In this video, Frank Rolfe gives a detailed review of the history of interest rates and how they impact the acquisition of mobile home parks. He also gives concrete strategies to forge deals in the new higher interest rate era based on time-proven approaches from the past. Following the discussion, he answers questions from the audience until he has exhausted all inquiries. If you want a lesson in how to creatively make deals happen in today’s environment – all based on the bedrock of science – then this video should be of great interest to you.
And if you want the complete science on how to correctly identify, evaluate, negotiate, perform due diligence on, renegotiate, finance, turn-around and operate mobile home parks – in the same format as this discussion – then consider attending our next Mobile Home Park Investor’s Boot Camp. It’s our last event of 2023 and it’s 100% live yet virtual, so you have no travel time or cost.
Making Deals in a Higher Rate Environment - Transcript
Welcome to our lecture series event. This is Frank Rolfe. We're glad to have you here. The 800-pound gorilla in the room these days is the fact that interest rates are back again to levels that they used to be at. After a long absence, we got all too familiar with really low interest rates for about a 14-year run, starting with the Great Recession, or what was called the Great Recession of 2007-2008, which plunged the rates down to levels that we have really never seen before in American history. And everyone just got complacent and thought, "Well, we'll stay that way forever. So, that's it." And we all got a mindset that rates would always be 0.25 on a CD and 3% on a mortgage. And no, that's not the case. That's not how the world really, really works.
So in this lecture series, we're gonna go over how to make deals in not really a higher rate environment, because historically, we're not in a higher rate environment, as you'll see in a minute. But the return to the original roots of the industry, which was making things happen at mortgage rates of around 6% to 8%. And we thought we'd start off with the history of interest rates. You may already know much of this. You may not. We've got a little graph here that's pretty great that shows you rates over the last 200 years. But I can give you as a quick prelude the fact that the interest rates back in 1776 when the country was founded were about 7%. And so really, life hasn't changed much as far as interest rate structure, all the way back from the early foundations of America.
So, here is that chart. And what you'll see in the chart, which is 200 years of interest rates, that you've got a few notable moments in America. You've got the moments here of relative stability. Then you have periods of decline, for example, as you can see there during World War II in the 1940s, we had very, very low interest rates because we were in a major conflict, major war, and the government was trying to do anything it could to make things improve. And that's always been a tool of the government since it started really controlling interest rates, was using them to kind of manipulate the economy to either raise them, is going on now with Jerome Powell to fight inflation and cool the economy down, or to lower them to ignite the economy.
And then you see there in 1981 era, you have good, old, the super high rates, the highest rates as you can see clearly in American history, nearly twice the norm; rates got all the way up there into the teens. And that was basically the result of Ronald Reagan trying to reignite the US during stagflation, which had occurred under Jimmy Carter and we were desperate to do something because we couldn't make anything work. Now, if you read up on that, it was not the interest rates that saved the day or solved inflation. It was, in fact, Reagan's energy deregulation policies. And in many ways, that explains our current inflation environment because they learned during Reagan that inflation is the result of attacks on fossil fuels, that basically fossil fuels are what either makes the economy work or causes extreme inflation.
And so if you read the findings of the economists coming out of the Carter stagflation era, it was, in fact, Carter's policies that were anti-oil and gas that caused that, which is very similar to today with Biden's anti-oil and gas policies, which have kind of created this current inflation mess that we're in. And then you'll see there on the right-hand side of your screen that you've got a new phenomenon not seen in the earlier 200 years, and that was us taking the interest rates down to basically zero during the post-Great Recession Era, beginning under Obama but continuing on all the way to current day, up until Q1 of 2022. If you wanted to get a CD at a bank, you were going to get maybe 0.25 or 0.5 if you were lucky.
And we'd never seen that in American history. And if you read a lot of old books, and I love to buy old books at bookstores and books on business, I'll buy anything, real estate books. Nineteenth century stuff is always fascinating because it's long enough ago that it seems out of this world, yet so much of what went on back in the 1800s is kind of reminiscent to today, even though it's 150 years, even 200 years old. And if you look at those books, I recently bought a how-to-invest-in-real-estate book that was from like 1890. And back then they didn't have calculators, didn't have computers, didn't have Google.
So if you wanted to figure out what the interest rate or the mortgage payment on your mortgage would be, you went to the back where there was a table of rates. But under the table of rates, all they had was 5%, 6%, 7, 8, 9, and 10. That was it. Nothing below five, nothing greater than 10. And whoever wrote the book did that because they looked back on the period that they had known as far as interest rates and that seemed to be about the way things had headed. You can also notice from this chart the fact that interest rates are in fact cyclical; they're marked by high points and then there's low points and they often flow gradually. You see them ascending to the all-time heights and then descending in about an equal order.
But that's kind of where interest rates have always been. So when people during the Great Recession thought that, "Oh, yes. Well, these new rates, these are right in line with what we've done in the past during recessions." No, that's not true. That's not in any way accurate based on history. And at the same time, people said, "Well, the rates prior to Q1 of 2022, those are surely the new norm because historically that would be correct." No, that's not true either. The big item is people just forgot about the cyclicality 'cause it was around for so very long. So unless you were 40 years old, you don't remember what interest rates used to be because during your entire adult life, they've always been super low. But that period is now, of course, changing.
