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What REO Sellers Need to Understand Better

By Frank Rolfe

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Published: 03Mar2012
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We purchased thousands of lots last year, so we must know what we're doing. But only a small portion of those deals were REO properties. For those who are unfamiliar with the code, REO stands for "Real Estate Owned" and it normally relates to banks that have foreclosed on manufactured home communities and placed them in their own bank portfolios temporarily, to re-sell and get them off their books. These are also commonly known as "distressed" properties, for they normally have come to foreclosure through some inherent flaw in operations or occupancy.

We would like to buy more REO properties. But there are several realities that many banks often forget, and these often render their asking prices unrealistic for any professional buyer.

New manufactured homes are no longer brought into communities by dealers

I received a call from a bank with a community in New Mexico. This property had good basics: 100 lots, city water and sewer -- the works. But the bank officer then ruined the deal when he told me the occupancy - around 20 lots. He told me, with much enthusiasm, that this was a "great" opportunity, because the homes that were missing had been old and ugly, and now I could bring in 80 brand new homes from the local dealer. I tried to explain to him that homes just don't come in from dealers anymore, and that those 80 vacant lots were of no value to me. If you are reading this article and don't know that dealers just aren't selling homes that go into communities anymore, let me educate you before it's too late. The sales of manufactured homes in the U.S. are down to about 60,000 units per year, from around 400,000 in 1999. In 1999, you actually could show some degree of fill rate in any community from the local dealers (although almost all of that was lost in repo-mania a few years later). But today, there is absolutely no fill rate at all. And if you want to fill lots, then you have to buy the homes yourself, which is extremely capital and labor intensive.

There is something called "stabilization", and it's very important in obtaining financing

You would think that most bankers would understand one of the basic concepts of commercial lending. That concept is "stabilization". It means that a property has sufficient occupancy to be considered "investment grade" and worthy of a loan. And it's a very important item when you go to sell a property, because a community that has low occupancy is not "stabilized" and probably impossible to get a loan on, given today's tough standards. In other words, if your occupancy is under 80%, you can probably forget about finding a loan.

Capital improvements cost money

How many REO properties have you been to that are completely shot - they have potholes as big as the Grand Canyon, a virtual forest to prune and remove, and water leaks creating small lakes throughout the property? But when you point these items out to the bank, they tell you that the price is firm. Now let's look at the logic of this. If you are supposedly buying a property at a 10% cap rate at $1 million, and it needs $100,000 of capital expense immediately to get it back in service, then you're not at a 10% cap rate, you're at a 9% cap rate. That capital expense has to come out of somewhere - and it has to be part of the yield formula. Normally, what's happened is that the former owner, when facing negative cash flow, just suspended all maintenance. But that's not going to magically go away when you buy it.

It takes a really high cap rate to make this compelling enough to buy

When we buy communities from moms and pops, we have a win/win structure of a 10% cap rate based on stabilized occupancy and existing net income, with the opportunity for improvement through rent raises and cost cutting, and typically seller financing based on 20% down. An REO property that offers none of these is not worth a 10% cap rate. So what is the fair rate? I don't know, as it is on a case-by-case basis, but certainly something in the teens is going to make it seem more worth the trouble. If we have to fix the infrastructure, fix the vacancy, and get a loan on it when it is not mainstream and hard to find an interested lender, then 10% is just not going to do it. In some cases, you can only close these deals with all-cash, and that means we need a 15%+ cap rate just to hit our investor cash-on-cash numbers on day one.

Conclusion

There are many great lenders out there who understand how the business works, and price their deals reasonably and with a win/win attitude. And then there are others who refuse or fail to grasp the realities of the marketplace, and put too high a price on their park and, as a result, never get them sold. I'm hoping we can educate all lenders on the correct pricing structure, so that decent parks don't sit around as ghost towns. We've got an affordable housing shortage in the U.S., and it's a shame to waste what little we have.

Frank Rolfe has been a manufactured home community investor for almost two decades, and currently ranks as part of the 32nd largest owner in the U.S. He currently owns parks in 17 states throughout the Great Plains and Midwest, and his books and courses on community acquisitions and management are the top-selling ones in the industry. For more information on mobile home parks investing, please visit http://www.mobilehomeuniversity.com.

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