All Manufactured Homes in Communities Depreciate (Or Do They?)
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.
All Manufactured Homes in Communities Depreciate
Or Do They
All Manufactured Homes in Communities Depreciate, and all site-built homes on real estate appreciate. If you’ve heard and believe this statement you may proudly count yourself part of the vast majority of people both inside and outside of our industry. It is a common stereotype, and, in fact, given today’s extreme imbalance between supply and demand (read Repo glut) that we have brought upon ourselves, the first part of the statement may temporarily be very 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 our industry, we need to answer the following three questions: 1) What are the factors that affect the value over time of any home, site-built or manufactured, 2) What are the actual value characteristics of manufactured homes sited in land/lease communities under “normal” market conditions, and 3) What can we as an industry do to protect and enhance the value of our homes in the future?
There are several factors that affect the value of virtually all products. The first factor is simply “newness.” Because there is inherent value in the state of being “new”, almost any product you can think of has a built-in tendency to lose value when it is no longer new. 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 universal factor affecting the value of any product 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 due to the scarcity of the product. Today’s large number of vacant lots in land/lease communities is a strong indicator of a serious over supply and under demand situation for manufactured homes. Combining this with lot rents that create a financial disadvantage compared to other housing alternatives (the next universal factor) makes for a deadly one-two punch.
The third universal factor affecting the value of any product is the cost of alternative or competing products that offer the same or very similar utility. In our case, that would be other housing alternatives such as apartments, single family homes, condo’s, etc. If the costs of our housing are not competitive with these alternatives there will be downward pressure on our values until they are. Conversely, where there is a serious lack of affordable housing coupled with strict rent control ordinances on leased lots, the value of homes on these lots will skyrocket as we see today in areas of California. Of course, should those rent control ordinances be lifted, and rents allowed to rise to competitive market levels, the values of those homes will fall just as dramatically.
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 is then further divided into: 1) curable and 2) incurable.
Physical deterioration is most often curable and is basically nothing more than wear and tear on a home and its resulting physical condition. Physical deterioration is cured through ongoing maintenance, remodeling, and repair. If left unattended too long it can become incurable when the cost of repairs is no longer economically feasible.
Functional obsolescence also causes loss of value and depending on its nature may be curable or incurable. A good example of incurable functional obsolescence in our industry was the shift many years ago from 12’ wide homes to 14’ wide homes. As 14’ wide homes became available, 12’ wide homes became less desirable for buyers and 12’ wide homes lost some value due to this functional obsolescence. Any changes or improvements to the layout, design, or other features available in new homes causes older homes without those new and now desirable features to experience functional obsolescence. The degree to which older homes can incorporate those 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. In the site-built world this would include such things as zoning changes, deteriorating neighborhoods, proximity to nuisances, etc. It also includes changes in demographics such as a community, state, or region becoming less desirable (a large employer moves or a military base closes, for example), or experiencing recession. In most cases, this category of depreciation is considered to be incurable. However, in our industry, a substantial increase in monthly lot rent that makes a community less desirable (which would be classified as external obsolescence) is curable simply by reducing the lot rent to a market level that is competitive with other local housing alternatives.
Fighting to offset all of these categories of depreciation and value loss factors 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 are today, have been in the past, and will be in the future, communities, states, and regions who will, at least for a time, lose the battle to depreciation primarily as a result of severe external obsolescence and unchecked physical deterioration (deteriorating inner cities, for example). So the second half of our beginning sentence is certainly not always true. Site-built homes can and do depreciate.
But what about manufactured homes in land/lease communities? What actually happens to the values of these homes over time and under normal market conditions?
To begin this discussion we must understand that today we are not experiencing “normal market conditions.” We need not rehash how we got into our current situation; we only need acknowledge that we have a serious lot vacancy problem (over supply), a huge number of distressed homes (Repos), which have recently and continue to flood the market, and lot rents that may not be economically sustainable when compared to other housing alternatives. Once this inventory of homes has been absorbed, lot rents become competitive, and our communities refill, we will once again begin to experience normal market conditions. But to understand how our homes perform with regard to value under normal market conditions, we need to look back a few years to before our current problems began.