Now, before we proceed, I just wanted to find, when we talk interest rates, there's several kinds of rates out there, the Fed Funds Rate, which is pretty much what they charge banks and you have the prime rate, which is what banks charge their best customers, then you have your commercial mortgage rates. And so the first thing you have to know is all those rates are kind of blended when you talk historically, I don't think we had tracking 200 years ago, the Fed Funds Rate or prime rate or... Much. So I think really, the mortgage rates is what we're gonna focus on. Because again, we're in the real estate business and that's the rate that's most important to us.
Now, clearly, they all tie together, I'd be the first to admit that. But when I talk about interest rates for today's lecture, I'm talking basically commercial mortgage rates. So if I said the rates right now are 7%, what I'm saying is an average of 7% on a mobile home park mortgage at a lender. But I want to define when people say, "No, wait, which kind of rate are you talking?" I'm pretty much going to be talking just about commercial mortgage rates. If not, I will define the other rate I'm talking about. And what were the rates when I got into the business in 1997? Well, they were about 7%. That's kind of where interest rates were back then. And in fact, if you look at the early books that Dave Reynolds and I wrote, one of our earliest books was called The 10/20 Method Of Buying mobile home parks.
Well, where the 10 came in was, we've always advocated that to hit a 20% plus return, all you have to have is a three-point spread between the interest rate and the cap rate. And since interest rates were seven and had been there for the longest time, we just assumed that that's the way the world would be. So we said 10 would be good because interest rates were at seven. And then we said try and get to 20, which meant basically trying to double your position through strategic rent increases, cost cutting, and filling a vacancy. But when I got in the business back in 1996, when Dave got in, when Sam Zell got in, everyone got in, of us three, back in the mid-'90s, the rates were kind of what they are today. So it's not really a Back to the Future movie, but that's kind of where things are today, I remember those well, that was back in the '90s.
So then how did we do deals back then? Back in the olden days, back in the '90s, when interest rates were at 7% and kind of like they are today. Well, let's see. Well, we did a lot of seller carry. We did a lot of seller carry because it was really hard to get loans back then, nearly impossible for most people. So seller carry was about as common as could be. And at the same time, sellers liked the carry because by carrying the paper they got an above market interest rate. And everybody loved the fact that when you seller carry, there's no stress, no stress as a borrower because you don't have any kind of application to go through, no board committee meeting and no stress as the seller. You didn't have to worry about what the bank said, you typically didn't even have an appraisal and there was no bank to get the thumbs up or thumbs down on.
So if the buyer completed due diligence and said, "Yeah, I wanna buy it." Well, then you went straight to closing. So, people like seller carry. And then we had master lease with option. What's master lease with option? Master lease with option is where you tie up a property that's underperforming and then you fix it and then buy it as opposed to the normal structure of you buy it and then try and fix it. And the beauty of master lease with option is, it allows you to fix the property to test out your theorems and then to go to the bank once you've fixed it. It's a whole lot easier getting the bank loan when it's fixed than when it's not working properly. And then of course you had bank financing. We had all the same kinds of banks that you have today back in the '90s. So banking is not a new invention. It didn't just start after the Great Recession. So the banks back then are pretty much the banks today. Although with all those decades that have passed, a few bankers have retired.
Then you had loan assumption. Loan assumption is something that's also been popular in the industry since the '90s. Basically what you would do is go to the lender, you already had the existing loan on the property, and say, "Hey lender, I want to buy the property but you have to resize the loan because I only wanna put 20% down." But you know the loan really well and I'm sure you don't wanna run out and get a new loan that you don't know anything about, and most bankers would say, "Yep, that's exactly right, I sure don't." And so therefore the loan assumption was done.
And then we also had conduit debt. Now one thing we did have in the world of conduit dead back in the '90s you don't have today, is they had dropped the minimum to do a conduit loan down to about 350, 000 bucks. Today the minimum to do a conduit loan is over a million dollars. So that's one slight advantage we had back then, but it was still very hard to get them done because most people were really not that psyched on the industry. A conduit loan again is something which starts with a conduit originator, they bundle loans together, and they sell them on Wall Street. They're also known as CMBS or Commercial Mortgage Backed Securities. You may say, "Wait, I remember those. That's what took down America and caused the 2007-2008 Great Recession." Well, this is commercial, this is not residential loans. So no, the commercial loans never caused the Great Recession or any such thing. But it is the same kind of general theory. At the end you don't really have a bank, you've got a servicer and you're not in a bank, you're in a conduit pool.
