Webster’s Dictionary has two meanings for the word “interest” 1) the quality of exciting curiosity and 2) money paid regularly at a particular rate. In this week’s Mobile Home Park Mastery podcast series, we’re going to combine the two together and discuss the curious puzzle of making sense of interest rates. You’ll see that there is a methodology based on risk and reward, and that today’s interest rates regarding mobile home parks and homes are really fair in all regards. Do we have your “interest”?
What do you think of when I say the word interest? Many people would say curiosity, but others would think loan payment. So I thought we'd combine those two together and have a little curiosity about loan payments and interest rates, and talk about interest rates, and are they or are they not really fair in the mobile home and mobile home park industry? This is Frank Rolfe, The Mobile Home Park Mastery podcast series. We're going to be talking all about interest rates and let's start off with the way we're going to evaluate each of these items.
Sam Zell is the largest owner of mobile home parks in the US through his publicly traded REIT, known as ELS. And he wrote a great book here about a year ago called Am I Being Too Subtle? And throughout the book you'll see the way that Sam Zell looks at life is on a risk reward format. His theory is you always invest in things that have high reward and low risk and you never invest in things that have low reward and high risk. So I think that's a great way for us to look at these interest rates to decide whether or not they seem fair.
So let's start off with mobile home park financing interest rates. So this is what you would have if you were buying or refinancing a mobile home park. Now, the current rates as of this moment are roughly... and again, these are very rough. The change's totally dependent based on the bank, the type of loan you have, many other factors. But roughly seller financing, which is how many people begin, is at roughly about right now 5%. Bank financing often is a little higher. It runs often right now based on the size of your loan from five to 6%. Conduit, also known as CMBS debt, ranges right now from about 4% to 5%. An agency, which is Fannie Mae and Freddie Mac, this is the highly aggressive newcomer to the block because right now over 50% dollar value of all mobile home park loans in the US each year come from Fannie Mae and Freddie Mac, collectively called agency debt. And their interest rate right now is roughly again, 4% to 5%, so the question is, is that fair?
Well, let's talk about that for a minute. Now, banks typically pay out the people who put money in the bank, one to 2% if they pay anything at all, a lot of check-in accounts garner no interest rate at all. So basically the bank is making about three to four points roughly on your loan. So if you put out a million dollar loan on a mobile home park, that means the bank would make roughly 30 to $40,000 a year of profit. So is that fair? I think it's fair. I think that that rate is about correct.
Of course, mobile home parks have risk. You always have risk in anything that you buy or you get a loan on, but they have either the lowest or next to lowest default rate in the United States. So each year if you look at all the different real estate niches, you'll always see mobile home parks is right there at the very top of the best lowest default type of loan. It competes typically head-to-head with self storage, although it's been edging self storage out in recent times. The problem is with self storage you always have people building new self storage facilities, whereas mobile home parks, there are never any new supply. So for that reason I think over the longest term you'll see mobile home parks will be the clear champion. But again, I think those rates are pretty reasonable. They offer of the bank, a reasonable return based on a reasonable amount of risk.
Now let's move on to capital partners. A lot of people out there, particularly, they build bigger portfolios. They ultimately run out of their own capital and have to seek other people's investing their capital end to continue to grow the portfolio. Capital partners typically get about 6% to about 10% interest and they also get equity in the deal after the repayment of their interest. So the way it normally works is with the capital partner, you've got return of capital, then you have preferred return, and then you have a split of equity of anything after preferred return.
So is that fair? Does it seem reasonable? Well, again, I would say yes it is. It's a higher interest rate than the bank, but the bank has a first lien position. Capital partner has not a first lien, but effectively a second lien position. So since they have a little more risk, they need to have a little more profit. And that's reflected not only in the interest rate, but also in the fact that they have a percentage of equity of all profits beyond the interest rates. So once again, I would say, well that interest rate is pretty fair.
Now let's move on to the mobile homes themselves. Most mobile home loans in America range from routes 6% to 10% plus. Now, the first thing you have to know is this is based on whether the mobile home in question is considered real property or personal property. What am I talking about? Well, mobile homes, when they first come off the factory floor, they're out there on wheels and they're classified the same as a car, so they're really considered personal property. However, if you permanently affix it to land, which let's be honest, that's nearly impossible to do, how do you permanently affix something land? You can. You can always cut it loose, but the more important item is if you surrender that personal property title, then that mobile home becomes real property and as real property, many banks will do a normal home loan on that.
Now, some banks don't like it because typically they like a stick-built structure. That's more of what they're used to as far as the banks go. But nevertheless, when you've got that kind of loan, then typically your interest rate might be around the regular residential rates of all the other stick-built structures out there. So let's just say right now their rates going to be roughly five to 6% possibly. I don't know if a mobile home on land is going to qualify for the lowest rates out there, but it might, I'm not really sure.
