The 7 Biggest Manufactured Home Park Investing Mistakes
Investing in manufactured home parks can be a lucrative venture, offering steady cash flow and long-term returns. However, like any investment, it comes with its unique challenges and pitfalls. Whether you're a seasoned investor looking to diversify your portfolio or a newcomer exploring this asset class, understanding the common mistakes made in manufactured home park investing (and how to avoid them) is essential to your success. By learning from the experiences of others, you can avoid costly errors and build a thriving, sustainable investment.
- Overleveraging
The temptation to put as much debt as possible onto a property as a lender will allow is often hard to resist. But it cannot be overstated how dangerous overleveraging can be. Economic conditions change all the time, and what seems like a safe investment can suddenly be underwater at refinance time—especially if interest rates experience a rapid increase as we have seen over the last several years. Instead, keeping your equity to a minimum in a deal helps bump up those returns and allows you to keep more cash for the next opportunity.
Aiming for a level of leverage that makes sense in a conservative set of assumptions also helps to stress test the deal in general— if the deal only pencils financially with a dangerous amount of leverage, it probably isn’t worth doing.
- Choosing bad partners
Nothing kills a deal (even a good one) faster than bad investors or partners. The term “bad” does not necessarily mean criminal or nefarious dealings, although it can, but instead refers more to a simple lack of communication between investors and operators or business partners. It is critical that all parties understand the deal, the risks, and who is responsible prior to engaging in any partnership. And while the start of a new investment partnership never the time anyone wants to discuss worst-case scenarios, it is imperative to ask all the “What if” questions and agree on contract clauses before you put ink to paper. Once the documents are signed, it is extremely difficult to get any meaningful changes enacted if you overlooked something or misjudged its outcome.
- Going bigger when it’s not better
Like overleveraging, many investors tend to scale up their acquisitions with each successive investment. (It worked the first time, so why not go bigger the second time?) This thinking can lead you toward a false hope for success, especially when the economies of scale start to show how much more cost-effective running a 100-unit park can be vs. a 20-unit park. The math is solid, but scaling up too fast can destroy the career of investors and operators if their new, larger investment needs outpace their budget or labor for keeping up.
A motivated operator can easily manage all aspects of a turnaround rehab of a single, smaller property, especially when that is their only property. Things get complicated, however, when multiple properties must now be managed and staffing needs to scale up to accommodate the increased needs.
Another fallacy that happens with the “Bigger is better” mindset is that, while certain economies of scale can indeed be gained with a larger property, it’s also true that these larger properties incur much higher costs when it comes to things like capital repairs and maintenance equipment. Without adequate capital and infrastructure, a park that's too large can deplete cash flow and lead to a severely compromised investment.
- Exiting too early
When a park is considered done—capital repairs are completed, deferred maintenance has been addressed and rent increases have taken effect—many investors take it as their cue to sell. The reality, though, is that the real benefit of owning a turnaround project manifests itself in the long term. In fact, keeping improved properties where all the hard, upfront work is finished can generate much greater yields for a fraction of the initial investment. In addition, there are tremendous tax benefits to keeping these properties long-term and periodically refinancing to free up equity. So, even when a great sale price can be obtained, it is always worth looking at a three to five-year ownership option to make sure that a sale is really the best option.
- Making incorrect assumptions
Investors can be prone to making overly optimistic assumptions and earnings potential when they see vision in a property. Dreaming instead of crunching numbers, however, is not a smart strategy. Instead, it is essential to stay grounded in reality, assume nothing, and analyze what is plausible—and then take an even more conservative approach on both costs and revenue assumptions.
Here’s an example: When you assume rents can go up 25%, but it turns out they can actually rise by 50%, it’s simple to adjust your rent increases to accommodate. If you assume 50% but can only get to 25%, however, you’ll find yourself facing significant problems (i.e., move-outs, slow leasing, tenant complaints, or legal action) that can be difficult, if not impossible, to undo. The same is true for capital repairs and upgrades: Make sure to price in a healthy contingency on all construction activity, or you could end up with incomplete projects, an empty bank account, and a lot of angry contractors.
- Undercapitalization
Cap rates can be misleading, especially if investors treat them like the yield on a bond. The hard truth is that the cash flow from year one (and often years two and three) is almost always invested back into the property in multiple ways—some that can be predicted before the acquisition, and some not so much. A lack of cash flow to fund improvements can lead to a scramble to produce cash from investors (or even worse, your own bank accounts), that are unpleasant and demoralizing.
Like over-estimating your earnings potential, it is better to assume you will need $100,000 in the bank at closing and only need $50,000 than needing to scrape together cash when the operating account runs dry. This is especially true when dealing with investors: Asking for an extra $100,000 at closing even if you “don’t think you’ll need it” is always better than trying to ask for additional capital 18 months into a project. In other words, giving extra money back that you didn’t need makes you look like a smart and cost-effective operator. Asking for more cash later has the opposite effect.
- Betting the market
We saved the worst mistake for last: Betting the market. Don’t do it unless you are 99.99% confident in your outlook, and maybe not even then. Why? Because a deal can seem great with a fantastic price, until it's discovered that the property is situated in an area of declining population, high residential vacancy, or about to experience a drastic loss of employment (i.e., a company shutting down, loss of federal funds, and so on). It is critical to examine every aspect of the market's impact on a property, and often this means looking at nontraditional sources, like spending time in the city or neighborhood you are considering. Have coffee, talk to residents, look at all the houses and apartment buildings, talk to business owners, and really get a “feel” for the town before the irreversible purchase of a mobile home park.