When Warren Buffet’s Berkshire Hathaway acquired Clayton Homes Inc. for $1.7 billion in 2003, investors took notice. In commercial real estate circles, the acquisition drew attention to a sometimes-overlooked specialty property: manufactured-housing communitites, also known as land-lease communities. While the Berkshire Hathaway acquisition made headlines, investors already active in the sector were keenly aware of its attractions, including recession-proof cash flow, high barriers to entry, and the potential for significant land appreciation.
Like most large players in manufactured housing, Clayton not only manufactures, finances, and sells homes, but also operates 68 manufactured-housing communities and 13 subdivisions across the U.S. And forget the stereotypes — many Clayton communities offer a range of architectural styles and features, with resort-style amenities such as clubhouses, swimming pools, and tennis courts.
An Evolving Industry
While more than a few poorly maintained and unattractive communitites still exist, the manufactured-housing sector has come a long way from its past down-market image. Home buyers today can find manufactured-home communities with the same amenities as upscale apartment complexes, and residents typically experience the same pride of ownership as in traditional communities of single-family homes or condominiums.
Even the property description has evolved. The term mobile home technically applies only to factory-built housing units built before June 15, 1976, when the U.S. Department of Housing and Urban Development code was created. Today’s manufactured homes often are indistinguishable from built-in-place residences. Porches and garages are widely available, and some homes offer working fireplaces, whirlpool baths, stainless steel sinks, surround-sound stereo systems, and high-end appliances.
But one aspect of manufactured housing that has not changed is its affor-dability. Depending on the region of the country and construction costs, new manufactured homes average from 10 percent to 35 percent less than comparable site-built homes, excluding land costs. Although some manufactured homes sell in excess of $100,000, most are sold for $20,000 to $40,000. Contrary to popular belief, manufactured homes appreciate at about the same rate as site-built homes, depending upon market factors and the availability of a local resale network to expedite sales.
In many communities, most tenants own their homes and lease the underlying land from the park owner. Pad rents range from $200 to $350 per month or more, depending on market dynamics, and usually include waste removal, but not necessarily utilities.
Whereas manufactured-housing communities have been a seniors-housing mainstay for decades, owners and developers have become increasingly adept at market segmentation and targeting demographic groups that may be priced out of the site-built market for homes with the amenities they want. A high-quality manufactured-housing community can provide consumers with affordable homes and high-end amenities. For example, a family-oriented community would have playgrounds for children, whereas a retirement community might have upscale clubhouses to accommodate social activities.
The Five-Star Rating System
To help lenders and investors assess, differentiate, and place a value on individual manufactured-home communities, the Manufactured Housing Institute, a national trade association, developed a five-star rating system that takes various attributes into consideration. The higher the rating, the easier it is to secure financing with the most attractive terms.
Attributes that lenders consider include whether the streets are paved or unpaved, single-width or doublewide lots, amenities, overhead or underground utilities, occupancy, on-site management, and the property’s general appearance. Five-star communities can feature pools, clubhouses, and tennis courts and often are in prime locations such as coastal retirement areas. Generally, lower-end properties are located in secondary and tertiary markets, have few to no doublewide units, and lack paved streets.
After several real estate investment trusts began specializing in manufactured-housing communities in the early 1990s, what once was strictly a mom-and-pop industry became more professionalized and institutionalized. Today the United States and Canada have approximately 50,000 manufactured-housing communities controlled by approximately 500 portfolio owners and operators, according to the Allen Report’s 2007 “Who’s Who Among Land-Lease Community Owners/Operators in North America.”
The top 10 owners and operators collectively own or manage 1,182 communities with an average of 313 home sites per community, or about 15 percent of the market. Of these, Equity Lifestyle Properties is currently the largest, with 108,980 home sites in 138 communities, followed by Sun Communities’ 136 properties.
These large investors prefer well-located properties with 200 or more home sites to amortize the cost of amenities and achieve operational efficiencies. However, most communities are smaller than 200 sites and some have as few as eight or 10. These properties are owned by municipalities or small to midsize investors, who may live on site and manage the properties themselves.
The average national occupancy rate among manufactured-housing communities was 91.3 percent in 2006, up from 90.1 percent in 2005, according to the Allen Report. Having gone through its own version of the subprime lending debacle in the late 1990s and a subsequent tightening of mortgage standards, the manufactured-housing industry has not been as hard hit by the current residential mortgage crisis as one might expect. Overly aggressive lending practices for manufactured-housing units sparked a 1990s boom that became a bust a few years later when record-low interest rates and the widespread availability of subprime mortgages for site-built homes siphoned off demand for manufactured housing units.
Juxtaposed against the challenges of financing the acquisition of manufactured housing units is the current commercial credit crunch that affects the community owners’ ability to capitalize the underlying income-producing sites. Many securitized lenders, or conduits, have pulled out of the lending market. Those who remain active are quoting spreads significantly wider than those from as recently as mid-2007. It is anyone’s guess as to when this primary source of capital will be back in force. In the interim, agency money from Fannie Mae and Freddie Mac continues to be a dependable source for acquiring or refinancing manufactured-home communities.
As the market recovers, some consumers forced out of the site-built housing market likely will return to manufactured housing. Rather than seeing an onslaught of foreclosures, some manufactured-housing communities are instead experiencing a leasing slowdown because potential occupants are unable to sell their site-built homes in the current environment.
Current housing trends notwithstanding, growth in manufactured-housing communities can be expected to follow the sun to southwestern and southeastern states such as Arizona, Nevada, New Mexico, California, Georgia, North Carolina, South Carolina, and Florida. Retirees in these states are driving much of this demand. Another growth area is the Gulf Coast, where Hurricane Katrina destroyed a large amount of housing stock.