The other kinds of mobile home loan though would be a personal property loan. Now this is where it gets a little iffy for the bank because banks are not used to making lots of personal property loans. They do them with cars. So almost every bank out there has done a car loan, but they don't exactly know what to do after cars. Some banks like to do loans on boats and RVs, but a mobile home is a little different. And on top of that, when you go out and buy a boat or RV, typically that customer is perhaps a little more well healed, has a little higher credit rating, a little more for down payment.
So how does the bank approach the mobile home loan? Well, for the longest time they haven't approached them at all. If you look at the industry starting in back in the late 90s, we had a period where a group called Greentree Financial kind of dominated all mobile home loans, but they underwrote them very poorly. They put them at zero down loans, kind of like the zero down loans at sunk America on stick-built homes in 2007. As a result, they had lots and lots of foreclosures starting in about the year 2000 and the losses were enormous. Since that time, no one really wanted to finance mobile homes anymore. So it's not even a question of interest rate, you just can't get the loans at all.
People do not have the down payment that would be required to even get a loan nor do they have the credit. Meanwhile, what's happened is the mobile home park owners have stepped in and they've started bringing in the homes and because they get into the business and they in many ways stand behind the loan, that's how you can get those mobile home loans that run anywhere from six to 10% on the personal property. Now, how does it work? Well in some of these programs, what happens is the park owner has to cover the mortgage payments, and a bay through lot rent, and paid to renovate the home if it needs renovations, and run the ads, and show it, and sell it if a customer were to default.
So that's the mobile home park owner really getting in the business of making those interest rates so low. If you take the mobile home park owner out of the picture, the interest rates would be, I don't know how high, but on top of that, no one would even qualify anyway. Let's look at the stats. Back in about 1998, 1999 there were about 400,000 mobile homes sold in the US. These were all sold through dealers. Today there's less than a hundred thousand sold. The low point was about 60,000 a few years ago. Why so low? Once again, no one can qualify for the debt. So if it wasn't for the mobile home park owners out there making it happen, it wouldn't happen. Now as a risk and reward in tandem when it comes to the mobile home loans? Well if it's anything, the scales are definitely tipped in the favor of the customer because what's happening is the park owner is having to take on some of that risk.
So that's the only way the rates can be so low. If it wasn't for the park owner, there wouldn't be any rates because there wouldn't be any deals done whatsoever. And on top of that, if they were to be done, the rates would have to be extremely high because after what happened in 1999 lenders were very, very concerned about the potential for losses, the potential for defaults. Now what's interesting is things have been working out really, really well. The default rate on mobile homes is running right now roughly around 6%. So that's extremely favorable. So you'd have to say that from the risk perspective, these homelands are working better than anyone thought. But what will be interesting to see is what happens when you bring onto the scene the new agency debt programs from Fannie Mae and Freddie Mac. Under the duty to serve law congress is ordering Fannie Mae and Freddie Mac, also known collectively as agency debt, to start making mobile home loans and to do it in such a manner that actually promotes the industry that makes these loans possible.
The test program starts this year. I think they're going to do 10 or 20 million of these loans as a test to see how they perform and then ramp it up from there. That will be very, very interesting to see. I don't actually know what the interest rate will be under that program, so we'll have to see. Perhaps they'll look over what's gone on with the homes of late, not looking back to what happened in 1998, 1999, and they'll say, "The default rates are seemingly low. The residents seemed to love the product, let's give it a whirl, maybe it'll set the interest rates at a reasonable level and maybe it'll set parameters that the customer can actually borrow the money and not have to get the mobile home park owner in the loop." It constantly blows my mind though when people criticize the interest rate on mobile home loans. You see that sometimes in the media, is very ill informed.
I would point out to anyone that if you take out the mobile home park owners participation and just look at what you pay on interest rates on other types of debt that have a similar credit level and similar down to a mobile home loan, those interest rates are running roughly 18 to 26%, and of course I'm talking about here is charged card debt. Charge card debt charges those rates because they have relatively high default rates. And once again based on risk and reward, people aren't going to loan the money unless they have a sufficient amount of reward to make that risk possible. So it's interesting to note that mobile home loans are running anywhere from 50% to 70% off what similar forms of debt with similar forms of customer are currently running.
So on that note, I would say that really across the entire spectrum from the parks to the homes, our interest rates are very much in sync with Sam Zell's principles of risk and reward. This is Frank Rolfe, The Mobile Home Park Mastery podcast series. Hope you enjoyed this discussion of interest rates and their fairness, and we'll talk to you again soon.