My Biggest Due Diligence Miss To Date

Ben Said It Best

Ben Franklin once said, "Diligence is the mother of good luck." In real estate, thorough due diligence is the barometer of success. Ignore it and you might strike out in the first inning. Excel at it and you might hit a grand slam. 

Real estate investors understand the importance of due diligence. However, even with hard work and good intentions, life doesn't always go your way. Markets change. Partnerships fail. Pro-forma statements over promise. And issues are overlooked.

Currently, my partners and I are working through a due diligence miss that is going to be a pricey fix.

Follow The Rules

My business partner and I first got interested in the asset class in July 2015. For over a year, we networked, read, spoke to brokers and industry professionals. We even purchased an educational information package for $1,000 with a detailed due diligence manual. We put in more effort than most new people I had spoken to. For our first acquisition, we partnered with a reputable mobile home park operator. One of the benefits of doing so was that we assisted them with their due diligence process.

Shortly after, we connected with an absentee owner that was getting sickly. She owned the property for over 10 years and she wasn't able to give the property the attention it deserved. The numbers were attractive, and the strategy was crystal clear. Raise rents and cut expenses to increase cash flow. We raised the necessary capital and closed on the property in January 2017. 

Something Is Wrong

Operations were going better than expected. Rent increases went smoothly. We experienced few collection issues. In the second month, we rented a unit for $50 per month higher than we underwrote the deal. 

Then one day we got a call from the state water utility commission. They mentioned that the water bills seemed extremely high for the number of units. It was running close to three times the normal limit. We immediately called the manager and asked to look around the property for leaks. He found one. We fixed it, but the problem persisted. We conducted a water audit, and the engineers noted that this problem has been going on for at least three years. The problem still exists. 

How did we miss this? We followed seasoned investors' advice. We went through the process before. Why wasn't this evident when I looked through the documents the first fifteen times?  

After talking with our property manager, leak detection experts, city water officials, water engineers, and multiple plumbing companies, the collective group hasn't been able to come up with a definite plan to reduce water consumption. At this point, we are guessing until we dig into the ground. All of this could have been avoided if we dug deeper in due diligence. We didn't do the math on the water usage on a per unit basis. Honestly, we didn't even know how much water a mobile home usually used in a month before this happened. What you don't know can sink you. 

One way to mitigate this situation is to partner with an experienced investor for multiple deals to see the common mistakes. 

The Saving Grace

We learned that even though we felt we had prepared thoroughly, we will still make mistakes. As Mike Tyson once said, "Everyone has a plan 'till they get punched in the mouth". All investors take jabs. They are unavoidable. Some you can't control while others will alter your approach to purchasing real estate. In all deals going forward, we will tighten up our due diligence process. We probably won't make that mistake again, but we will most likely make another one in a different area. Real estate isn't about not making mistakes. It is bound to happen. It is about reducing your downside risk and buying low enough will help weather any storm you might inadvertently put yourself in. 

Luckily, we purchased this cheap enough that we should still make money after all the repairs have been made.

Are There Still Deals in Hot Markets?

Headlines create small talk; they get people talking. It's their business model. The problem is when it affects one's decision making ability. One narrative that has been fanned for the last eighteen months is that we are in an overheated market. Some interpret this as now is not the time to buy real estate. Wait on the sidelines for the next recession. This is a broad stroke across hundreds of markets. Fortunately, deals do still exist, even in hot markets. 

Real estate, especially residential and certain segments of commercial, is a fragmented industry meaning there are hundreds if not thousands of players. On the flip side, think of e-commerce sales. According to Business Insider, 43% of all online sales in 2016 went through Amazon. Residential and commercial real estate don't have an equivalent. It is a more local business. Real estate is in the micro, not the macro. Buying a single family home or mobile home park in Orlando, FL based off a headline that the Fed will move interest rates 25 basis points will likely be a losing proposition. Neighborhood amenities, rent growth, job centers, etc. will play more into the valuation than any national headlines.

With fractured ownership comes opportunities, people get sick, change jobs, file for divorce, lose a loved one, and a whole list of other life stresses. These events happen in good and bad times. Finding good deals usually means alleviating some stress from a person or organization's life. I'd argue in today's world people have less financial control of their life, so the opportunities might be greater. 

However, let's say you believe your market is different. It is truly too hot. You will wait. Say in one year from today, the market experiences a downturn. Are you ready? Most people know they should "buy low and sell high" but few actually do. Especially if this is your first time. Those headlines that you were reading about overheating are going to be selling the fear. Markets in Disarray as Lending Locks Up. If you believe that you will act, what stopped you from doing it in 2009-2012? Analyze your reason for hesitation. Maybe you have a valid reason. Otherwise, you are watching the opportunities float on by.

