In this episode, Frank Rolfe discusses the critical numbers you need to hit when investing in mobile home parks in order to get maximum return on your investment.
Welcome to Mobile Home Park Mastery. This is Frank Roth. Today, we're going to be talking about the mathematics of the mobile home park, how you value a mobile home park, and even more important, how you make money with a mobile home park. We're really going to be talking about money, but also some bigger picture concepts that tell you some tips you need to know in order to make money with a mobile home park.
Let's start off with what is the typical spectrum of revenue and expenses on a mobile home park just to get you in the feel for how they work. On the revenue side, you typically have one overreaching revenue item, and that is lot rent. A mobile home park is all about renting land. That's what makes this unique. We don't want to own the home you live in; we just want to rent you the land underneath the home you live in. Lot rent is our bread and butter. That is our key business. However, some mobile home parks will also have some other income items: late fees, the mobile home rent themselves. Some people have mobile homes that they own in their park that they rent out. Vending machine income, laundry income, many other small items but the bread and butter and the only number I want you to focus on when looking at the economics of a mobile home park is the lot rent. The land rent. That is where the money is.
We don't even use in our calculations the home rent, the late fees, vending machine income, laundry room income. We don't even use that in our initial calculations for the simple reason, you can't put 30-year debt on that kind of income. The only thing you can put a 30-year note on is real estate income, and that is the lot rent. On the expense side, what are the typical expenses you have in a mobile home park? Well, you have a manager, you have utilities. Many mobile home parks pay the water and sewer for the entire park. You've got trash, electricity, in some parks you have gas, so utilities are the biggest part of what you pay. Then beyond that, like all real estate, you have to pay taxes. You'll have repair and maintenance, but the bottom line is there's not a lot of cost. A typical mobile home park, you only write roughly 10 checks per month. It's a very, very simple business. It's not complicated.
It's not like owning a manufacturing plant. It's not even as complicated as owning an apartment building where you have to do all those repairs and you have to really drill down on how you're going to try and make money managing, battling the tenants, constant turnover, repairs, capital costs, and replacing roofs. Very, very simple model. There really is no real estate model simpler than renting land. If you look back in fact in the earliest beginnings of real estate, John Jacob Astor in New York City. What did he do? He rented land. That was his model. He liked just renting land. He wouldn't build buildings; he would just rent the land to people. I might suggest that renting land is the most basic and the earliest form of real estate if you really look at it, but that's what we're in. We're in the land rental business.
You might say, "Well if the model is that simple, then how the heck does anybody screw it up? How come everyone can't make a fortune in mobile home parks? What's the deal there?" Well, we own currently about 260 mobile home parks. We're the fifth largest in the United States, and so we've done this over and over again. It kind of is mind-boggling why most people haven't figured it out, but let me give you the secret to making money with a mobile home park. Number one: only use lot rent in your calculations, and number two: always focus on getting a three-point spread. What's a three-point spread? Well, a three-point spread means that the difference between the interest rate on your mortgage and the cap rate that you buy the park on is three points. Now, you probably already know what the interest rate on a mortgage is. That's easy. You have a loan and let's say it's at 5%, but what the heck is a cap rate?
A cap rate is a feature of real estate that allows people to compare the value of deals and the performance of deals, so it's really no different than having RBIs in baseball or double doubles in basketball. What a cap rate is, it's a fraction. On the top part of the fraction is the net income from the property, and the lower part of the fraction is the cost of the property. What you then do is you divide the upper part of the fraction by the lower and that's your cap rate. If you're looking at a mobile home park that has, let's say $50,000 a year of net income, you'd put $50,000 on the top part of the fraction, and the cost to buy that park is $500,000. You put that in the lower part of the fraction. You divide $50,000 by $500,000, what do you get? 10%. On that deal, the cap rate is 10%. Going back to my spread analysis, what does it mean? It means to make money, big money in mobile home parks, what's an issue is the cap rate, which in that case was 10%, and then the spread between the cap rate and your interest rate on your loan.
