oh my gosh, it's a trap. And that's what the human gut instinct often is. We all have a fight or flight mentality dating all the way back to the time of cavemen, and that's why your ancestors survived to last another day, because they knew that if they went in that cave, there might be a saber-toothed tiger lurking in there, and they knew better. When you feel something's a trap, when you feel uncomfortable with a situation, you need to avoid that deal. This is Frank Rolfe, the "Mobile Home Park Mastery" podcast. Hope you enjoyed this. Talk to you again soon.