Here’s the simple playbook to hitting 10% to 20%+ returns with mobile home parks – even in recessions or depressions. It all revolves around using debt as a tool to create higher yields. Even in times like today of higher interest rates, you can still make high yields by calibrating your cap rate to meet the interest rate. Or by structuring seller financing to hit the target.
In this video Frank Rolfe demonstrates the simple math behind hitting high yields with mobile home parks, regardless of what direction the U.S. economy is going. You will quickly see the scientific principles behind high rates of return and understand why mobile home parks are in the unique position to use these tools.
As Easy As 1-2-3: An Explanation of High Mobile Home Park Yields - Transcript
People ask frequently why mobile home parks are able to attain such high rates of return. It's very, very simple. It's really as simple as 1, 2, 3. So it's also important to note that with a mobile home park, you can reach a high rate of return without relying on anyone else. If you wanna invest in the stock market and you think you're going to make great riches, you only are if the stock market helps participate in your plan and go up and as we all know it hasn't been doing that a whole lot recently. Most of the indexes are down over the past year. So in this mobile home park industry, you basically control your future and you control it, and you hit high yields using a basic, very simple tool, relying on nothing more than math. So we're gonna now show you how you make high rates of returns with mobile home park using simple science and the tool known as leverage. So here we go.
Let's start out with the 1-point spread. Now, what's a 1-point spread means, it means that there is a one point difference between the cap rate you're buying the mobile home park under and the interest rate on your loan. Your cap rate in this case is one point higher than the interest rate on the loan. So let's assume you buy a mobile home park at a 10% cap rate and you finance it in a 9% cap rate, so there's our one-point spread, and that shouldn't say cap rate, should say interest rate but you know what we're talking about here. So you're buying it at a 10 and you're financing it at a 9.
The net income on the park is $100,000, so if you buy it at a 10% cap rate, this mobile home park which produces $100,000 a year of net income, you'd be paying a million dollars. And let's assume you buy it with a mortgage with 20% down, and an interest rate at 9%. So we have a one point spread between the cap rate and the interest rate on the mortgage, cap rate being 10, interest rate being 9, and we've bought it, use your leverage, with 20% down payment. So then what happens? Well, your net income is $100,000 a year, and the interest rate on your loan is $72,000 a year, so the difference between your net income and the interest rate on the loan is $28,000 a year. That's pretty simple math. You put down $200,000 to create that $28,000 a year of income towards your down payment, and your cash-on-cash return is in this case, 14%. So that 1-point spread is effectively getting you about a 14% return on investment.
So now let's change that up now to a 2-point spread. So now we have two points between the cap rate and the interest rate on the loan. So in this case, we're gonna buy the park at a 10% cap rate, we're gonna finance it at an 8% interest rate. And that income on the park is $100,000, so at a 10% cap rate, we're paying $1 million for the mobile home park and putting down 20%, with this case, the interest rate being 8% of the mortgage, so the same purchase price based on the same 10% cap rate, but now we've lowered the interest rate down where there's a 2-point spread between the cap rate and the interest rate. So now we have a net income of $100,000 a year, just like before, but our interest rate on the loan is now $64,000 a year. That's declined because our interest rate went down a point. The difference between the two is now $36,000 a year. We had a down payment of $200,000, and yet we get back $36,000 on that down payment, so with the 2-point spread, we now have a cash-on-cash return of 18%. So the 1-point spread got us 14, the 2-point spread gets us 18.
Now we move on to the 3-point spread. So now we're going to look at what happens mathematically when you have a 3-point spread between the cap rate on the deal and the interest rate on your loan. So now we're going to assume we're buying a mobile home park at a 10% cap rate, and we're going to finance it at a 7% interest rate. So the net income on the park is $100,000. We're gonna buy it at 10% cap rates. We're paying a million dollars again, just like we were with the 1-point spread and the 2-point spread, and we're buying it with a 20% down on mortgage just like before, but it's 7% interest rate. So our net income is $100,000 a year on the mobile home park. The interest on the loan is $56,000 a year, and the difference between the two is $44,000 a year. So the difference is going up because the interest on the loan is coming down, no other reason. So on our $200,000 down payment, we're now getting $44,000 a year back, which gives us a cash-on-cash return of 22%. So the 1-point spread got us 14, the 2-point spread got us 18, and the 3-point spread got us 22. And you probably noticed that we're going at four points per point. So we'd have to then imply a 4-point spread would get us 26%. Because again, this is just simple math, there's nothing fancy to what we're describing here at all.
Bottom line is, it's really just that easy. By using the tool of leverage and by using the power of debt, we're able to create a higher yield. Now you might say, "Well, that's great, but that works the other direction too, right?" It is true. So when you deal with leverage, when you deal with debt, it can also have bad repercussions if you do it the other direction. The good news is, that with mobile home parks, our biggest profit driver is increasing rents. So increasing rents is something that you can do pretty much annually, unless you're in one of those five states that has rent control. So you can constantly drive in your net income up, but there's other ways to drive it beyond just raising rents. You can fill lots, if you have vacant lots. You can lower cost, the most common of which is to submeter and bill back water and sewer expense, so you have other profit drivers too. But from the moment you buy the mobile home park, you're always raising to try to increase that spread because that spread between the interest rate on the loan and the cap rate on the park, that's what creates these high levels of value.
Now, you might say, what about other real estate sectors? Can't they do that too? They also offer leverage which they do, but the problem is you can't get any kind of spread going on. If you look at most of your apartment deals today, the spreads between cap rate and interest rate on the loan are under one point. They're very, very small. Same is true in all of your sectors. And the other problem you have is in the other sectors, as the economy declines, the demand for what you have to offer goes down too. You've probably read that nationwide office buildings are at around 50% occupancy, so a recession and depression only makes that worse. Same is true with retail. Same is true with self-storage. There really is no safe harbor against the pending US recession, depression or stagflation, other than a necessity that everyone needs, which is housing. So as a result with the mobile home park business, you can not only get the spread, which is unattainable in the other sectors, but you have the safety valve, the safeguard against the decline of the US economy, because honestly as the US economy goes down, mobile home park demand goes up because we are truly contrarian.
But when people say, "So how do you get those high yields? I can't believe you can actually hit a 14% or an 18% or a 22% return or higher." The answer is very simple, it's just math. It's just using that tool of leverage with a 1, 2 or 3-point spread that produces those lofty returns. Also, if you'd like to learn more about the mobile home park business and how to create those spreads, feel free to attend our next mobile home park investor's boot camp. It's April 21st through 23rd. You'll learn the science of the industry, the correct way to identify, evaluate, negotiate, perform due diligence on, renegotiate finance, turn around and operate mobile home parks. We'd love to see you there. Thanks for your interest in our industry, and we'll talk to everyone again soon.