From the viewpoint of investors and lenders, manufactured-home communities are hybrid properties, with characteristics of both rental apartments and single-family homes. Some investors own both homes and land, generating cash flow from both the financing of home sales and pad rental fees. Others prefer to simply own the land and lease individual sites to homeowners, with in-house staff or a third-party property management company managing the day-to-day operations.
The latter approach also is preferred by many lenders because it provides monthly cash flow similar to apartment rents, with the added stability that homeownership provides. As with single-family detached homes, community residents who own their manufactured-housing units are less likely to leave than those renting them because of inherent pride in maintaining their homes and yards. It is difficult and costly to relocate a manufactured home, so owners are more likely to stay. The best investment-grade communities usually are adults-only facilities, which tend to have the lowest turnover rates.
The other advantage of owning the land rather than the homes is that land potentially can be sold or developed for another, more profitable, purpose. If located in a developing area, an older mobile home community can become a very valuable infill location sought after by home builders or commercial property developers and easily can be repurposed with minimum demolition expense. An institutional owner may have the wherewithal to undertake a redevelopment of the land when the time is right. In fact, today’s stable cash flows coupled with the possibility of a long-term land play is what motivates some institutional investors to acquire manufactured-home communities.
Length of ownership, therefore, depends on the property owner’s investment goals. Institutional capital often has a five-year time horizon, whereas a seven- to 10-year time frame is more typical of private equity firms and individual investors.
Some investors seek properties that historically have been mismanaged by an owner satisfied with below-market rents or who is unwilling to invest in upgrades or improvements that would justify rent increases. A community with public utilities, for instance, presents an opportunity to generate instant upside if the owner submeters water, electric, and sewer services to pad renters, thereby reducing expenses by as much as 15 percent.
The Lender’s View
From the lender’s perspective, manufactured-home communities present a level of risk that is comparable to that of rental apartments. What lenders like is the steady, predictable income stream provided by uninterrupted lease payments.
What they dislike are manufactured-housing communities in which most housing units are rented, not owned. Some lenders will not finance a community that includes more than a certain percentage of community-owned homes, which can range from 10 percent to 25 percent, depending on the lender. If the community meets that percentage requirement, the lenders will underwrite the pad rent derived from these units, but give no credit to the cash flow generated from the actual unit rentals. In essence, community-owned units have no value to some lenders, where underwriting is concerned. In fact, some lenders view community-owned homes as risk elements, on the premise that renters have less pride of ownership, are prone to relocating frequently, and may have weak credit ratings.
Many lenders have a clear understanding of this property type and, depending upon the market environment, may be willing to offer loan-to-value ratios and interest rates comparable to apartment investment terms. Higher-end properties are considered less risky and, therefore, qualify for more favorable terms. Lenders also look at rent trends, such as whether rents are regularly increased and whether rent concessions are ever granted.
Local market dynamics naturally affect the values of manufactured-housing communities, as do operating expenses and other factors. Cap rates vary widely, even within a single market, often driven less by geographic location than by characteristics of an individual community and its potential buyers.
As of December 2007, cap rates nationwide ranged from 6.9 percent to 10.2 percent, according to Mortgage Statistics. Large, amenity-rich properties with public utilities and no rentals are most in demand among investors and therefore usually sell for lower cap rates. For instance, an age-restricted, 300-site community with major amenities, public utilities, and no rentals might sell at the lower end of the range, while a same-sized, age-restricted community with no amenities, many rentals, and on-site utilities would likely sell at a higher rate. A non-age-restricted community with fewer than 50 sites, minimal amenities, substantial rentals, and on-site utilities also would sell at the higher end of the range. However, the recent tightening of the credit markets has complicated the valuation of all real estate as underwriting has moved toward a more conservative approach, pushing cap rates upward.
Income and Expenses
Home site rents generally range from about $200 to $350 per month and annual increases of 3 percent to 5 percent are the industry standard. Investors typically seek a total monthly payment (home loan and site rent) priced between local two-bedroom apartment rents and the monthly payment for an introductory site-built home in the area. If a typical two-bedroom apartment in the market is $200 or $300 per month, then the manufactured-housing community will probably not be competitive. If the two-bedroom apartment rent is $550 to $600 or more, then a $200-per-month pad rent and a $250 to $300 manufactured-home payment is an affordable alternative.
The average operating expense ratio for manufactured-housing communities was 41.1 percent of adjusted gross income in 2006, down 0.2 percent from 2005 reports, but slightly above the desired ratio of 40 percent. One reason is that some communities began offering homes as well as pads for lease, a strategy that may boost income temporarily but tends to drive up operating costs, according to the Allen Report.
The operating expense ratio can vary significantly from one community to another in the same city even if located adjacent to one another. Professional property management significantly can reduce expenses while adding value to a community and is commonly used by large portfolio owners. As institutional owners have acquired multistate portfolios in need of qualified managers, several industry associations have begun offering specialized training programs aimed at manufactured-housing community management.
One of the largest expenses in a community is the water and sewer service. If utilities are provided by a nearby city and sub-metered to tenants, expenses will likely decrease significantly. If the property is served by a well or lagoon and a septic system, all bets are off — increasingly strict environmental requirements can lead to costly improvements.
Another area of expense risk is mortgage default. Approximately 10 percent of manufactured-home buyers default on their mortgages — a rate about five times higher than that for site-built home buyers — and presumably default on their pad rents as well.
Yet, despite these risks, investors seeking alternative options in today’s uncertain market might do well to consider manufactured-home communities. Despite the rockiness of the housing market, home ownership remains the quintessential American dream. The affordability of manufactured homes, combined with the amenities provided by the manufactured-home communities, is sure to attract new demographic groups seeking the realization of that quest.