Let's assume right now you get a loan and it's at 6%. On a 10% cap rate, you have a four-point spread. That's a fantastically good number. A four-point spread is going to give you a cash-on-cash return somewhere in the high 20%. For most people in real estate, the dream goal is the 20% return. 20% cash-on-cash has kind of always been the benchmark separating great deals from average. In mobile home parks, it's very easy to get great deals. Why is that? Well, typically when we're buying a mobile home park, we're buying directly from the mom-and-pop who's not that sophisticated at pricing. That's item one. Item two is there's a general stigma to the industry that holds back most people from investing in it. You have all these zillions of people who invest in apartments and single family, but a tiny, tiny fraction that invest in mobile home parks. Through supply and demand, it just keeps the cap rates extremely high.
Another item is that in most mobile home parks, because mom-and-pop lost interest in the business a decade or so ago, there's all kinds of things you can fix instantly to increase your net income. Those typically fall in the realm of raising rents or increasing occupancy, or cutting costs. The reason mobile home parks have been so lucrative for people has simply been because they offer such a terrific spread between the interest rate and the cap rate. What you need to do to get a 20% + cash-on-cash return is you got to have a spread of three points. That's impossible in apartments and retail, and office, and anything else you name. Three points doesn't exist. Let's model to that for a minute. Right now, a bank interest rate in the US is typically around 5% to 5.5%. To get a three-point spread, you'd have to find things that are priced at an eight to an eight-and-a-half cap.
Well if you look at apartment deals out there right now, you're never going to find that. Apartments are typically priced in the six cap, maybe a seven cap at the most. What does that give you? That gives you maybe a point-and-a-half to a two-point spread, and that's about it. You can't get to 20% on a two-point spread. Mobile home parks are really the only thing out there where you can get the three-point spread, and again, the three-point spread is what gives you that super high cash-on-cash return. Can you even do better than a three-point spread. Certainly. We do it all the time. You can also do it. You can find deals right out of the chute, or sometimes priced at a 12 cap. The interest rates are right now at about 5%, so what does that mean? That's a seven-point spread. That's an amazingly high cash-on-cash return.
Now, a couple asterisks of what I just said. Number one, that is predicated on the idea that you get a loan that's roughly about 70% to 80% loan to value, which means if you're buying a property that's $1 million, that's assuming your loan will be $700,000 to $800,000 in size. You have to have that kind of leverage to make the three-point spread work. If you buy a property for all cash, sadly all you're going to get as your total return is your cap rate, so there is some element of what we call "sensible leverage" required to get that three-point spread to give you those kinds of high returns. Also bear in mind, when we did the cap rate analysis a moment ago, the lower part of the fraction, the price of the deal and these don't include any major capital expenditures you're going to make right after you buy it.
If you're buying a deal for $300,000 and then you're going to have to put in $100,000 of new roads or new water lines or whatever it might be, you're really paying $400,000. It's not just the price; it's the all-in price of the deal and improvements on the lower part of the fraction. Assuming you've got the price correct of what it is for the deal and the improvements on the lower part of the fraction, and the true net income on the upper part of the fraction, and you divide the upper by the lower, that's your cap rate. If your cap rate is three points greater than the interest rate on your loan, assuming you've got a 70% to 80% loan to value ratio, then you'll be right off the bat up in the 20% cash-on-cash return level, which is the zenith for most sectors of real estate. They dream of getting there, but in mobile home parks, you kind of get there from day one.
Let's model this together just to show you, I cannot demonstrate enough, the value of the spread. Let's assume you're looking at a mobile home park that makes $100,000 a year and it's $1 million. That's at a 10 cap. Let's assume you're buying that mobile home park utilizing a loan of, let's say, 80% loan to value. You have to put down $200,000 on the $1 million price, and you have a loan for $800,000. Since the cap rate is at 10, let's make the interest rate 7%. Although that's higher than it would be right now, but that gives us the three-point spread. 7% interest on $800,000 is $56,000. We knew that the park makes $100,000 a year. $100,000 minus $56,000, leaves $44,000 per year, and that $44,000 is your return on your $200,000 down payment. That is a 22% cash-on-cash return. It's as simple as that.
