In the second of our three part series, we’re going to discuss the current state of mobile home park economics – including cap rates, cash-on-cash returns, the importance of spread and other topics. Think mobile home parks offer higher yields that other real estate sectors? How high? We’ll examine that and other important issues on this podcast.
Money; we all like it, and if you don’t need it it’s still a great scorecard. We live in a capitalist country. So what is a mobile home park in relation to making money? Well, as an investment it’s proven to be pretty darn successful. Many people may have seen those Lakers games where you have the guy who always sits court side. He has on some pretty strange outfits I will admit. Typically there with one or two models, a fraction of his age. People always ask, “Who is that guy? What is he doing there?” He would never say who he was or where he got any money. And those court side seats, as we all know, cost 10 or $15,000 per game. So how was this possible? What was going on? At the end we found who he is. He’s a mobile home park owner there in Los Angeles.
Again, mobile home parks traditionally have been a great source of making money, but today’s we’re going to talk about basically where the investment type stands today. We’ve talked about the past, we’ve talked about the future; let’s talk about right now. That’s what really matters if you're trying to evaluate whether this would work for you or not as investment type.
First let’s talk about cap rates. Right now in the industry as we sit here at this very moment I see cap rates every day cross my desk, they’re in the range of 6% to 12%. That seems to be about the norm. 6% would be the highest of the high as far as quality of park in the most desirable locations, and even then, let’s be honest, it might be a bit of a stretch to make sense of it even then. However, that is not a cap rate that is that uncommon to see on flyers for some of the nicest parks that are for sale. However, at the same time, I see many, many other deals that come through that are the 8 and the 9 and the 10, and all the way up to the 12% cap rate. So if I had to guess what the range of cap rates are in America today I’m going to guess a range of about 6 to 12%.
Another fact we know as that financing right now runs typically about 4 to 5%. Whether it’s conduit or agency or bank or seller carry, it all seems to hover right now in that range of something with a four on the front or a five on the front. It hasn’t always been that way. When David and I got in the business 20 plus years ago it was seven. All of your interest rates had a seven on the front. We grew to believe that would be the norm forever. However, it hasn’t been, thanks to the great recession, quantitative easing, today those rates are down sustainably, down to again about 4 to 5%.
As far as the spreads go in the industry right now you’re looking at a two point spread all the way up to about an eight point spread based on those caps and financing rates. With a cap rate at a six, if you finance it at a four, you have a two point spread and a cap rate of a 12 and you finance at a four, it’s and eight point spread.
Now, you may be saying, “What the heck is a spread and why should I care?” Well, here’s the deal about spreads. The spread is the differential between the cap rate and the interest rate on your loan. And assuming you buy with about 80% LTV leverage, what you’re going to find is that a three point spread equates to about a 20% cash on cash return.
Let’s just model that out there in midair. If I bought a mobile home park for a million dollars and I put down $200,000 and I financed $800,000 at 5%, a million dollar park that I bought at a 10 cap … Let’s actually change the model up here. Let’s change the interest rates up just to make it simple. If I bought a mobile home park at a 10 cap at a million dollars it means it has an NOI of $100,000. So I have $100,000 of net income and that’s why I paid a million dollars for it at a 10 cap. If I set the interest rate at a seven just so we have this three point spread and I put down 20% or $200,000, so I have $800,000 of NOI, 800,000 at 7% is $56,000. Take 56,000 away from $100,000 you have $44,000. If you look at your down payment of 200,000, which is yielding $44,000, that’s a 22% cash on cash return.
Most peoples’ goals in the industry is to hit about a 20% cash on cash return. So as a result, you've got to have the three point spread. The message here is right now in the industry three point spreads are extremely abundant. I don’t personally know anyone down there who’s buying one and two point spreads mainly because I don’t really hang out with the rates, so I don’t really hang out with the guys at [ELS or Sun 00:04:57]. Some of them will buy stuff at cap rates so low that it’s mind-boggling.
I heard that someone bought a park at Laguna Beach recently. Not a very large park. They paid $80 million for it. Now, supposedly the spread was zero. So they bought the mobile home park at the same cap rate as the underlying loan. And the underlying loan rate I think was only 3%.
Now, you may say, “Well, how do you make any money with that?” I don’t know. Nobody knows. I can’t really tell you. Perhaps if your assumption is massively rising rents you could maybe someday eke out some kind of reasonable cash on cash return. But for the rest of us out there buying mobile home parks, big and small, the whole point of it is to hit a three point spread, which right now is not that hard. So if you’re going to be borrowing at a 4% interest rate, you need to buy something at a seven cap or better. 5% interest, you need to buy at an 8% cap or better.
The good news here is it is possible we have that. That is on the menu. If you were looking to buy apartments, if you were looking at buying office buildings, you’re going to find you can’t find three point spreads. They just don’t exist. Even self storage right now; if you’re looking for self storage with the three point spread good luck to you. You’re not going to find anything, because the way the markets have worked the cap rates simply are not allowing that three point spread do occur. Now is that smart or stupid on the part of people in those sectors? I don’t know. Personally, I think kind of stupid. I don’t think there’s that much room to grow the rents in mini storage or office or apartments. I think they’re kind of tapped out.