Beginning in 1989, Datacomp did a series of value trend studies (1989, 1992, 1996, and 2000) of homes in land/lease communities. In each of these studies we were able to identify homes in our closed sales transaction database where we had captured both the original new home sales transaction and the subsequent resale transaction. 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, we were able to determine the percent change in value per year.
The average change in home value in those four studies was -.44%. Which means that the average home in our study depreciated slightly less than ½ of 1% per year. However, that’s a little deceptive. When we looked at the data in more detail we discovered that on average 47% of the homes in our studies APPRECIATED an average of 3.8% per year while the other 53% depreciated 4.1% per year. In other words, slightly less than half of the homes in our studies APPRECIATED while slightly more than half our homes depreciated.
We next took a closer look at those homes that depreciated, and we discovered that 80% depreciated at 1-3% per year, while 20% depreciated at 7-10% 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. We have coined the terms “Shock Depreciation” or “Value Evaporation” to describe the type of severe value loss that these homes experience, and from other studies we have evidence that this severe value loss is both predictable and preventable. The bottom line, however, is that these studies indicate that under “normal market conditions” nearly half of our homes appreciate. And of the slightly more than half that do depreciate, 80% do so at a manageable and predictable rate that still offers new home owners the opportunity to build equity.
The final and most important question is, “What can we do to protect the value of our homes and prevent “Shock depreciation” or “Value Evaporation” as we work to return to normal market conditions?” We believe there are four key steps that we can take immediately:
1)Consumers must be educated as to the role that the condition, upkeep, and appearance of their home and lot plays in the value of their home. The depreciation caused by physical deterioration is primarily their responsibility. Lenders must make sure that our homeowners have the financial resources to maintain their homes after the loan payment and lot rent have been paid.
2)Community owners must balance their short and long-term profit objectives. Regular and ongoing investments must be made to keep the appearance and quality of the community from deteriorating. Also, they must understand that severe “Value Evaporation” is the immediate result of rapidly rising rents, and repossessions and vacancies will follow unreasonable rent increases as sure as night follows day. The combination of the home payment plus the lot 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” every single time. No site builder in his right mind would ever dream of building a 3000 square foot, two story home in a neighborhood of 1200 square foot bungalows, yet our industry does just that with up 20% of the new homes we sell into communities. Today, the new home “one-size-fits-all” advance formula allows the same advance regardless of where the home is being 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 go a very long way in eliminating this problem. As this article is being written the groundwork for just such a system is already being laid by the Community Classification Taskforce, which has been sponsored jointly by the NCC and the Financial Services Division of 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 those homes being able to retain and increase their value. MHI’s Executive Committee has already begun to make good progress on this front through their unanimous support of the Resale Taskforce proposal to embrace an industry supported listing service and resale database to assist both professionals and homeowners to more effectively transact home sales. Also needed for a healthy and vibrant resale marketplace is the availability of good financing alternatives with lenders willing to offer loans for used homes at rates and terms equivalent to those of new homes which, of course, are now the exact same ones being financed now as used.
Just as each of our companies must be able to articulate and demonstrate a solid value proposition to survive, so too must every industry be able to articulate and demonstrate its value proposition. Whether placed in land/lease communities or on scattered site real estate, our core value proposition continues to be, “Affordable Single Family Housing.” Allowing our homes to continue to experience severe depreciation that is both predictable and preventable undermines the very heart of that value proposition. We have no hope of rebuilding our industry unless we are willing to take the necessary steps to protect the long-term value of our homes.
Does Collateral Matter? (Part II)
Author: Ted Boers, Datacomp Appraisal Services
Bio: Ted Boers is the founder 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.
Does Collateral Matter?
Part II
During 1998 there were in excess of six hundred thousand sales of pre-owned manufactured homes. Approximately three hundred and fifty thousand of these homes were financed. Some of these homes were financed by lenders who were concerned about collateral value and some of these homes were financed by lenders who were not. This article describes the variety of collateral valuation methods used by today’s manufactured home lenders and the inherent risks associated with each of these methods and concludes with an assessment of how these various methods may impact the profitability of a lender’s manufactured home portfolio.