And those options are pretty much the same back then as they are today, except today we have an even bigger weapon and that and that's Fannie Mae, Freddie Mac, which we'll call Fannie/Freddie. Fannie/Freddie came out of nowhere not that many years ago and today they underwrite over half, by volume, of dollars of all mobile home park loans. So you today have one of the most formidable lending options which we did not have back in the '90s, which is Fannie Mae and Freddie Mac. So really you financing options today are superior to what we had back in the 90's. So what are the rates today? Well, the rates today vary. It varies on the kind of loan and it depends on all kinds of things, from the length of the loan to the quality of the mobile home park, type of lender, all kinds of factors. So right now, probably the lowest rates you're going to find are a Fannie Mae/Freddie Mac loan with a variable rate of interest on a shorter term, maybe five years and you might be able to get maybe 6,2-6,4% on that.
And from there you gravitate up to your conduit loans, and conduit loans are a ten-year fixed rate on a 25-year amo and your conduit rates right now are probably going to be in the sevens. From there you gravitate up to your bank loans and your bank loans today are going to be somewhere between the sevens, even up to the eights. So what does it mean? It means the rates are pretty much back as they were all the way back into the founding of America kind of, they're right in line with what the normal average was for all that time. So really the big challenge and when we talk about this higher interest rate environment and such is working with sellers who refuse to acknowledge the fact that there's been a huge shift in rates since Q1 of 2022. Because Jerome Powell did what no one had done before, unless you go back decades, and that was raise the rates at a speed that just on the surface seems absolutely insane, to take rates from 0.25-5.25 in a matter of months. So just think on the surface of how insane that would be seem, that it's almost crazy. It's like taking an airplane that's always just kind of been coasting along, flying level, maybe a little up there and then try to make it fly vertically. It was tried once during the Trump era. They raise rates a little, the plane started shaking violently and they let back off on the rates.
But with Powell, his mandate, at least to himself, has been, well, I was going to raise them as far as I darn well please and I will continue to do that until the economy blows up. He gave people basically three metrics in which he would stop raising. Number one, inflation below 2%. I can personally guarantee you, that's impossible. Why? You can only achieve it with energy deregulation. So as long as the country continues on this course of trying to pretend that fossil fuels are no longer that important and and we're all going to change over to new green energy sources, if you just read up historically, going back to the time of Carter, that will never work. So we will never break the inflation gap doing what Powell is doing. So that's not going to happen.
His next metric is, he wanted to see great pain and suffering by industry. He wanted to see higher unemployment rates, is a big one. And then that's not really happening because what's happening there is of course that no one wants to work anymore, coming out of COVID [0:16:06.6] ____ millennials have decided they don't need to work. About half of all millennials I believe now live with their parents or are paid for by their parents. So since they basically aren't going to participate in the workforce, it's easier to have low unemployment 'cause there's no on actually trying to get jobs.
And then finally, he wanted to see a basic collapse of the stock market. We thought that we saw the beginnings of that recently, but now it's all changed back as millions and millions of stockbrokers start calling all their customers saying, oh, there's great values right now. This worthless stock that's at $5 a share is a great bargain, buy it and hold it for 180 years and you'll make tons of money. So the bottom line is that rates have zoomed up and people are saying, I want the old rates, I want the old pricing, I want the cap rates of how it was in the good old days. And so you have a disconnect, because sellers, they want that old price that you as a buyer can't pay it. And even if you wanted to pay it, then you can't really go to the bank and expect them to participate in your program because the bank has things such as coverage ratios and such which are pretty much set in stone, they're not gonna make loans outside of the mandate from their board on making loans. So, those kind of arguments just are never going to prevail.
So to make deals today is kind of similar to back to the '90s, and that is you just have to be creative. Things are not as simple. When things were just on a flat zone for 14 straight years of low interest rates, everyone got a little fat and happy because they did the same thing over and over and over and over again and life seemed to be pretty blissful and everyone is at peace with everything, but that's just no longer the case.
So we've to go back to how it was, and that was being very creative. So, how did we do it back in the '90s? How were we creative deal makers back in the 90s' and why? Why were we so creative back in the '90s if you were buying mobile home parks? Well, the first reason was, there was no financing. You'd go to a bank and you'd say, "I want to finance a mobile home park." When you said the word mobile home park, it pretty much shut down the conversation. They would either be pleasant to you and nod, and then say, "Okay. Well, I'll get back to you," which meant they never would. Or they just shut you down right off the bat and just say to you, "Oh, I wouldn't finance a trailer park. Are you talking a trailer park?
I even went back to my early billboard banker. I sold the billboard business and re-approached them, I think on my fifth deal that I bought, and I just got the major cold shoulder. I'd been a customer of theirs on the billboard side for almost two decades, never missed a payment, done extremely well, sold it to a public company. But they didn't like this new idea one iota. If billboards weren't weird enough for them, trailer parks were forbidden. So that's how it was for everyone back then. There just wasn't any bank financing. You could not just go to a typical bank and say, I need a loan on a mobile home park. They wouldn't do it.
Also, there were no home financing programs back then. So it was very very hard to be creative on parks that had big fill issues because you might have a lot of demand, but how do you translate that demand into homes on lots and humans and homes? And the answer back then was you couldn't unless you had an amazing array of capital. We didn't have things like CASH program or PEP or Triad or Zippy or any of these options. No, no, no. Basically, if you wanted to put a home on a lot, you had to go buy a home yourself and stick it on the lot. And maybe you could do seller carry, because that predates the SAFE act and Dodd-Frank. But nevertheless, who really wants to go from the parking lot business into being in the banking business? 'Cause that's what park owners were doing when they did that. It wasn't uncommon to see people who had mobile home parks where they had twice as much in mortgages they were carrying on homes than they had in the park itself. So today is far superior to that because now we actually have banks doing what banks do, which is make loans and mortgages to homeowners.