I also don’t think you can expect interest rates to be this low forever. So when those loans come back around again a decade from now I question that you’ll be able to refi at a 4 or 5%. I think you’ve got to have a big spread if you want to make money. Even if you just want to sleep at night knowing that you didn’t overpay for the property. That’s where the key items here, if we’re talking about the current state of the industry and the current state of the investment type is we offer that three point spread. That should be about all you need to know if you’re looking at getting into it. I don’t know when else you can get three point spread.
When I got in the mobile home park business to begin I looked at a lot of different asset types. I just sold my billboard company, I had money to invest. I couldn’t find anything out there that was in any way attractive other than mobile home parks. That was a different time in American history. I think today it’s even worse. I just don’t know where else you can find those three point spreads.
The good news is our industry allows you to actually hit 20% cash on cash returns or better. That’s frankly amazing in today’s real estate environment. That’s probably where the biggest news items there is in the current state of the industry is the fact we still have three point spreads.
Now, some other things you need to know about the current state of the investment type known as “mobile home park,” number one, it’s a bet on rising rents. Anyone out there who buys a mobile home park today, whether they know it or not, they’re in some ways gambling on the fact the rents are going to go up. I am a firm believer, I’m an enthusiastic believer. I’m even criticized for being so enthusiastic as to say that mobile home park lot rents in the United States are crazy stupid low. I don’t care how big an affordable housing advocate you are and who thinks it’s heresy to say that a product is too cheap, but they’re obviously way too cheap and they have to go up. They don’t make any sense.
I’m not saying this simply from the perspective of a park owner who would like to get more money. I’m saying this as a perspective of an economist, remember I had a Stanford economics degree at one time, and based on economics our lot rents are stupid. Now, why do I say that with such conviction? Many of the markets that we own mobile home parks in the medium home price is let’s say $100,000, and the average three bedroom apartment rent is $1000. My lot rate is sitting there on a national basis at $280 a month. How do these three compare? How is there any correlation in those three subsets of numbers? The answer is there’s not. It’s stupid. If the lot rent was $500 and the apartment was $1000 and the single family medium was 100,000, even then I'd say they’re stupid low. But 280 … Come on, give me a break.
There’s a restaurant not far from my house; about 10 miles away that sells barbecue. They’ve been doing it since the 1940s. Until recently they had a barbecued sandwich on there. I’m talking a bun with beef brisket, smoked, really tasty and sauce. That whole thing was 50 cents. Now, that makes no sense. Why 50 cents? You can’t go to Arby’s and get a little mass-produced roast beef sandwich for less than over a dollar. Why 50 cents? Well, they raised the price recently. I don’t think it impacted the sale at all. People still buy the sandwich in droves even though it’s two or three times as much now. Why? Because it’s still stupid cheap, but it used to be stupid incredibly crazy cheap.
But that’s not how economics work. We work in a world supply and demand. The demand drives up pricing and that’s how it works. That’s how it should work. Not how it worked in our industry, however, because moms and pops would raise their head and said, “No, I’m sorry Mr. Supply and Demand, we’re checking out of the economic cycle. We’re going to deliberately suppress our rents to an insanely low level just because we just kind of want to do that.” It just doesn’t make a lot of sense. We buy mobile home parks frequently where the prevailing market rent is 100% higher than what they’re charging.
I think if you look at the state of the investment today one of the big things that you’re doing when you buy a mobile home park is you’re latching onto a lot rent that is completely unsustainably ridiculously cheap that has no place to go but up. Let me point out to anyone listening who says, “Well, but you’re not be fair or honest, because apartments that includes the unit but your lot rent is just the land.” Here’s the state of the industry today; over 80% of our customers own their homes free and clear. 80%. So no, I am talking apples to apples. They could either live in the mobile home park and pay a lot rent that’s crazy stupid cheap or they can go buy a stick build or an apartment. But it is apples to apples, because that lot rent basically is coming with the unit.
The unit in some of these situations is only valued on the tax rolls at $500 or $1000. So let’s be honest, that price still includes their entire housing payment, and it’s ridiculous how low that that total housing payment is. Now, more power to those folks who’ve been able to do this, but at the same time, it doesn’t make it economically right.
I talked to Charles Becker, the economist at Duke that studied the industry a while back. He’s writing a paper on lot rents in America and why they’re so cheap. One of the key takeaways was our moms a pops never kept up with inflation. If you look at mobile home park built in the 60s where the lot rent was 50 a month, that lot rent today would be 500 a month if you just look at 1960s dollars, but yet it’s not. It might be 250, it might be 280, it might be $300. They never kept up with inflation and that’s why you have such a big change between what the market would support and currently what they’re charging. They just simply did not do a good job of keeping the lot rents up to par.