There are at least four different responses or methods, evidenced by today’s manufactured home lenders, to the question of how to best determine the collateral value of the pre-owned manufactured homes they finance.
The first response, exercised by some lenders, is to do nothing. This may work for small, local lenders who know their customers and are in effect comfortable with a signature loan, but is obviously dangerous for everyone else.
The second method is to “Book-It.” This is a fairly common approach which has the benefit of being fast but carries with it significant inherent risk. First we’ll define what we mean by the term “Book-It” and then we’ll discuss the inherent risk.
The lender who uses the “Book-It” approach buys one of the value guides that is available on the market. At the point of approving credit this lender would look in the book to determine what the home is worth.
For example:
Let’s say this lender is reviewing a loan application for a 1991 Redman Venture Villa, 28 x 56. He looks up this make, model, year and size in the book and determines that according to the book this home is worth $26,561.
At this point he is done. He just “booked it”!
Now let me explain why that is not a good way to determine the value of a manufactured home and frankly why the “Book-It” approach should not be used at all for lending purposes:
1. The “Book-It” approach ignores condition.
The values published in the value guides typically assume that the home is in average condition. This may be the case but since the home has not been inspected we really don’t know. Since condition can impact the value of the home by as much as 40 or 50%, ignoring condition can be dangerous to the health of a lender’s loan portfolio.
2. The “Book-It” approach does not verify size.
The size that the lender was given, which was used to look the home up in the value guide, probably came from the title. However, it isn’t unusual for the size on the title to be wrong. Many title sizes include a three or four foot hitch in the length and can include as much as a full foot on each side of the home for the overhangs. Making the assumption that the home is four feet longer than it really is and two feet wider than it really is can result in the book value being overstated by as much as 15%.
3. The “Book-It” approach ignores location.
The values published in the value guides typically assume that the home is in an average location. This may be the case but since the location has not been inspected we really don’t know. Since location can impact the value by as much as plus or minus 20%, ignoring location can be dangerous to the health of a lender’s loan portfolio.
4. The “Book-It” approach relies on knowing the make and model of the home.
In order to look the home up in the value guide you need to know the make and the model of the home. This presents several problems. The first problem is that 50% of the time the model is unknown. You might know that it is a Skyline but you do not know which Skyline model. Since the value guides list as many as one hundred and fifteen Skyline models, each with different values, any attempt at selecting a model would be an arbitrary guess.
The second problem is that many times you need to know more than just the make and the model. Frequently you need to know the make, the model and the series. For example, let’s say that you determined that the subject home is a Skyline Homette. You open the value guide to Skyline Homette and discover that there are twenty-seven different types of Skyline Homette with a value range of $12,000 to $17,000 for the year and size of your subject home. Guessing at which end of the range your subject home belongs could result in overstating or understating the value of your home by 30 – 40%.
5. The “Book-It” approach creates the possibility of adverse selection to the lender.
The reason the “Book-It” approach may result in adverse selection to the lender is that a well-maintained home in a beautiful community may book out at significantly less than the sales price whereas a thrashed house in an undesirable community may book out at more than the sales price. In this situation the lender may inadvertently be willing to finance the thrashed house in the undesirable community and pass on the well-maintained home in the beautiful community.
6. The sixth reason not to use the “Book-It” approach is perhaps the most important. The value guide publishers warn that the value guides should not be used for lending purposes without an inspection of the home.
However, even with this warning many lenders still just “Book-It” because it’s easy to do — easy but dangerous to the financial health of a lender’s manufactured home portfolio.
Some lenders even use a variation of the “Book-It” approach in which they finance 120 – 140% of the book value. The reason some lenders do that is because they know that the average book value is too low so they increase it by 20 or 30 or 40% on the basis that the home probably has components and accessories that warrant this increase.
However that practice too is dangerous because the resulting value may be much too high in poor markets or for homes in poor condition, and may not be high enough in good markets or for homes in excellent condition.
Again, the result is adverse selection against the lender.
So much for the “Book-It” approach. Now let’s look at the “Inspection Adjusted Book Approach.”
This approach starts with an interior and exterior inspection of the home. The inspection process focuses on:
• inventorying the components and accessories of the home.