This is not a call to mindless investing. Be smart. You might have to look at 5x more deals to find the right opportunities, but they exist. Don't let the headlines be an excuse to avoid doing the work. Keep searching and don't sit on the sidelines. There has never been a better time to be alive. 

How to Find Mobile Home Park Deals

Mobile home parks are no different than any type of real estate business. Finding deals takes the most amount of effort. In frothy markets, patience and discipline yields lasting results. The majority of parks are owned by mom-and-pop operators, leading to lucrative opportunities. This comes with some headaches though. Deals can take years or fall apart in moments. However, a full deal pipeline can compensate for any deals that go sideways.

Here are four ways I've looked for deals in the past year: 

- Online: There are two websites that have the bulk of the mobile home park listings: loopnet.com and mobilehomeparkstore.com. It is quite difficult to find an opportunity on these sites. Every newbie uses this as their starting place. Consider looking online to practice valuation and get a feel for what is on the market. What is the going price per pad in the Charlotte market? etc.

- Brokers:  Keep a line of communication open with several mobile home park specific brokers. The nuisances of the business can trip up people not familiar with the industry. In general, brokers want to know if you know what you're doing and if you can close. They want to get paid. I can't blame them. There are two types of brokers: local and national players. When starting out, you will likely find more success with smaller, local players. The national players have large list of buyers and usually go after larger deals (over 100 pads) that will be difficult to be competitive in. Even brokers often times overprice in hot markets. Remember no deal is better than a bad deal. I've had mediocre success with this option.

- Cold Calls: Pick up the phone. Create your own deal pipeline. Mobile home parks were built from the 1950s-1980s, meaning many of the original owners or their family members still own the property. Typically, they are older and don't use much technology. Phone calls are very effective, but the hit rate is quite low. Follow-up is king! This has been my most successful way to source deals but takes the most amount of work.

- Direct Mail - As with cold calls, letters can be quite effective with this demographic. Craft the message for the audience and stand out. Owners often get multiple pieces of mail per month. Send several times over the course of a year, and you might receive an unexpected phone call in a few months time. There has been a few times when I have received a call several months after I've sent a mailer. Be consistent. 

Think of your business as a brand. Nike doesn't put out one commercial and go away. Well, neither should your business. You should be constantly generating leads. You never know when the next lead might come through. Hit all avenues.

When I first got started, someone told me it would take about a year before I would get up and running. He was right. I closed my first deal in the same month a year later.

As always, feel free to reach out. 

Differences Between Mobile Home Parks and Apartments

Mobile home parks have risen in popularity since the last recession. Frankly, I am apart of the crowd. A friend mentioned that I should look into them. I did. Today, I own two communities. 

At first thought, mobile home parks seem very similar to apartment complexes. Tenants pay rent. Landowner manages and maintains the property. However, mobile home parks have a few different characteristics than apartments, which can be confusing. 

First, there are two different types of tenants. One category is called a lot renter. This tenant owns their mobile home and pays lot rent to the property owner. Some call this a land or ground lease.The benefit of this situation is the property owner isn't responsible for the home's repairs and maintenance, since the tenant owns the home. The second type is a park-owned home tenant or similar to an apartment renter. If something breaks in the mobile home, it is the landowner's responsibility. 

Furthermore, mobile home parks have a supply constraint. In other words, zoning and permitting departments in populated metro areas demand arduous requirements, essentially making it financially infeasible to build new parks. Several counties I've spoke to have bluntly stated that new mobile home parks aren't allowed. This is a benefit to park owners in the area as a developer can't build a competing product right next door. This can't be said for multi-family properties.

As mentioned previously, mobile home parks have a class of renters called lot renters. In general, this type of tenant rarely leaves the park. High turnover can kill any real estate investment. The cost to move and setup a mobile home costs over $3,000, irrespective of location. This is especially difficult for the typical mobile home park renter. On average, mobile home parks have lower vacancy than apartments if the majority of their tenants are lot renters. Several park owners have told me that they have tenants who have lived in their park for over 40 years.

On the contrary, mobile home parks have a negative stigma. Most people wince as they drive by. Drugs. Violence. Disorder. While this isn't an accurate depiction of the asset class, many bankers feel the same way. For smaller deals (under $1M in loan size), it can take a serious effort to find an accommodating community bank. They do exist, however. For larger deals, regional banks, CMBS, Fannie are open to mobile home park lending. 

The advantages of lot renters, supply constraint, and low vacancy create an attractive investment that fetches returns that exceed any other form of real estate including apartments. Mobile home parks is the real affordable housing option that most people overlook.