Winning By Default

In a typical Lonnie Deal you would buy a MH for $2,000 cash and sell it for $600 down and 36 payments of $200. In these transactions, the initial investment is recouped within a few months and triple digit ROIs are common. The essential ingredient for these deals is a source of inexpensive MHs already sited in a community. Unfortunately, this is frequently missing in turnaround parks, which often have vacant lots that need to be filled. In this situation, homes have to be brought in and the cost skyrockets. Buying a used home can cost $5-18k, plus the cost of transportation, foundation, skirting, utility hook up, decks, etc. is an additional $5-10k. So when it’s all done, a park owner can have $10-28k invested in a used home that they’ve brought in. When purchasing a brand new home, basis can exceed $30k. Since these homes usually can’t be sold for 2-3X their cost, the margins are smaller than typical Lonnie Deals. These homes have an investment horizon measured in years. The flip side is that you keep your money working for you longer.

Whether using your own capital or obtaining it from financial institutions or private investors, how quickly the initial investment in the home is recouped indicates how well the lending aspect of the business is performing. Using an Excel spreadsheet, I ran scenarios to determine the financial impact of repossession of these homes. I tracked basis while varying the # of payments received (approx. length of time before default), amount of down payment, turnaround cost (rehab, legal, marketing, etc), subsequent borrower payment amount, and retail price depreciation. In most scenarios, it takes less than 72 months to recoup the initial cost.

EXAMPLE:
initial basis = 25k
monthly pmt = $400
retail price depreciation = 5% per year (this is high; a case can be made that MHs in stable MHCs don’t depreciate)
upon repossession: turnaround cost = 10% of remaining retail value
subsequent down payment = 5% remaining retail value
The initial buyer makes 48 payments of $400 before defaulting. The remaining basis is $5800. After spending $2000 in turnover costs, home is resold for $20k with $1000 down payment and monthly pmt of $320. New basis is $6800. When the 2nd buyer makes the 22nd payment, basis = 0.

In this model, a large variation in the value assigned to any given variable did not have a large impact on basis, with the exception of the # of payments received from the initial buyer. This variable had a strong impact on how quickly basis reached zero. In most cases, if the first buyer defaults after the 5th year, the initial investment will have been recouped, so future payments are pure profit. From that point on, repossession activity involving the home will have the same high ROIs associated with typical Lonnie Deals.

If you’re trying to raise money from investors, you may want to create a spreadsheet for them. One of their concerns may be what happens if a home buyer stops paying. Using a spreadsheet you can show them how profitable this can be. Choose your initial buyer very carefully, but after they’ve paid for a few years, it’s actually more profitable for you if they default than if they pay off the loan. With MH notes, if they pay, you’re paid, but if they don’t pay, you get paid even more.

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