The reason that we've done so well the last two decades with the park that we've owned and so have so many other people is the simple fact that we are allowed in the mobile home park industry to find deals that maintain that three-point spread. It's not because we're magical operators or that we have the Midas touch. All it ties back to is that simple little quirk in math of the three-point spread. Now with that being said, let me also caution you that interest rates are going up. To maintain the three-point spread, you often have to be very aggressive, very proactive to make sure that you keep that spread at the forefront. Right now, interest rates are running on most mobile home park deals about 5% to 5.5%, but as quantitative easing is relaxed, and what that is, that's a thing that began under the Obama Administration after the 2007 Great Recession began to liberally try and jumpstart the economy by keeping interest rates artificially low. The government went in and suppressed interest rates by buying all these securities themselves, and that is called quantitative easing.
As it goes away, because you can't keep quantitative easing going on forever, right now it's in its tenth year of happening. As it goes away, you're going to see rates probably go up about another point. Those 5% and 5.5% interests will go up to 6% to 6.5%. That means you need to be buying mobile home parks in that event that are at least a 9% to a 9.5% cap rate. If interest rates should inch up a little further from there, you're going to have to raise your rents enough to maintain that healthy three-point spread. It also means when you're out looking at deals, don't let brokers try and convince you, "Oh, you don't need high cap rates anymore. This is the new America. Interest rates are always going to be super low." That's a total lie. Interest rates cycle. They always have since the beginning of time. In 1776, interest rates were around 7%. That's crazy, right? Over 200 years ago, interest rates were a couple points higher than they are now. What does it means? It means interest rates cannot stay this low forever, and you have to be ready when they go up to accommodate that by raising rent.
Don't for a minute ever be convinced that interest rates are stable and that they're stable low. Those who lived through the Reagan era will remember interest rates in the mid-teens. I've seen, lived through, and owned a business during the highest interest rates in American history. I've also lived in and owned a business in the lowest rates in American history, which is what we've seen since 2007. One more footnote, I don't think you'll ever see Reagan-style interest rates return. Why do I say that? Because the government will go bankrupt very quickly. When Reagan raised those rates so high to try and save the economy back in the '80s, the US deficit was very, very small. Our total federal debt was I want to say maybe a trillion dollars, something like that. Today, it's about $20 trillion. We are the biggest borrower on the Earth.
If you had to start paying on that $20 trillion an interest of, say, 12% or 14%, the government would go immediately in solvent. We would have no government, we would have no army. No police, no fire, no nothing. We'd go back to a hunter-gatherer society living in our homes and hunting in our yards hoping to catch a deer or something. I don't see anyone will ever allow interest rates to go up like they did under Reagan, but I do see interest rates over the long term returning to their normal, healthy level, which is about a point higher than it is currently. Always be watching for that when you're buying mobile home parks to make sure that you maintain not only a three-point spread, but that you have the capability to keep that spread as interest rates rise. Typically that's done through raising rents or it might be cutting costs. It might be filling lots, but regardless of what it is, you as the asset owner, as the mobile home park owner have to make sure that you maintain that healthy spread. Spread is where all of the money comes from.
Basically, I want you to remember two items from this podcast: number one, the key to the mobile home park industry is land. Renting land. Just focus on renting land. Only use the numbers that come from renting land. Number two, the way to make 20% + cash-on-cash returns comes from the spread between the cap rate and the interest rate. You must always maintain that as being roughly three points. If you can remember those two items, it will always keep you out of trouble when you're out looking at mobile home parks, and it may also answer why mobile home park owners are so successful in making money. It's as simple as that. This is Frank Roth with Mobile Home Park Mastery. I'll be talking to you again soon.