Author: Dan Rinzema, Datacomp Appraisal Services
Bio: Dan Rinzema is president of Datacomp Appraisal Services a company that specializes in mobile home values and valuation and operates MHVillage.com which is a website that specializes in the mobile home industry.

A Depreciating Asset

How to Increase Home Values in Land Lease Communities

Have you ever heard someone say, “All manufactured homes in communities depreciate and all site-built homes on real estate appreciate?” It is a common stereotype, and, in fact, given today’s extreme imbalance between supply and demand (due to the glut of repossessed homes), the first part of the statement may temporarily be close to true. But it certainly has not always been true and it need not be true in the future. To separate fact from fiction and to begin rebuilding what’s left of the industry, the following three questions must be answered:

1. What are the factors that affect the value over time of any home — site-built or manufactured?

2. What are the value characteristics of manufactured homes sited in land-lease communities under normal market conditions?

3. What can we as an industry do to protect and enhance the value of manufactured homes in the future?

UNIVERSAL VALUE FACTORS

There are several factors that universally affect the value of virtually all products. The first factor is newness. Because there is inherent value in the state of being new, most products have a built-in tendency to lose value as they age. All other things being equal, we will pay more for a new widget than we will for an identical used one and the older it is, the less we will generally pay.

The second factor is supply and demand. If the supply of housing (site-built or manufactured) is greater than demand, the value of that product will decrease. Likewise, when the demand for a product is high the value typically increases. Today’s large number of vacant sites in land-lease communities is a strong indicator of over supply and low demand. Combine this with site rents that can create a financial disadvantage compared to other housing alternatives, and it makes for a deadly one-two punch.

This brings us to the third universal factor, which is the cost of alternative or competing products. In the manufactured housing industry this includes alternatives such as apartments, single-family homes and condos. If the costs of manufactured homes are not competitive with these alternatives, it causes a downward pressure on value. Conversely, in places where a lack of affordable housing is coupled with strict rent control, the value of a manufactured home skyrockets— as is seen in parts of California. Of course, should those rent control ordinances he lifted, and rents allowed to rise to competitive market levels, the value of the homes would fall dramatically.

CAUSES OF DEPRECIATION

In addition to the universal value factors above, economists divide housing depreciation into three general areas: 1) physical deterioration, 2) functional obsolescence, and 3) external obsolescence (also called economic or location obsolescence). Each of these categories can be further evaluated as being curable or incurable.

Physical deterioration in a manufactured home, which is often nothing more than common wear, most often falls in the curable category. Physical deterioration is cured through ongoing maintenance, remodeling and repair. If maintenance is left undone for too long it can become incurable when the cost of repairs are no longer economically feasible.

Functional obsolescence causes loss of value and depending on its nature may he curable or incurable. A good example of incurable functional obsolescence in the industry was the shift from 12-foot-wide to 14-foot-wide homes. As 14-foot-wide homes became more available, smaller homes became less desirable and lost value due to functional obsolescence. Changes and improvements to the layout, design or features available in new homes causes older homes without those features to experience functional obsolescence. The degree to which older homes can incorporate new, desirable features determines whether the obsolescence is curable or incurable.

External obsolescence is any loss in value from causes outside of the home itself. This includes such things as zoning changes, deteriorating neighborhoods, proximity to nuisances, etc. It also includes changes in demographics, such as when a community, state or region becomes less desirable. For example, when a large employer moves or a military base closes. In most cases, this category of depreciation is considered to be incurable. However, one cause of external obsolescence in the manufactured housing industry is curable. When a substantial increase in monthly site rent causes a community to become less desirable, it can be cured by reducing the site rent to a competitive market level.

Fighting to offset all of these factors of depreciation and loss of value are the forces of inflation, continuing prosperity, population growth and a seemingly insatiable demand for more housing. So far, at least in the site-built housing market, these forces are winning in most (not all) housing markets in the U.S. There have always been communities, states, and regions who have, at least for a time, lost the battle to depreciation as a result of severe external obsolescence and unchecked physical deterioration (deteriorating inner cities, for example). In these areas, all housing depreciates regardless of whether it is site-built or manufactured.

DETERMINING VALUE

What about manufactured homes in land-lease communities? What happens to the values of these homes over time and under normal market conditions? To begin this discussion, it must be recognized that the industry is not currently experiencing normal market conditions.

While we need not rehash how the industry finds itself in its current situation, it must be acknowledged that there is a serious site vacancy problem (over supply); a considerable number of distressed homes (repossessions); and there are many communities with site rents that may not be economically sustainable when compared to other housing alternatives.