• evaluating the interior and exterior condition of the home.
• measuring the actual size of the home.
• assessing the desirability of the location.
Once the inspection has been completed the book value is modified, typically using the value guide publisher’s forms, to adjust the book value
based on condition, location, actual size, components and accessories.
Let’s see what might happen if we used this approach on the 1991 Redman Venture Villa, 28 x 56, we referred to earlier.
Based on the inspection we learned that:
• the home’s actual measurements were 27 x 53.
• the condition was above average.
• the components and accessories were inventoried and determined to have a value of $6423.
• the location was assessed to be significantly above average.
Based on this new information combined with the book value, it was determined that the home’s value was $42,549
So now we have a “Book-It” value of $26,561 and an “Inspection Adjusted Book Approach” value of $42,549
Which one is right?
Before we answer that question let’s look at one more way to determine the value of a manufactured home. We will refer to this method as the “Comparable Approach.” This approach can be used in conjunction with the value guides or independent of the value guides.
The “Comparable Approach” includes the entire inspection process as described in the “Inspection Adjusted Book Approach.” In addition to inspecting the condition and the location and inventorying the components and accessories and measuring the actual size, the “Comparable Approach” inspection also assesses the quality of the home. (The primary benefit of assessing the quality of the home is that the need to know the make, model and series as described above no longer applies.)
In the “Comparable Approach” the home’s value is determined by comparing it to recently sold, like quality homes with similar size, age, condition, components, accessories and location. For example –– if we found three identical homes that were recently sold for $30,000 we could safely conclude that the subject home was worth $30,000. However, since in the real world any two homes are probably not totally identical, the appraiser makes adjustments to compensate for the differences.
The “Comparable Approach” is the approach that has been used by the Real Estate Industry since ________.
Most people would agree that the “Comparable Approach” is the most accurate. However, many lenders do not use it because it’s a lot more work, takes time and costs money.
When we applied the “Comparable Approach” to our 1991 Redman Venture Villa we concluded that the appraised value was $36,000. This compares to the “Book-It” approach of $26,561 and to the “Inspection Adjusted Book Approach” value of $42,549.
I believe we can conclude that the “Comparable Approach” is the most accurate method of determining value –– but it is also the most difficult to do. In some markets it is almost impossible to find good, local, recent, comparable sales and it may take a little longer than the other approaches.
Now let’s address the question of how these various valuation methods might impact the profitability of a lender’s manufactured home portfolio.
Most lenders would agree that there is an inverse correlation between owner equity and the probability of repossession. In other words the lower the owner equity, the higher the probability of repossession.
Given this premise, let’s look at how an appraisal can help the lender certify that there is owner equity by reviewing the following example.
Let’s say Mr. Smith was the buyer of the Redman Venture Villa that we described above. Let’s assume that he paid $35,000 and put 10% down.
If the lender that Mr. Smith applied to for financing used the “Book-it” method to determine collateral value, a good loan would have been turned down because the “Book-It” value was only $26,561.
If the lender Mr. Smith applied to for financing used the “Inspection Adjusted Book Approach” method to determine collateral value, this home could have been sold for as much as $42,500 and the lender might still have approved the loan. A sales price of $42,500 would have put Mr. Smith into a $6,500 negative equity position and unbeknownst to the lender would have been a high risk loan because it may take years before Mr. Smith develops any equity in the home.
If the lender Mr. Smith applied to for financing used the “Comparable Approach” to determine collateral value, the lender would have had reasonable assurance that Mr. Smith’s equity was the difference between the $36,000 appraised value and the 90% of the $35,000 that was financed.
The conclusion of this analysis is that the more accurate the appraisal, the greater the lender’s assurance that the loans being bought are adequately collateralized.
In addition to accurate appraisals being sound business practice for today’s lenders there are two other benefits.