So you then have the fact that back in the '90s, the difference between park rents and apartment rents was much smaller. If you had a mobile home park back in that era, well, you might have an apartment rent in your area of $600 a month and your park might be at two or 300. That's only a two for one. Maybe you have a 2X of apartment or a mobile home park rent equal the apartment rent. Today, where the average apartment in the US is 2000 a month, but that's factored in places like San Francisco and Los Angeles, so those, toss those aside for a minute. Nevertheless, you're gonna see almost every apartment across America that's gonna be over $1000 a month at a time when the average lot rent in America is maybe $300 a month. So now we're at maybe a three or four for one. And there's some markets out there where it can be as much as a five or six for one. So we didn't have as much ability to push rents back in the '90s as we have today, at least visually on paper.
And then a big item which you would never know if you weren't around in the '90s, is this whole trailer trash stigma. Back in the '90s, you were coming off the heels of Jeff Foxworthy and shows such as Myrtle Manor and Trailer Park Boys and it was very chic back then to describe anything to do with mobile homes as trailer trash. I once had a manager named Stephanie at my park at Glenhaven. I took her out to Home Depot to buy parts for Glenhaven. We were rehabbing some homes, buying some lumber, paint, caulk, that kind of stuff. When we went up to the cash register to pay, we were gonna have it delivered. She said, what's the address? Stephanie immediately gives an address I'd never heard of before. But since she was the manager, I thought, well, you know, I don't wanna second guess what she's doing. I don't wanna embarrass her.
So as we walk away from the teller, I say, what address was that, Stephanie? She said, oh, that's the church next door to the park. I said, well, how is that gonna work? They're gonna bring a truck and deliver all this heavy stuff at a church next door. How are you gonna get that to Glenhaven? She says, I'll have to hand carry it. I said, so you're gonna hand carry a truckload of 2x4s, sheets of plywood, five gallon bucket of paints, all of this stuff you're gonna hand carry from the church next door over to Glenhaven? That's correct. Why would you do that? She said, because I'm too ashamed to say that it goes to Glenhaven. So that was the sad predicament people had back in '90s, is Americans loved the whole trailer trash shtick, and we all suffered through it back then.
So then how do you make deals creatively today? We've talked a little bit about rates. Hopefully you realize rates are not exorbitantly high, but are right in line with the US average. We talked about doing deals back in the '90s. And how you have to be creative. Today to get things done, okay, well, how do you do it today? Enough of the history lesson. So what is there today that makes stuff happen? Well, the first thing you can do is tell the seller, I can get you the amount that you want, but you're gonna have to carry the paper, because in many cases, that is the primo solution, that is the big brainstorm to save the day when mom and pop say, well, I won't sell my mobile home park for less than a million dollars. And you realize that a million dollars would have been pretty much retail back in Q one of '22, but today would never fly based on current interest rates at current banks. Now his million dollar dream is down to maybe 600 grand.
How do you solve it? Well, just say, look, if a million means that much to you, I have a plan. I'll get you the million dollars and here's how we're gonna do it. I'll go ahead and give you the down payment and you're gonna have to carry all the paper on it. You're gonna have to carry it on a 30-year amortization on a ten-year term with a balloon at the end of ten and you're gonna have to do it on the following interest rate. And the interest rate you give them might be a flat amount of 4%. It might be stair-stepping, year one 1%, then year two, then three, then four, then five, whatever your stabilized amount is.
The seller financing is as big a deal today creatively as it was back in the '90s, because when you can get out of the banking environment, what do you do? Well, you save any discussion of values versus rates 'cause you're on at that point, the old values, and that's what they're really after. To help sell this idea, you also can offer the seller two prices, a carry price and a cash price, and show them the cash price based on legitimately what it would be if there's a bank involved at current bank interest rates and the seller carry price, if they'll carry the paper. And in many times they'll look at those two prices and they'll say, I like the seller finance price more. But that's probably your best way to creatively get a deal today, is to bypass the higher rates, bypass the banking system, and just do it based on the seller being the bank.
Another creative idea, number two, is to figure out the most that can be paid based on the most that the bank will finance based on their coverage ratio, and then put the rest down in cash. So to do this, let's go over that structure. Remember that banks are not infinite in their underwriting ability because they typically wanna see a debt coverage ratio, 1.2, 1.25, something like that. And they are not going to really break that formula because the board of the bank tells them you can't do it. If you do that, more than likely the loan will go bad. So when you go to the bank and you say, here's how much net income the park produces, they can tell you how much they can finance based on that stream of net income. It's just math. There's really no other terms that are attached to it.
