Podcast Episode #6: The State of the MHP Economy

So we’re going to be talking about: Is now a good time to invest, or should I wait for the real estate correction? Let’s use this example that we just talked about, so I live in Barrington and there is a mobile home park near here that might be up for sale. Let’s say I might be interested, would now be a good time for me to look into this as a… because it is a seller’s market, right? Or should I wait for a buyer’s market? What do I do?

Glenn Esterson: Sure. No, all good questions. You’re all the way up there in New Hampshire, and New Hampshire is, it has some advantages because you guys don’t have income tax, and then you got to have higher property taxes, but you also have a more stabilized market up there, overall, and you tend to have higher quality parks overall than, say, South Carolina does. Okay.

So what you’re seeing now in the markets is we’ve got a lot of writing on the wall that recession is around the corner, and for some investors especially thinking about buying their first park, it might make them put the brakes on, on their investment strategy for a minute.

So I’m going to preface everything I say with this: In all markets, good times and bad times, there’s people getting rich, and the challenge is finding the deals that work at the time that you’re ready to invest and having a plan to mitigate the downside if all hell breaks loose.

In a park like the ones we were discussing in Barrington, New Hampshire, that particular park is a super pretty park, and it has strong occupancy, and very little deferred maintenance, and no park-owned homes. My gut says this part is going to do excellent during a downturn. You said it yourself, your little town has a 172 new houses being built, which doesn’t sound like much if you’re in Atlanta. But if you’re in Barrington with 3000 people, that’s actually a significant number, and being that this is pretty close to Boston, very close to Dover and a few other areas, I don’t think the economics are going to hurt you in a recession in a market like this with mobile homes.

That said, if you were buying a [inaudible 00:03:08] value add with a lot of park-owned homes and deferred maintenance, I would probably advise against it.

But if you’re thinking long-term hold and you can grow this income from about a 6% return today to maybe a 10% return over the next few years, that that’s a real good number for a high quality asset like this particular deal.

So the economy: We are in what I’m saying kind of the final round here of expansion. We very well might be already in a recession if you listened to people from Europe telling us where we’re at, and if you look at the writing on the wall, we have a lot of activity right now that that makes us think that, “Hey, we could be in a recession or headed towards one.”

Last night I read a report from POLITICO Magazine which did a very large survey on the economy and where we are, and 75% of the people they evaluated say that we are going to be in a recession in the early part of 2021. I think maybe that might be accurate. Nobody’s got a crystal ball. But the reports that I’m reading are sounding like, “Really it’s going to start hurting come around summertime of this upcoming year, 2020.”

So if you’re a seller that’s going to make you think, “Geez, if I’m going to sell the next couple of years, I better start selling now and get ahead of this.” Or if you’re a buyer, you might be thinking, “Well geez, that’s not too far to wait. What if I just wait and see if I can get a better deal.”

What’s going to happen is deals like this deal that we discussed in Barrington are probably not going to suffer, and therefore you, the only thing that’s going to be harder about this deal might be financing during the recession, and chances are this deal is going to get swallowed up by a big guy, and it’s not come back up to the market in the sense that the cash flow [inaudible 00:05:07].

But if you switched over to different markets and different types of a value add, when you look at where the T-Bill is, which by the way was at 1.51 just the other day, the lowest we’ve seen ever, and a short-term debt and long-term debt no longer makes sense compared to each other. Short-term debt is actually being cheaper now than long-term debt, we’re having a flight to safety from around the world as negative interest rates become a common thing in other countries, so people are coming to the United States keeping those kind of propped up for a minute, which is nice.

But then we also have to worry about the debt curve conversion that’s happened, which historically has been a six month marker to the start of the next recession, and you have to look at the election cycle that’s coming into play. Whether you’re on the left or the right, or right down the center, any of the events that are happening especially comprehensively looked at, is going to have an effect on you.

If Trump wins, maybe that’s a good thing, maybe it’s a bad thing. If he loses, it’s probably going to be a little hard on the economy because people are pretty robust with Republicans and business, and all that kind of jazz for better or worse.

So these are all issues and you have to be cognizant of right now. If you’re buying a value add, a [inaudible 00:06:24] value add, I would maybe, especially in a secondary or tertiary market, I would maybe say hold out, maybe it’s not the right strategy, especially if you’re a new guy. You might have some hard times like I had to go through during the last recession.