1. Accurate appraisals help lenders detect down payment fraud. (See Marty Lavin’s article in the October 1998 issue of the Merchandiser.) As Mr. Lavin indicates in his article, “While fraudulent loans are not certain to lead to default, they do lead to a much greater incidence of default.” In addition to the eleven excellent suggestions Mr. Lavin lists to reduce the incidence of sales fraud I would add one more –– Use a credible appraisal approach to verify the collateral value of the home being financed and the collateral value of the trade-in that is being used as the source for the down payment. In the case of the Redman Venture Villa, an “Inspection Adjusted Book Approach” appraisal may have allowed the selling price to be increased to cover for a nonexistent down payment. A “Comparable Approach” appraisal would have alerted the lender to potential down payment fraud.
2. Accurate appraisals increase the secondary market’s confidence in a lender’s portfolio resulting in improved probability of sale at perhaps better pricing levels.
So what should a lender look for in the process of determining the value of a pre-owned manufactured home?
I would suggest at least the following five components:
1. Make sure that a physical inspection of the home is being done.
2. Make sure that there is a location/community evaluation.
3. Make sure that no one is guessing at make/model.
4. Make sure that whoever is doing your appraisals is independent and has your best interests in mind. The reason I say that is because there is an element of subjectivity in appraising that can be used against you if the person doing your appraisals doesn’t have your best interest in mind.
5. Recognize that a comparable-based appraisal is more accurate than a cost-based appraisal but that it is more difficult to do.
Does Collateral Matter? (Part I)
Author: Ted Boers, Datacomp Appraisal Services
Bio: Ted Boers is the founder 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.
Does Collateral Matter?
Part I
Most of us have heard about the “C’s” of lending: Credit, Capacity, and Collateral. Most bankers recognize the need to take all these “C’s” into consideration in the process of evaluating the creditworthiness of a prospective customer.
The question that this article addresses is — How important is collateral when financing a manufactured home? Does collateral matter?
In today’s competitive financing environment there is a tendency to overlook the importance of collateral. However, because a competitive financing environment may result in financing loans on the more marginal end of the spectrum, collateral is more important than ever.
Combining marginal credit with inadequate collateral value may result in an unprofitable loan portfolio. One way to prevent that is to use an appraisal to evaluate the adequacy of the collateral as a standard component of the loan approval process.
There is a train of thought that suggests that collateral doesn’t matter; all manufactured homes depreciate and therefore financing manufactured homes is strictly a credit business.
Obviously credit is important but collateral does matter, and according to a study by the University of Michigan half of all manufactured homes do not depreciate. Studies completed by Datacomp Appraisal Systems confirm that fact.
Since Datacomp is in the manufactured home value business, Datacomp has studied value behavior, value trends, depreciation and appreciation for over twelve years. Datacomp research has consistently shown that many manufactured homes appreciate. It is also clear from this research that most homes that do depreciate do so at the rate of one or two percent per year. This level of depreciation is typically not a problem for lenders who verify that there is adequate collateral value as part of the credit approval process. If there is adequate collateral value at the beginning of the loan, the payoff balance tends to go down faster than the value, given a normal rate of depreciation.
So the key to maintaining a reasonable balance between loan payoff and collateral value is to accurately determine the collateral value at the beginning of the loan. That can best be done by an appraisal of the home.
We tend to blame depreciation whenever a home resells for less money than its original sale price. For example, let’s say a home is originally purchased for $35,000 and resold five years later for $32,000. Concluding that the home depreciated $3,000 over five years assumes that the home had a market value of $35,000 when it was purchased. That may not necessarily have been the case. Just because someone paid $35,000 for this home does not necessarily mean that it had a market value of $35,000.
Why would someone pay more for a home than it is worth? The main reason is that the buyer does not know what the home is worth. The buyer may be relying on the lender’s willingness to lend ninety percent of the purchase price as confirmation that it is indeed worth that much.
In this case the loss in value may not have been caused by depreciation at all but rather by the fact that the home was originally sold for more than it was worth.
Financing homes that are sold for more than they are worth dramatically increases the risk of repossession because the owners will have a difficult time selling their home for enough money to cover the payoff balance for at least the first eight to ten years of their loan. In addition, repossessions caused by inadequate collateral value tend to have higher loss severity.
So Collateral is important and it is clearly in the lender’s best interest to make sure that the collateral value is adequate to support the loan. Lenders who get an independent appraisal and make it an integral part of their credit decision process typically have lower repossession frequency and severity and more profitable loan portfolios.
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