Once the excess inventory of homes has been absorbed, site rents become competitive and communities refill, the industry will once again experience normal market conditions.

To understand how manufactured homes perform under normal market conditions, it is important to look back a few years.

Beginning in 1989, Datacomp conducted a series of value trend studies (1989, 1992, 1996, and 2000) of homes in land-lease communities. In each of these studies, it identified homes in its closed-sales transaction database where both the original new home sale and the subsequent resale transaction were captured. Comparing the original sales price of the home to its subsequent resale price, and then factoring in the number of years between the two transactions, Datacomp was able to determine the percent change in value per year.

The average change in home value in those four studies was -.44 percent. Which means that the average home in our study depreciated slightly less than 1/2 of 1 percent per year. However, averages can be a little deceptive. When studying the data in more detail, it discovered that on average 47 percent of the homes in the studies appreciated an average of 3.8 percent per year, while the other 53 percent depreciated 4.1 percent per year. In other words, slightly less than half of the homes in our studies actually appreciated while slightly more than half depreciated.

Datacomp then took a closer look at the homes that did depreciate and discovered that 80 percent depreciated at 1 to 3 percent per year, while 20 percent depreciated at 7 to to 10 percent per year. In other words, most of the homes that depreciated did so very slowly, while a few of the homes depreciated at an exceptionally and unexpectedly high rate.

Datacomp coined the terms “shock depreciation” or “value evaporation” to describe the type of severe value loss that these homes experienced. From other studies, it found evidence that this severe value loss is both predictable and preventable, which will be explained a little later.

According to these studies, the bottom line shows that nearly half of manufactured homes appreciate. And of the slightly more than half that depreciate, 80 percent do so at a manageable and predictable rate. By offering loans and terms that allow the homebuyer to pay off the loan faster than depreciation (15-year loans with competitive rates), the homeowner can still build modest equity.

BUILDING VALUE

These studies beg the question of how the phenomenon of shock depreciation and value evaporation can be avoided. There are four key steps that can be taken immediately:

1. Consumers must be educated about the role of proper maintenance of the home and homesite in maintaining and building value. The depreciation caused by physical deterioration is the responsibility of the homeowner. Lenders must make sure that homeowners have the financial resources to maintain their homes after the loan payment and site lease have been paid.

2. Community owners must balance their short and long-term profit objectives. Regular and ongoing investments must be made to maintain the appearance and quality of the community. Also, they must understand that severe “value evaporation” is the immediate result of rapidly rising rents. Increased repossessions and vacancies will follow unreasonable rent increases as sure as night follows day. The combination of the home payment plus the site rent must stay competitive with other housing alternatives. This is a basic economic law that simply does not bend.

3. The price paid (and amount financed) for a new manufactured home must represent a fair market value for the community in which it is sited. The single most prevalent, predictable and preventable cause of shock depreciation is placing a new home where it simply does not belong. Placing a new multi-section home in a community composed of 20-year-old single-section homes in an economically depressed housing market will cause immediate and severe value evaporation. No site-builder would build a 3,000 square-foot, two-story home in a neighborhood of 1,200 square-foot bungalows, yet the industry does just that with up to 20 percent of the new homes sold into communities.

Today, the “one-size-fits-all” advance formula for new homes is the same regardless of where the home is placed. A market-based, new-home appraisal or a location adjusted advance formula, that takes into consideration the market area and the specific attributes and resale values in the community, would virtually eliminate this problem. Currently, the groundwork for such a system is already being laid by the Community Attributes Task Force, which has been jointly sponsored by the National Communities Council and the Financial Services Division of the Manufactured Housing Institute (MHI).

4. Finally, we must create a healthy and vibrant resale marketplace. An environment where buyers and sellers can easily, effectively and efficiently buy and sell their homes is critical to retaining and increasing value. MHI’s Executive Committee has already begun to make good progress on this front through its unanimous support of the Resale Task Force proposal to embrace an industry-supported listing service and resale database to assist both professionals and homeowners more effectively transact home sales. The availability of competitive financing for previously-owned homes, at the same rates and terms as new homes, is also vital for the creation of a healthy and vibrant resale marketplace.

Just as a company must articulate and demonstrate a solid value proposition to survive, so too must the industry articulate and demonstrate its value proposition.

Whether placed in land-lease communities or on scattered-site real estate, the industry’s core value proposition continues to be, “to provide affordable single-family housing.”

Allowing manufactured homes to continue to experience severe depreciation, when it is clearly predictable and preventable, undermines the very heart of that value proposition. We have no hope of rebuilding the industry unless we are willing to take the necessary steps to protect the long-term value of our homes.