Or, if it’s a park like this one in New Hampshire, I would probably give it the full steam ahead. Man, you better get it now before it’s gone and it doesn’t come back, because that’s the kind of deal that people really want. If I’m a buyer, I don’t mind paying top-of-the-market prices for a high quality asset if I know over the next 10… 7, 10, 15 years, I’m going to grow the equity return on there to a double-digit level, so the [crosstalk 00:07:05]-

Jason Sirotin: These investments, when you look at these investments, Glenn, these are not something that we should look at as a quick turn. This is a marathon, right?

Glenn Esterson: Yeah. A lot of them are. I mean, look, there’s plenty of guys that have bought… that have sold them a park, we fixed it up and then we sold it again a year later and have doubled our money on the park, plenty of times I do that, and that’s fine. I just am now putting the brakes on doing that with a lot of my clients just because of where we are in the cycle, and I’m starting to set expectations that: Hey, a quick turnaround site might not be doable in the timeframe that I think is available, especially considering the work that’s necessary on the park that you just bought. So I would probably be setting expectations more for like a three- to five-year period before you can exit on a kind of flip and fix.

Jason Sirotin: Got you. Another thing I wanted to ask is, does the size of the park matter? Like right now, let’s use the one in Barrington, how big is it and does the size matter in a down or up economy? Like is it safer to have a smaller park? Or is it safer to have a larger park? Or it doesn’t matter?

Glenn Esterson: Gee, so yeah I’m going to say it depends. Historically people want larger parks if you have scale and you have better efficiencies to run. If you have a nice park like this one, which is about 80 spaces, that’s a good size. To me, that’s not a big park, it’s not a small park, it’s a straight up, middle-sized park. For 3.5 million bucks I think you would find worse ways to spend your money.

But if this park was 80 spaces and only half-full, I would be very… I would question the strategy because who knows if you’re going to be able to instill that park during a downturn, and you’re be… and right now you’re paying for the premium of value add in vacant space right now. So I would be cautious.

Now small parks, I think are great. I don’t know what the problem is for a lot of people, but they don’t like small parks. Personally, I think small parks are a great way to make extra money, especially for the new guys coming into this field, call it a park under 25 units.

I just put a parking in Charlotte under contract, an ugly little duckling of a park, but it’s got all the right bones, and all the right features, and I think it’s a great deal. Guess what? We listed it at a very aggressive cap rate, but we got it under contract in less than two or three days of marketing, at list price, for cash, because the location and the bones of the park makes sense so that the next guy knows he’s going to get some good rent growth, good times or bad times.

It might take a few more years if the recession comes, but at the same time he’s going to be able to achieve probably 25% rent increases over the next couple of years.

That’s a small little guy with like 12 or 13 spaces. But I think for a first-timer that’s the perfect type of park to buy, because you’re going to learn the ropes and you can go bigger from there, and selling these small parks is pretty easy, especially in a good market when there’s lots of buyers. But if you don’t sell it, it’s good income to keep because you’ve got a turnkey by that point. Buying a value add smaller park with some hair on it with these systems, the infrastructure systems, and things like that would be a bigger challenge than maybe you would want to digest on your first deal, and definitely when you’re considering if you’re buying at the top of a market before a recession.

I know that’s not the clearest answer, but I hope that kind of gives you some ideas.

Jason Sirotin: Yeah. Those parameters around it, so I’m wondering: Is now definitely… Like, let’s say I was looking to do something that I would consider, and maybe you can correct me, a bigger move. What about building my own park? Is this the worst time to build your own park?

Glenn Esterson: Woof. You know, like I started it off, there’s winners and losers in every market, good or bad, and I’m actually doing a few development deals right now, and the guy that’s buying them is very, very, very cognizant of where we are in the economy, and he’s still able to address high prices.

Now, just to clarify, building a new park is damn near impossible. Okay. Most places will not give you the zoning to do it. If you remember from a few episodes ago, that’s one of the inherent values of mobile home parks, is the zoning-

Jason Sirotin: Oh, yeah.

Glenn Esterson: … and they’re not giving it anymore. So what people are doing when they’re developing now is they’re buying these super ugly ducklings that have been terrible performers and mismanaged, and are essentially scraping them to the dirt and starting over, so they’re going to reenergize the whole park.

But, man, is that a daunting task. I mean it could easily be a five to seven-year project before you’re full, and it can be a lot of challenges if you miss… if you miss the mark on what the local economy is like, and what the local demographics are like, it could be a real daunting task, and not one that I would ever suggest to anybody who’s in this business for less than a couple of years that doesn’t have a development background to even consider.

While it might pencil out on paper and look great. I could also show you some beach front property in Central Iowa that might look great too on paper, but it might not really exist in real life. You know?

Jason Sirotin: Right.