So what then happens is they come back and they say, okay, well, based on our debt coverage ratio, the most we can finance is $600,000. But let's say mom and pop want a million one. Well, if you really love the deal and you wanna do it well, you could put up $500,000 in cash down. The problem you'll have if you do that is it totally screws up your loan to value ratio, and that therefore screws up all the different rates of return. 'Cause remember that leverage is what gives you the higher return in real estate. When we say that a three point spread between the interest rate and the cap rate is what yields over 20% cash on cash return, that's because of the tool known as financing and leverage. If you take leverage out of the equation and you bought a park, let's say, at a ten cap, then your cash on cash return would only be ten. However, if you bought that park at a different financing, a different leverage, a different tool, then you can't hit those rates of return. But that's the way many buyers are now doing it.
Now, what are they doing when they do that? Why would they do that? Why would they buy at a lower loan to value? Because they don't anticipate, as you saw from the schedule a moment ago, that interest rates are anything more than transient by nature, and they tend to go up and they go down. And most people are guessing that when your rates go up the fastest they have in several decades, more than likely they'll go down about as fast. If you recall from the chart we saw moments ago, if you saw the trajectory when it went up sharply up, as you saw in 1981 with Ronald Reagan, it came sharply down. So it's no surprise that interest rates are kind of like an elevator, and the faster you ride them up, the more faster they're gonna come back down again.
So buyers are saying, look, I don't trust or have any confidence in Jerome Powell as a human or as his rate setting ability, or his ability to even conjecture what's going on. So I'm going to bet rates are gonna come down significantly. You probably saw just today an article from UBS, which is a fairly large lender and has a fairly large economics forecasting department, they predict rates to be down as much as three points by the end of next year. Why? Because everyone assumes that we are either already in a recession or going into a recession. So some buyers are saying, since we're going into a recession, and as a lecture series I did earlier this year, I went over every recession and the impact on interest rates since 1950. And if you were at there, you recall that if you add together the interest rate swing from high to low from the start of the recession to when we come out, the Fed had reduced them an average of two and a half points per recession. And if you take two and a half points off, UBS is saying three points, with a little rounding, you'd have to say, ah it's a pretty safe bet. So as long as you bet that we're going into recession, then UBS and other economists would be correct, more than likely the rates will come down several points. We just don't know when and we don't know how fast and we can't even peg when the recession begins.
You may have seen in the news in the last few days that the trucking industry is in a free fall right now because there's nothing to ship. Traditionally, when there's nothing to ship, that's a very good forebearer of recession because it means no one's buying anything. You also might have seen articles that our M2 money supply is shrinking dramatically. And that has never been seen ever, except during the start of a recession. So if you're gonna do the borrow to the limits of the coverage ratio and supplement that with cash and then refi shortly when rates come down, plan, that's the foundation of that type of a strategy.
Aggressive strategy, creative strategy number three. Aggressively increase rents after closing. The one very item that we all know is true, but everyone's afraid to talk about because media hates this narrative of mobile home park owners as evil Simon Legrees raising rents. And I proudly tried to explain to anyone who ever asks, whether it be the media, I was on a podcast recently, a giant podcast, where that was again the topic. The problem, which no one cares to accept, is that mobile home park rents are absolutely, insanely, ridiculously low, not even in the realm of where they should be. And the reason that you're seeing this happen is very easy. There's a guy named Charles Becker at Duke University who wrote a paper on this years ago. I'm sure if you tried to call and ask him any questions today, he'd hang up on you, because in today's cancel culture, you would never wanna be a professor writing about the fact that mobile home park lot rents are way too low.
But what happened is you had mom and pop quantitative easing for decades. They never raised their rents in line with inflation. So as a result, even though the average lot rent when the parks were built in today's dollars is $500 a month, our lot rents in America are about half that. So right off the bat, if you took all the rents at every park in America and raised them all to $500, all you would have accomplished is restoring them back to where they were dollar wise, from back when they were built, without even taking into account market forces like apartment and single family prices. When you look at the fact that in most parts of America today, the mobile home park lot rents are $1000 a month under apartments, with the fact an apartment is not a detached dwelling, you can't park by your front door and people knocking on your walls and ceilings, and you have no yard. Even then, despite the fact it's an inferior product for many people, we're $1000 a month less. And what does that tell you? It tells you our rents need to go up a lot.
Many times deals that people can put together with moms and pops, even though they're wanting pricing back prior to Q1 of '22, you can easily pay if you'll simply put some of those rent increases into your pricing. In many states, you can raise the rents within 90 days of closing after giving due notice. So if you use in your budgets the new rents, well, you're only wrong by about three months. So many buyers today, that's what they're doing. They're saying, well, my first rent increase, I could take the rent from 300-350. I'll go ahead and run all my budgets based on 350 because I know I can get there, assuming you're in a non rent control state.
