The average car in the U.S. has an engine with 120 horsepower. Yet there are engines out there with ten times that much power. Mobile home parks are no different, as they often have ten times more cash-flow ability than more conventional forms of real estate. How much horsepower does a mobile home park have and how can you gauge it? In this week’s Mobile Home Park Mastery Podcast, we’re going to review where the horsepower in a mobile home park comes from, and how to calculate its maximum output using some key metrics.
Few people can look at that rectangular piece of metal known as an automobile engine and tell you just on sight what the horsepower could be. But an automotive engineer can do it using a calculator and some basic facts. This is Frank Rolfe, Mobile Home Park Mastery podcast series. We're going to be talking about park horsepower. How to calculate it and what it really means.
Now, in the world of automobiles, horsepower is the power that transferred to your axle, to your wheels, that makes the car go. The more horsepower typically, the faster the car can go. Of course, there's a lot of additional variables like the weight of the car and the type of tire and the type of terrain but by in large, the more horsepower in the engine, the better for the typical driver and also the greater the cost.
In the mobile home park industry, horsepower actually has a different name. It's know as EBITA. EBITA stands for earnings before interest, taxes, depreciation and amortization. Basically true cashflow. EBITA really means the revenue less the expenses before any additional items are taken out that have nothing to do with actually how much money it makes. Such as your note payment, your personal income tax and depreciation.
Now to calculate the maximum, EBITA or horsepower in a mobile home park, we've got to know just a few items. The first is how many usable lots the park has. The second is, what are the market rents? The third item is, what is the utility system constructed like in the park? And then finally, are there any bill back regulations that would preclude you from having the residents pay their own water and sewer cost?
Let's model this out to start off with. Let's say you've got a 50 space mobile home park, the market rent is $300 a month, so you have 50 times 300, 15,000 times 12. $180,000 of potential total revenue and we deduct from that the expense ratio. If you've got city water and city sewer and you are allowed to bill it back, in that case, you would have 180,000 times .7 because you have a 30% expense ratio, would be the industry norm in that construction and that would give a total EBITA of a $126,000 a year. Pretty good for a 50 space park, I think we would all agree.
If however in the same park, 50 time 300, times 12, $180,000 of revenue, we can't bill the water sewer back to the resident but the park must pay it itself. Either because you have private utilities or the law does not allow it. That's going to give you a 40% expense ratio and that's going to yield a potential EBITA or horsepower of $108,000 a year.
That's how we kind of calculate what is our total horsepower or in this case, EBITA of a mobile home park. What else do you know about those variables before you can even do the calculation? Well the first is, how many truly usable lots you have. Let's say that mom and pop has a mobile home park and it's got 50 lots but of those 50, 10 of those are small, they can only be used for RVs. Now let's change the calculation. Now instead of 50, we've got 40 times 300, times 12. And then, let's assume again, the residents are paying their water and sewer so 30% expense ratio. Now our EBITA or horsepower has dropped to $100,800 a year.
But now let's turn to the rents. Let's assume that mom and pop are charging a rent right now of $300 which we just modeled but in fact the market is $400. Therefore we know after closing on the park, over a small number of years we'll able to bring the rents up to market levels. Now we are at 50 times 400, the market lot rent, times 12, times .7, assuming the residents pay their own water and sewer. Now I've got an EBITA or a horsepower of $168,000 a year. Significantly higher.
What does it all mean? If I can calculate the EBITA, then I calculate how much money the park can derive so shouldn't I always be looking for the parks with the highest ability of creating EBITA? Possibly yes but not always. There's still more things that we need to know. One is, what is the risk I must incur to create that horsepower? If I am buying a mobile home park with 50 lots, with 50 occupied and my rent is below market, all I have to do to tap into that horsepower is basically raise the rents. Assuming there's no laws in that state. Assuming the rents are fair. Assuming you can do it in a manner where the residents are happy by putting capital expenditure back in the park and making it a better, more professional place to live, there's not much that can stop me from raising the rent and therefore that's a fairly safe bet.
But what if I was buying the park with only 20 occupied and I have to fill 30? Now I have much more risk. I've got to buy homes. I've got to bring them in. I've got to run ads. I've have to show and rent or sell the homes. That's a lot of work and I don't have a lot of control on some of those steps. I have no control over the quality of the people who come in and apply to buy. I don't know their credit. I don't know their down payment. Clearly, tapping into that horsepower's not always the same. Some properties it's easy and some it's much more difficult.
If I have to get involved in a property which much more difficulty I have to have a much larger reward. In that case, the horsepower may be achievable but we also have to put an element of risk on it. You've got to be able to figure out risk reward.
