Although economists are confused on the exact timing of the pending recession, there’s one thing they all agree about: the continued issue of U.S. inflation. Under Biden inflation has soared from around 2% to nearly 10% -- the highest increase in 40 years. And most are asserting that inflation cannot be tamed by the Fed’s action on raising interest rates over 4 points and will probably never be lower than 4% again. So what’s the true story about the impact of a permanent higher inflation level on mobile home park ownership?
The Good News
A perpetually higher rate of inflation is not altogether bad for mobile home parks for a number of reasons which include:
- Real estate has historically always benefitted from inflation. Inflation is not new to the U.S. and there is historical precedent regarding its performance in the investment arena. It has been well-documented that the top performing sectors during inflation are precious metals and real estate. The reason is simple. Inflation leads to higher rents and higher income, which equates to higher valuations. Meanwhile, the debt on the mobile home park remains static. This is the classic formula that has propelled real estate to the top of the pack – the simple fact that loan leverage fuels a faster return on your money. And, unlike gold and silver, mobile home parks pay cash dividends while gold and silver do not, nor can you typically get leverage on the purchase of precious metals.
- Mobile home parks have a relatively low expense ratio so the impact is reduced. Most mobile home parks have an expense ratio of 30% to 40%, That means that only 30 cents to 40 cents of every dollar is an expense that increases with inflation. Compare that to a grocery stores which typically have expense ratios of 95%. When their cost of goods sold goes up, the amount of inflation pretty much is how much you’d have to raise prices just to break even. But if mobile home park rents go up with inflation and expenses go up with that same rate, the park owner is still coming out on top because 60 cents to 70 cents of every dollar was profit and there was no increase on that portion.
- Mobile home parks have the ability to raise rents faster than inflation. This is the big difference between mobile home parks and other real estate sectors. With the average mobile home park rent in the U.S. at around $300 per month, there is plenty of room to literally double that rent level and still be highly affordable. However, apartments nationwide average around $2,000 per month so the ability to boost that rent to meet inflation is dubious.
- Buying mobile home parks protected from inflation is still attainable. We have always advocated buying mobile home parks with a healthy spread between loan interest rates and cap rates. This spread is what allows park owners to hit double-digit cash-on-cash returns. A spread of two points or more is not possible in most real estate sectors because the market is too competitive. But mobile home parks have always suffered under a “stigma” that has kept most mainstream investors away and that is now giving park buyers an advantage.
- Affordable housing is the big winner when the economy goes down the tubes. Just like the Dollar Store, mobile home parks are all about providing the cheapest form of housing in the U.S. That’s the product that has been in hot demand for over two decades, and only keeps rising in demand.
- When the rates go down again you will make huge profits without changing the net income. If you buy a mobile home park at a 8% cap rate and borrow money at 6%, you will look like a genius if interest rates retreat to 5% or 4%. Here’s the math. Assume you bought a mobile home park at a 8% cap rate for $875,000, and it makes $70,000 per year in net income. Then assume you borrow 80% of that price at a bank and pay 6%. If the interest rate on that loan drops to 4% then you make an extra $14,000 per year directly to the bottom line without doing one single thing better with the property.
- Economic downturns cause many mom and pop owners to sell. It’s a well-established fact that mom and pop owners typically get the desire to sell when the U.S. economy is doing poorly, even though common sense would tell you sell when times are good. The reason is simple. Many mom and pop owners are just like everyone else: bad news depresses them and they decide they want to just retire and not worry about the economy anymore. It’s the same reality that northern owners sell more in winter when it’s freezing outside and southern in summer when it’s unbearably hot. After all, sellers are just people.
- Seller financing is one way to escape the lender ramifications. One way to escape the financing industry altogether is simply to buy with seller financing. This is the alternative to banks, higher interest rates – all kinds of issues. And mobile home parks are one of the last sectors you can still obtain seller financing in. The reason is simple: most mom and pop sellers own their properties free and clear. A seller with debt on their property can rarely engage in seller carry.
The Bad News
Now let’s focus on the bad attributes of inflation when it comes to mobile home park buying and operating, which include:
- Higher interest rates mean higher cap rates. If you own an existing mobile home park, your value is based on the cap rate the appraiser uses, and higher rates mean lower values. To hit the value you had in January 2022 you will have to either wait for interest rates to go down again or increase your net income a corresponding number. Most economists predict rates to start declining between Q3 of 2023 and Q3 of 2024. Nobody knows the answer.
- Some sellers refuse to accept this. While this is a inconvenience to park owners, it’s a dire threat to those trying to sell their properties at the values of less than a year ago. As a result, many sellers will hold off until they build up their net income with rent increases or rates decline, which will reduce the number of parks on the market in many cases. This, of course, is offset by the general malaise of a down trodden America when will shake lose some properties that were on the fence about selling and now just want to cancel their newspaper subscription.
- Lenders always go to a “flight to quality” when things are in turmoil. Another side effect of inflation and market instability is the regular movement of lenders to higher quality properties. This means that buying parks with failing infrastructure, high vacancy and similar issues will be more difficult when it comes to finding a loan.
- Rate adjustments on existing loans. Many mobile home park loans have variable rates, and even those on fixed rates come up for periodic renewal. Higher inflation results in higher interest rates which equates to higher loan payments.
- Generally just a depressing time all the way around. One of the worst byproducts of high inflation and economic calamity is that it’s just a generally depressing environment to live in. Of course, that’s true whether or not you own a mobile home park. Have you ever seen more depressing news that right now? I haven’t since the 1970s.
Like everything in life, there are good and bad parts to every occurrence. Higher inflation is no different. You need to position yourself properly for what may be a protracted level of inflation at rates not seen since the days of Jimmy Carter.