Glenn Esterson: It’s not something I really recommend new guys doing, and really the guys that are doing it are pretty accomplished, and if you’re interested in that aspect of mobile home park development, that’s something I think that is better covered as a separate topic to those that are interested, because most people are going to say, “I’m not doing that. That’s way too much risk,” and rightly so.

Jason Sirotin: If you’ve been in the game, and you’ve owned a park for like six years now, and you’ve been contemplating an exit. Is this a situation where now is the best time to sell? Because if you don’t want to hold on through it… through to weather whatever economic downturn is in front of us, it seems like what you’re saying is like: Sell now unless you’re ready to ride it out.

Glenn Esterson: Exactly. That’s kind of what I’ve been telling people lately is like, “Hey, look. We have more buyers… more sellers than ever entering the sales cycle right now. Okay, and so what that’s going to ultimately do as we flood the market with new properties is going to revert this back into a buyer’s market, or at least stabilize the seller’s market that we’ve been in, and when you balance it up against the potential recession, and that could spell trouble.”

If you’re a retiree that’s like, “Hey, I’m in my 60s, I’m ready to be done with this day-to-day stuff, and I just want something easier, so I’m going to think about selling my park.” You’re thinking, “Well, I’ll probably sell it the next year or two, or three.” I would challenge you to suggest thinking about selling it now to get ahead of the curve, to get ahead of the other sellers and to still maximize the pricing.

We haven’t seen pricing go up in the last six months. It’s really been pretty flat, so that when that simple fact would make me say, “Hey, I’m not going to be like everybody else. I’m going to get ahead of the curve and start planning an exit now, because I really want to retire in the next few years, and if the recession happens, it might delay it by three to five years, maybe longer, just to get back to the same value.”

Because you can’t sell your park during a recession because there isn’t financing, or you’re having some challenges with occupancy, and you have been able to raise rents, your value is not going up, it’s straight-up going down. So that’s something to really, really consider.

A guy like me or you, who’s not thinking of retirement anytime soon, yeah, I’m not too worried about it. But you know what? We’re also capitalists that are looking to make a buck usually pretty quickly, and that would be something I would… I would want to ponder as well, “Geez, maybe I take less now than I thought I was going to get, just to stave off the pain of going through a recession, and if I’m capitalized low because I sold my park early in time, maybe there’s a few good deals I could pick up during the recession.”

Jason Sirotin: Because you’re so-

Glenn Esterson: That’s not how I would be looking at it.

Jason Sirotin: Because you’re so in the mix with everything, Glenn, what are your thoughts on deal flow right now? Are you seeing an increased deal flow, regular or decreased; because I feel like that might be a good indicator too?

Glenn Esterson: Increase, I’m getting more deals now than I ever had in my life, and we’re probably… I mean my list is probably 50 units, or 50 deals right now, and we’re just scratching the surface of what’s available. If I had more arms and more mouths to speak on the phone with, I bet you we’d be doubling that list pretty soon. What that is, it’s great as somebody who is in the center of it all, but what that means to a buyer is that, “Hey.” Or what that means for the sellers, “Hey, there’s a lot of other competition out here now.”

That’s competition it doesn’t always breed, better pricing for sellers anyways, when you have other sellers trying to sell. You’re going to put some brakes on that. Right now the low debt that we have is really sustaining the pricing we have, if that that does start to tick back up as it did this time last year, that’s going to have a negative impact on your pricing. So as the recession comes in, maybe they keep suppressed interest rates for an extended period, but typically when they start getting confident again, they start raising those rates and that’s going to end up hurting your value. So, again-

Jason Sirotin: Do you think that… What is your opinion on that move by the Fed to reduce rates? Does that that help the industry or does it matter?

Glenn Esterson: It helps all industries superficially, right? Because every time they lower the debt, it means it’s cheaper for us to buy a park, or buy an investment, or buy a car, or buy a house, or any of that kind of stuff. But it’s kind of artificial, and what ends up happening is we start having this is very frothy environment where it’s like, “Oh, we got cheap money, there’s always going to be cheap money.” But no, man, cheap money doesn’t last long. When it gets to a tipping point, it turns back into, “Oh-oh. We’re going to have problems.”

Kind of like what we did with 2008 and ’09, where we had such cheap debt, and such loose underwriting, and such loose mortgage processes that it created a massive correction, as we all remember. So you have to be cognizant. I just trust that the Feds, they’re pretty smart guys, for being guys that are pretty removed from the day-to-day of life, and I can’t say they’re doing it right or wrong, I mean they’re smarter guys than me, so I’m going to trust that they’re doing it right.