Also today if you’re buying a mobile home park you’re definitely also betting on filling lots. Virtually every park you’ll see to buy out there is going to have anywhere from 10 to 30% vacancy, maybe even higher in some markets like Michigan. Why is it vacant? Well, it shouldn’t be vacant. We are absolutely dripping in people needing affordable housing in the US. HUD is turning down three out of every four applicants for affordable housing because it has no money. It doesn’t mean those people found affordable housing elsewhere; they did not. America needs affordable housing badly. So why do we even have vacant lots? It’s very simple. The government’s done nothing to foster the average American’s ability to buy a mobile home from the dealer. Nothing more than that.
If you go down to any dealer in America and want to buy a mobile home let’s look at what you have to provide. Number one, a really high credit score. Number two, which is nearly impossible is, 10 to 20% of the purchase price of the home. So if you’re looking to buy a mobile home for $40,000, you’ve got to come up with between 4 and $8000. Now, it seems very unfair because the government helps you to get only 3% down on a stick build. Yet we’re wallowing in there at 10 to 20% down. How is it fair? It’s not. A lot of that will be solved over time under the concept called “duty to serve.” This is a mandate in America that is not new, but the concept that, “Oh gosh, we better go ahead and follow it," seems to be.
Suddenly the government is feigning that they never noticed we had an affordable housing crisis before and they’re trying to find new ways to solve it. That’s fantastic and I’m glad they are, but they need to hurry because every day that goes by someone does not have a place to live that’s either nice or safe pr clean or that they can afford. How are they going to do it? There’s discussion that Fannie Mae and Freddie Mac may start helping people get mobile home loans, and that would be fantastic. There’s also the new section 8 voucher program, H.R. 3700, that’s been passed in Congress but has still not been enacted, which that is a scandal in my opinion unto itself. But hopefully someday they will get around to enacting the laws that have been passed and giving people the ability to own something at an affordable price. When that happens, again, we’re talking all about filling lots.
Any way you cut it, all of the writing is on the wall that all these vacant lots in these parts will over time be occupied, but there has to be some help. One big program that’s helping is the CASH program from 21st Mortgage that allows park owners to bring homes in and sell them in position directly through CASH. So the park owner has no out of pocket if it works properly. On top of that CASH actually underwrites the customer so there’s no SAFE Act or Dodd-Frank concerns on the part of the park owner.
The bigger item, if we’re talking the state of the investment today, is that over time you should see growing occupancy. Those are two great things that we see going on right now going forward is going to be rising of rents and rising of occupancy. It’s not in order to gorge customers again on the rent side; it’s simply to get the pricing in line with market. Market forces are what fuel American capitalism. Supply and demand are formulas that have gone back in time, all the way back to the Holland tulip bulb crisis back in the 1600s, and you can’t get away from them. What’s going to happen is people needed affordable housing, people who compare the pricing of apartments over stick build will over time realize that if double the lot rent, or even triple the lot rent in some markets, is still by far the best alternative and definitely where things that should be.
Also, that going forward in the current state of the investment that more and more, until ultimately all park owners, bill back water sewer to the resident. This is a big deal because water sewers are a single largest cost item. So if you can bill back water sewer the customer, you could effectively eliminate the largest single line item on your P&L, and it’s the only fair way to go. Can you name me any other form of housing that includes water sewer? I can’t. Everywhere you go today everyone is getting onto the bandwagon and making the customer pay for their own water and sewer. Why should they? Because it fosters conservation. It allows people to have a budget based on what they want to spend. When you make everyone pay a flat water fee, which is what you do effectively whenever it’s included in the lot rent, you’re guesstimating water sewer for everyone, they have no ability to impact their own finances.
If someone says, “Hey, I need an extra $20 a month; I’m going to use a lot less water and sewer,” that should be their choice. That should be there right. It’s crazy having people all having to pay a set amount regardless of what they use. When that happens they think, “Well, I might as well use as much as I can because I think my neighbor is, and I’m paying for their water anyway,” and it’s wrong. In many states in America we’re really short of water. Look at New Mexico, look at California, look at Arizona, look at Nevada, water is becoming scarce. The only way to foster conservation is to bill back water sewer the resident. And oh, by the way, it also is great for park owners because it eliminates our largest single line item.
I think as the industry matures and you see more park owners getting involved in it and bringing professional management, you’re going to see more and more people pushing water and sewer back on the customers. But the good news is even right now it’s the norm. If you’re looking to buying a mobile home park today, right this second, you’ll see that old mom and pop probably gave all water and sewer free in the lot rent. You’re also find in that market if you call around most everybody has either stopped doing that or is in the process to stop doing that. So get another great driver to P&L throughout America for mobile home parks is a rising tide that park owners are no longer going to provide free water and sewer, but instead foster conservation, they give people the ability to control their own destiny, their own budget, and allow them to choose how much water and sewer to use themselves, knowing full well that they have to pay for it.
So again, that’s the investment today what we see out there. We see very attractive spreads. We’re seeing very attractive futures on lot increases, on occupancy and water sewer costs. Next, on our next podcast, we’re going to talk about the investment environment today. Should be very interesting. We’ll talk to everybody again soon.