Sam Zell wrote a book a while back called, Am I Being Too Subtle? And in the point of the book was, you always want to buy things that have low risk and high reward and never buy things that have high risk and low reward and that's also part of the horsepower of the park. Determining whether or not it's really worthy of that investment, is how easy will it be to get that?
Another issue is, the cap rate because a correlation of that horsepower is always the overall value of the property. Sometimes, the higher the EBITA doesn't always result in the higher the value. Let's assume for example, that the park has a really poor location. It's in a rural area or an undesirable area. Then, you may have to sell that down the road at a higher cap rate. That means the actual overall value of your engine, despite having good horsepower or EBITA, it still may not be as high as you originally thought.
And also don't forget this, part of the horsepower calculation of that mobile home park is not just the cashflow that we just calculated. Not just the EBITA but the overall change in value when you go to sell it. Some mobile home parks show as much additional horsepower when people sell them as they did along the way when they operated them. For example, if I bought the mobile home park we just described at a $100,000 per year EBITA, and I was able to raise that over a five or seven year horizon to $200,000 of EBITA, I've effectively doubled the value of the park. When I go to sell it, I have to take all that income I derived upon sale and work backwards and figure out how much I had really made along the way over all those years. In some case, that may double the amount of EBITA that I constructed.
The final cap rate that you apply, the final price that you sell it for has also a big bearing on that overall value. And once again, you have to look at both components, the price in the end versus what you paid and additionally the amount of horsepower, EBITA it creates. Decide, was it really a smart buy or was it not?
And to really figure that out, we've got to know a lot more about the market dynamics. Is this in a large metro area? Are the home prices high? Are the apartment rents good? Even such items as the permit itself. What's the risk of the city trying to block you from bringing in new lots? What's the potential for the city to try and cause you problems or grief as you go along? There's really quite a few elements we have to factor in to our overall horsepower calculation.
I guess one thing you're hearing here is that most mobile home parks have the ability to increase their horsepower a lot. I've been criticized often for commenting that lot rents in America are far, far too low. But I can't make down from that assertion because it's completely true and fully supportable. Don't believe me? Just listen to Charles Becker at Duke University. An economist at Duke, Becker wrote a paper here a couple years ago to declare that lot rents in America on mobile home parks were far too low. He has no political ties to the industry. He doesn't own a mobile home park. It wouldn't matter to him whether he said they were too high or too low. He was simply trying to make an observation based on fact.
What's happening across America is, most of our lot rents are far too low because moms and pops didn't want to raise them. They were concerned that it would drive out their residents and equally, they enjoyed a lot of the affection on the part of the residents and they were afraid if they raised the rents, people wouldn't like them anymore.
However, that mom and pop quantitative easing really isn't part of a modern America. As the industry matures and it's sold to more groups that are trying to run these as professional businesses, they're going to be less concerned about getting Christmas cards and more concerned about providing good rates of return to investors.
On top of that you have the fact that you've got to have higher rents in order to put in the correct capital expenditures to update the parks. And further to make them worth more as a mobile home park than some other use. Regardless, the rents have a lot of room to go. When we're looking at the horsepower or a mobile home park, how many lots we have versus how many lots are occupied, that variable is one option we have to gain horsepower, filling vacant lots but the biggest part of the engine, the biggest driver in most parks is just raising the rents.
And the others we've discussed is the utility bill back situation. America today, we're trying to conserve utilities. Water, sewer is very precious in a lot of markets. There's no way to cause conservation unless people are accountable for their use. It's our observation in most mobile home parks, the water sewer usage amount drops by roughly 30% when you first install the meters.
Again, those are the three main drivers to EBITA or horsepower to mobile home park. Total number of lots, the market rent and if you can bill back water and sewer. That's so much easier than trying to figure out and calculate the horsepower on an engine. And, unlike the engine, it's much more profitable. A lot of people like cars. I like cars. I admire cars that people have fine tuned the horsepower. I admire hot rods and all kinds of super cars and everything else known to man. I live in Missouri, it's a car culture here. We're always looking at cars, going to car shows. But let's face it, if you eke another 100 horsepower out of the engine on that Chevrolet, probably not as profitable use of time as eking an extra $50,000 out of the EBITA of a mobile home park.
Again, horsepower's always an interesting topic and every mobile home park does have an ultimate horsepower. You can actually map out where it will top out at. And the only variable to what you map out is going to be if over time you can raise the rents even higher.
This is Frank Rolfe, the Mobile Home Park Mastery podcast series. Hope you enjoyed this discussion of mobile home park horsepower and we'll be back again next week.