But I would tell the investor (a) regardless of what those guys are doing this is where we are in the market today, and it is something to be cognizant of. If you’re a long-term holder, you can skip this whole episode because you’re probably going to be just fine either way. But if you’re really a player in the market, or if you’re a new guy entering the market, or if you’re a guy looking to really ponder when the best acquisition period would be for you, that’s what this discussion is going to help those guys out with more.

Jason Sirotin: So Glenn, if I’m coming to the table right now, and let’s say do this deal in Barrington, and let’s say it’s 3.5 million. What do I have to do as the buyer, cash wise, to come to the table? Because I remember in another episode we talked about that banks aren’t really into lending on mobile home parks. Am I getting that right? Do I need to come with like a bag of cash?

Glenn Esterson: Yeah, sort of. it’s not like buying a house where you can get in for 5% down, on a deal like this one just because the quality is there, and the books of records are there, and the market’s there, you’d probably get into this one pretty cheaply, but my term of cheap is 20% down. Then you’d probably get some pretty sexy loans somewhere right now in that 4.5 to… in that 4% to 4.5% interest range, and probably an amortization of somewhere between 15 and 25 years amortization.

Maybe you get a better loan, maybe you don’t, but I think that’s probably where the debt is. So at 3.5 million, if you had to put down 20%, so that works out to $700,000 down to getting this deal, and day one, yeah, you’re not going to have some kind of crazy sexy return on day one numbers, but probably 6% or 7% on unlevered and probably 8% or 9% levered, but you should be able to run that number up to double digits over a couple of years with some 5% rent increases done in the proper way, and things like that.

There are nine vacant lots, so you’d be able to bring those online and things like that too. So that’s, for a deal to get into for 700,000, while it’s not chump change, it’s also not having to come up with $3.5 million like you would if this was a value-add deal, a bank probably wouldn’t want to touch it, and that might be harder to get into.

But the add-on to that right now, just on that note, to get a little off topic here, I was reading a report the other day that the amount of bridge loans being given right now: short term interest-only loans, okay, are exceeding the pace of standard loans. So what you’re having is, all these guys out there on cheap, cheap interest-only money, doing deals that probably would not make sense at all using conventional money. That’s usually a sign in all markets that we are at a peak when that number starts to [inaudible 00:21:38], when your interest-only money starts becoming more rampant than your conventional money, that’s also a sign of peaking. So you’re being [crosstalk 00:21:47] to consider-

Jason Sirotin: Interest-only meaning sort of like what led us to the housing crisis, where you can get into a house, a-million-dollar house and it’s like $800 a month, because you’re only paying the interest.

Glenn Esterson: Paying the interest on it, right.

Jason Sirotin: But you do, you’re like a balloon payment at the end of that?

Glenn Esterson: Right. Exactly. You’re not eating up any of the principal in that balance. When that note comes due, your principal is still the same amount, and then you go and re-fi out of that if you can and you’re kind of restarting all over again. But interest-only does have a big effect in the investment world with real estate because there’s a lot of value-add deals out there that a bank is not going to loan on, so it’s a way to help adjust for that.

Historically they’ve been high interest loans that we’re doing bridge loans. Nowadays, man, there are not high interests, they’re in the 5% to 8% range now, which is not a high interest rate historically considering my mortgage is on my house and I live in now, at my farm, are all in the 6%-ish range. Granted I should be refinancing, and I would advise anybody listening right now to really go think about refinancing 100% of their properties, because I’m in the process of doing right now too; 6% is great historically, but in today’s markets of 4% you could probably save some real bucks.

Jason Sirotin: Yeah. That would be a massive savings for a lot of people, to kind of wrap this up, I have one more question that is a little loaded, as I think about this property near me. If you’ve got a place with 80-some-odd homes on it, you’ve got all your payments and everything. How much cash am I churning out of an ’80s home in, in New Hampshire, and a plot of that size?

Glenn Esterson: Sure. All right, so on a deal like that you’re putting in… you’re putting down 700,000, and you’re not having to worry about putting in any kind of extra capital for deferred maintenance and things like that. Let’s just pretend we didn’t negotiate with the seller, and we just paid the 3.5 that he wants.

Jason Sirotin: Yes.

Glenn Esterson: Okay. The market rent… Well his rents right now are at 455, I’m being extremely conservative, pretending we don’t grow the rents aggressively, and we just do a 5% increase, that’s roughly 475 is where you’d probably go at the end of year, at the end of the full year you’d probably raise rents the 475. Right?

Jason Sirotin: Yeah.