And there you have it. When people criticize mobile home park lot rents going up, you ever notice they only wanna talk about one item, and that's a percent of increase, never the dollar. They'll say, oh, that mobile home park, it raised its rents by 30% without telling people who read the article, yeah, they went from 300-390. They went up only $90. They love to play that shenanigan. It's no different than if you look at the hot dog combo at Costco, which is a $1.50. And if Costco then decided to double that to $3, significantly lower than any other food established, you know, they would be widely criticized [0:33:07.7] ____ 'cause many would say that they raised the prices by 100%, not letting you know that it's only a $1.50. Or look at the case of the Dollar Tree stores I love so much. They raised them from a $1 to a $1.25. That's a 25% increase in your product cost. Of course, the truth is, it's only a quarter.
Number four. Selling off the park on homes quickly following closing. If you look at many of the mobile home park deals that you will see, you will see that much of their woes financially revolve around just one thing. And that's these nasty little creatures called rental homes. Now, why does mom and pop have these rental homes that seem to drive them insane? Well, they typically inherited them. They didn't mean to have them. Somebody died in lot four and the family gave the home back to the owner, or somebody moved into the park, didn't pay the rent, got evicted, ran off, the home becomes abandoned, and somehow it also enters mom and pop's rental pool. And those rentals lose money pretty much every day because mom and pop rent them at a crazy low amount, maybe four or $500 a month, which includes all repairs and maintenance and everything. So subsequently, they're losing maybe $200 a month per home, maybe worse. So often the way you fix mom and pop's dilemma and are able to pay more is simply to get rid of the rentals as soon as you close. Sell them for cash, give them away. There's no way you're gonna make any money renting mobile homes, particularly older mobile homes, because you're not taking into account the fact you could simply give the home away and change the lot rent to the full market rent.
So let's assume someone's paying $500 a month for the rental mobile home. We have found that if you drop their cost of living there by $100 collectively a month, so go from 500-400, they'll be very happy customers indeed to buy that home. But what if you just reset the lot rent to $400 a month? What happens then? Well, you're doing a great job because you would have had at least $200 a month of repair and maintenance on typically on an old mobile home. And if you add in tax and insurance and everything else, it probably averages maybe $300 a month, which you now effectively saved by simply getting rid of the home. So a lot of times creatively, when you're looking at what mom and pop have to offer and you look at their P&L, you will notice that the repair and maintenance cost on the rental homes is greater than the rental home's actual revenue when you take away the cost of the lot rent.
Next, fill vacant lots using a floor plan lender. We did not have that weaponry back in the '90s. Today you can get on with a group like 21st Mortgage's CASH program or PEP or Zippy or Triad, and you can basically bring in homes at little or no out-of-pocket cost to fill your lots. And then they will finance the ultimate buyer of the home. It's a genius plan. It's a win-win for everyone. The park owner benefits, they benefit, customers benefit. I don't know anyone who does not benefit under that program. So you can buy a park often where the whole way you're gonna create the value is to fill the vacant lots, it's in a desirable area, strong [0:36:30.4] ____ test ed. And all you do is just bring in homes with your floor plan lender and sell them and fill up your vacant lots. And that's one way you could take a park where mom and pop want X, but they've still got 20% or 30% of the home sites vacant, and how you could bridge the gap by filling those vacant home lots.
Next, cut waste in the form of water, sewer cost, utility repair and manager cost. I have a million stories of mom-and-pop parks that we bought that the entire turnaround plan was simply fixing things that they had done wrong for many years. There was a classic case of the park we bought in Kentucky where the streets were not your typical asphalt color of dark gray or light gray, but in fact some of the streets were green and they were green from algae of continuous running raw water, which had been going on forever. And they were running about a $5000 a month water loss over these collective leaks. So we asked mom and pop during due diligence, why don't you fix the leaks? And pop tells me, well, I can't fix the leaks, don't you know, because they say the leaks are under the streets. So then I'd have to rip the streets out, fix the leaks, put the streets back.
I don't have that kind of money to fix that stuff. So I've just been eating 5,000 a month. Well, during diligence we brought out American Leak Detection and lo and behold, they put in little flags where they found every leak. They use a special technology, which is a sounding technology which listens for leaks in the ground. And lo and behold, it turned out it was not a whole lot of leaks. It was just about two and they were not under the streets, they were on the side of the streets. So basically for a few thousand dollars, we were able to solve $60,000 of cost. That 60,000 of costs translated to about 600,000 of value at a 10 cap.
Then you've got utility repair options where you have moms and pops who slave away and suffer with utility issues that are constantly breaking, which they could just much more cost effectively fix. Maybe a section of the sewer line that they're calling out Roto-Rooter constantly. And then they don't realize that you could eradicate all those Roto-Rooter bes if you simply replace that one little section of sewer pipe. Typically when you find, dig down and find it, what you'll see is the sewer pipe. Someone put it in at an extreme right angle or some other crazy thing because mom and pops often didn't know how to install utility lines. And all you had to do was replace that little section and suddenly all that repair costs went away. And there's many parks that we bought where the manager was making over a hundred thousand dollars a year. We had a park once in Kansas City, the manager was making $106,000 a year managing a park that only had about 80 occupied lots. By comparison, the normal manager cost in that park would be about a thousand a month.
So they were overpaying the manager by about 80, $90,000 a year. I asked mom and pop, why? What gives? Surely they knew that 106 was excessive. And they said yes, it's a very sad tale. I started off paying them about 15, but they've been here for several decades. So every year they'd hit me up for a raise and then where I got really killed was they hit me up for health insurance and I couldn't get rid of 'em, they'd been around too long and I totally just blew it. And I knew that I blew it 10 or 20 years ago when I broke through the $50,000 mark and I just kept going and I was just too nice, I couldn't bear to fire them. You could then fire that person, replace them with someone who's appropriately costing and save yourself at a 10 cap, $800,000 or so of value.
Another idea is to have a seller carry a second lien on the park owned homes. Under that structure, you go to mom and pop. Remember, the banks will not typically even do loans on park owned homes and you say mom and pop, here's the deal to hit your price. I am held under hostage by what banks will do under their coverage ratio and I don't have the cash to bridge the gap, but if you wanna carry a second lien on the park or second lien on the park owned homes, then I'm game, I could maybe do that. Now, if you do do that, I caution you, make sure that the amount of the payoff to release each home from the collateral pool is affordable within the amount that you've put in as a lien. If you went and put $20,000 on each home in mom and pop or gullible enough to do it, the problem's gonna be how are you ever gonna get the titles released?
Because those are encumbered in the lien for the whole park. So you can put a second lien on the park owned on homes, but you gotta be sensible about it. Or have the seller carry a second lien on the park. Some people have actually get gotten away with almost no down payment by simply having their down payment portion paid in the form of a seller second. Now, not all banks would agree with that strategy. Many banks would say, you can't do that. You can't use the seller second as your down. And then others won't allow you to have a second at all. You cannot have a second on a conduit or a Fannie Mae/Freddie Mac loan. But some banks will in fact allow you to have a second lien on a park if you simply ask them.
Then you have master lease with option. That's what I did on my fifth park I ever bought back in the '90s. It worked as good in the '90s as it works today. Basically, as we discussed earlier, you take a park that's not performing well, but mom and pop have a price that they will not go in under. And you effectively test your theorem by tying it up under master lease with the right to buy it at a certain price, fix the park, and then close on it. And what it does is it allows you on a no risk basis, to simply raise the rents, fix things up, and then go to market. So a park that can't get a loan of a certain size today might get that loan of a certain size later once you've fixed it. It's a very, very handy tool to creatively get a deal done.
Then you have assume the existing low rate loan. Let's think about that for a minute. Alright, so let's say the bank interest rate's seven and a half right now, but let's say they got a loan prior or during Q1 of 2022, and that rate back then was maybe, let's say five. The five is not lost entirely. Let's say they have a 10 year note. You're in year two, year three, well, you still have seven years of 5% on the table if you can just assume that loan. The good news is that almost all conduit, Fannie Mae/Freddie Mac loans are in fact assumable if you qualify. But even some banks will allow you to assume those loans. And you might say, why would a bank do that? Why would a bank let you walk into the shoes of someone when the interest rate's at five, when they can get seven today? Well, what's at issue is, they know that loan.
So they've already had experience with it. They know that the risk of default is low, they got their monthly payments on it. If they go out and write an all new loan, yeah, they might get a higher rate, but there's much greater risk. They don't really know that collateral, they don't know that borrower that well, there's no track record with it. So sometimes assuming that existing low rate loan is another type of solution, or you can have assuming the conduit of Fannie/Freddie loan, I know we just went over that one. For some reason I have it on here twice, I think just to reemphasize that all conduit Fannie/Freddie loans are assumable. So assumability on item 10 with regular banks, that's not always guaranteed. They don't have to let you assume it, but on conduit and Fannie/Freddie, they are freely assumable. So you can step into the shoes, typically with a 10-year term of that lower rate loan, or you could just take the park apart and sell off the pieces.
Everyone always thinks about mobile home parks as a mobile home park, a parking lot, but in many cases that little parcel of land is in a pretty good location, normally on a major secondary or even a freeway, and it's just the right size for a developer. It's just perfect. Typical sizes are anywhere from a few acres to 10 acres, 15 acres, and that's just about what the size every pad user wants, every apartment complex, Home Depot, you name it. So you got great frontage, you're the right size, and most importantly, the city hates you because they hate anything to do with mobile home parks. So as a result, they're more than happy to give people any zoning that they desire and that makes it simple; you can simply buy the mobile home park and cut it up in pieces. I did that with a mobile home park once in Springfield, Missouri, it worked famously well.
I sold all the frontage off to a Harley-Davidson dealership and everything behind that to an apartment developer. Had no issues. I had to do one replanting and rezoning and never any pushback from the city. They were delighted to see the park leave the building. So often, I would say mobile home parks are perhaps the most easy to develop property in any city. And in fact, if there's any kind of zoning you want, I don't care what it is. It could be a lead smelter. You have more likelihood of getting that done by virtue of getting rid of the park than you have in any other format. I once got a call from a developer out in South Carolina and their whole plan was they were going to buy a mobile home park next to a piece of land they owned and use that as a bargaining chip to get better zoning on the land they owned.