Glenn Esterson: For that first year alone, if we run it at a… what I think is going to be an appropriate… an appropriate expense ratio of about 45% on this thing, and you might, and you might do better than me, you might get 42% and that little percentage does have a dramatic shift in the numbers. But let’s just pretend that we’re running this thing at, here we go. Yeah. Let’s just pretend we’re running this thing at a 44% expense ratio, and be a little cautious here, cognizant here with, with all of that.

I’m going to say that the return on this thing, day one, doing nothing different other than just operating it the way I think you’re going to operate it, on current income, is going to be something like… let’s take this out here. It’s going to be something like a 13.5% total return to you.

So a total return, like cash-on-cash, and all these other metrics just means all the actual dollars that are earned on this deal compared to the down payment that you did, so if you’re… It’s all the income earned, all the NOI, and then you have what’s called principal reduction that’s added to it. So when you pay principal it’s actually reduces your cost, so that’s real money.

On a deal like that, you’re looking at about 13.5% starting point. But at the end of year one, once you put in that little increase, that number should jump up, maybe to about 15%, and then if you run it out a little bit further, you’re probably looking at somewhere is around an 18%, 19% return, call it by year three or so, so that’s the advantage.

Jason Sirotin: But if I’m looking at it from… Let’s take it to neophyte terms. I don’t know shit about this. How much cash am I pulling out every month? You’re saying, whatever that is I’m going to get to keep 13% of that?

Glenn Esterson: Yeah. So basically on this deal you’re going to have an NOI of about $220,000, okay. So if you didn’t have any debt whatsoever and you just getting $220,000, okay, off of your $3.5 million dollar investment, you’re looking at about a 6.5% return. It’s nothing sexy, but it’s a nice stabilized deal, and in my world is pretty sexy. But now if you lever that deal, your debt in that deal is costing you about $180,000, so you’re walking away with about $40,000 cash, but you’re also putting in the piggy bank another $60,000 of principal. Okay?

Jason Sirotin: Right.

Glenn Esterson: So you’re really walking away with about $100,000 at the end of that first year, plus or minus, that should be about where you are, so 100,000 out of 700,000 works out to about that 13.5%.

Jason Sirotin: Got you. Got you. So in the end, if I did this for five years, I’ve got about $300,000 in equity in the park, plus I’ve got some cash, and now I can go and hopefully get a sale, which is going to pay me back my 300 plus whatever I can get as far as a multiple?

Glenn Esterson: Correct.

Jason Sirotin: Got it. Okay.

Glenn Esterson: Correct. The sale value that would project on something like this, you keep it for five years and you run up rents 5% a year, and you’ve created some efficiencies so your expense ratio is a little bit lower, and you’ve brought those, a few of those vacant lots online, you’re probably looking at a deal around $4.5 million or so at your exit, with no additional capital improvements of any significant amounts, having to be applied in here.

So you’re getting… you’re getting a lot of extra on your total returns there, and when you go and sell you pick up a 3.5 instead of 4.5, that’s a million bucks, plus the 300,000 that you’ve paid into your principal, so you’re actually getting 1.3 million, and then plus the income that you’ve earned each year call it, it probably averages out to like a $75,000, and your IRR is probably somewhere or around, I would guess you, probably IRR at the end of the day of a five-year cycle is going to be around an 18% return, and that’s healthy numbers, man.

Jason Sirotin: That’s pretty good.

Glenn Esterson: That’s if you work it every single day.

Jason Sirotin: Especially if you’re looking at… if the park is as nice as you’re saying it is, and it looks like it’s in a good area and it has good tenants, it sounds like a no brainer. That sounds like a hot deal.

Glenn Esterson: Right. You’re going to have an easier time than another guy who’s buying the same deal in Tuscaloosa, Alabama, or something like that. You’re going to have an easier time. Not that Tuscaloosa is bad market, but it’s just a market most people haven’t probably heard of.

Jason Sirotin: Right?

Glenn Esterson: Do you know? Yeah, so-

Jason Sirotin: Absolutely. So I want to end with one final question, and that question is: The mobile home park economy State of the Union, are we good? Are we bad? Are we just like right in the middle line?

Glenn Esterson: I think we are good, with the caveat that there is some stormy weather on the horizon and it’s time to kind of button down the hatches, and cut off any of that dead weight that you don’t need to have. If you’re a retiree, it’s a great time to be exiting right now.

Jason Sirotin: Glenn, thank you so much for giving us all this amazing expert information.

If you want to reach Glenn you can go to his website, VMHPexpert.com. You can contact him via email at [email protected], and even better, you can call Glenn directly on his mobile telephone at (423) 483-0492.

For the Mobile Home Expert Podcast, I’m Jason Sirotin with Glenn Esterson. Thanks, and we’ll see you next week.