So they were deliberately going to buy a park. So they called me up not caring if the park made money or not, because they weren't buying it to make any money. It was not a really big park. It was about 25 lots, but it was a hideous dump. All rusted flat roof homes, horrible repair, absolute eyesore for a city that was trying to rebuild its image. And they simply wanted to know if the theory would work. And I said, yeah, I think it'll work because the city is gonna want to get rid of that park any way you can. So if you want to get a variance to have slightly smaller homes or smaller lots, yeah, it would be a genius stroke. And that's exactly what happened. They bought the mobile home park and they used that as a bargaining chip with the city to get more attractive zoning.
So, don't always think of all mobile home park deals when you're thinking creatively as ending up being mobile home parks. If you look through those news narratives that I do every week, you will notice that probably the number one and most common article are mobile home parks being redeveloped into other uses. And as I say in my comments in those news articles, that the simple formula is low rents equals redevelopment. So every mobile home park deal out there might have another use. We've taken and sold pieces of parks off pretty much continuously now for 30 years, sometimes the entire parcel, sometimes portions of that. But don't take that out of your creative deal making toolbox 'cause yet again, that is another option for you.
The bottom line is that rates run in cycles. They go up, they go down. But opportunity is a constant. You can't just focus on one item. You can't just say, well, I'm gonna sit out this next many years because interest rates are high. The problem is that interest rates aren't high. The interest rates right now are pretty much the norm of what rates used to be. So the key question is finding good mobile home park deals, right? And it's not really a hundred percent, the industry is not completely contingent on what happens in interest rates. They've gone up, they've gone down, they've gone up and down. While I've been in this industry, they've gone up and down before I was in this industry. They'll always go up and down even into the future. One other observation is if you're gonna even buy a mobile home park, one reason now is probably a really good time, is you'll be able to ride those interest rates down.
So the key question is, will Jerome Powell go higher? I don't think so. I don't think he has the capability to go higher. You know, when you looked at the chart, when we started off on interest rates over the last 200 years, there's one item that was left off the chart. I don't know if you noticed, but there was nothing on the item showing the skin in the game that the US has as far as its debt. And that's 'cause it had almost no debt. For those who are older like myself, who can remember the days of none other than Bill Clinton, of all people, which is itself kind of terrifying...
But Bill Clinton, under his regime, coming off of all the good things that Ronald Reagan did and fixed, we had a period there where we actually had a budget surplus. We weren't actually going into debt, we were paying our debt off. So our national deficit was going well on his way to zero. And back in that era, it was very common to see articles where they said, hey, good news, America will be debt free in only X number of years. Well, clearly that never happened. But the key item to remember is that the amount of ability that Jerome Powell has today to dictate rates is not really true because we are by debt the poorest nation in the world. We have about 33 trillion of debt, which is projected by the end of this decade to hit 50 trillion of debt. Let's do some simple math together. Alright? Let's just round it to 30 trillion of debt.
Thirty trillion of debt back when rates were 0.25% wasn't a whole lot of interest. Everyone would agree. But 30 trillion of debt at 5% is $1.5 trillion of payments. And now let's look at another issue. The US government only brings in $4.4 trillion a year from all revenue sources, taxes, and you name it. 4.4 trillion isn't gonna get you very far when you suddenly tack on 1.5 trillion in interest cost. So clearly, we cannot afford this as a nation. It was a nice charade that Powell has done talking big that he's gonna take rates up and oh, he's just gonna stay there forever. And he can probably say that because at his age, he'll probably retire tomorrow. Who knows? But the problem is going to be that our nation will go bankrupt at those rates. Our nation needs to get those rates down and pronto. So more than likely, the scenario rates going up is not even in the ballpark proportionally of the odds of rates going down.
And if you were to buy a mobile home park, let's say right now with interest rates at seven and a half and the interest rates decline by three points down to four and a half, well, you look like a genius because if you bought that park with a point or two of spread and then the rates go your way and you refinance, now you've gotta build in spread of four or five points, which means your rate of return is 30 or 40% cash on cash. So right now, of all times when people think, well, this is not a good time to buy 'cause rates are high, no, it's actually the reverse. It's a great time to buy because the rates are high and going to go down. That's the truth. The time you would not wanna buy was when rates were low and were going up. You could have been the best operator in the history of the world and you still wouldn't make any money because the rates were working against you.
However, that's not what's going on right now. So, and part of it, in mobile home park business, as in all forms of real estate, how well we manage riding the wave of the rates is kind of how well you will do. And you wanna ride the ride that wave, as you saw in the earlier graph when the wave is going down. You don't wanna be surfing the rates when you've got rates going as it did in '81 back up to 15%, you wanna be riding them on the decline. So really, a lot of your strategy regarding creative deal making and the mobile home park industry has to do with your own conjecture on rates, where rates are heading and what is the future. But as far as opportunity, it's always there, stuff, same stuff is out there now, 44,000 moms and pops, only 4000 institutionally owned, number of parks hasn't diminished, they don't reduce the number of parks during times of higher rates. So really it's all about getting creative helping moms and pops understand values or hitting their values and using creative tools to get there. Alright, so now we're gonna go into the Q&A format of the lecture.