John Oliver had a very interesting (and now very popular) segment earlier this week that highlights some great points on the state of the mobile home industry, both from an investor and ownership perspective.
Mobile homes can be a great way to live affordably, and if you check them out lately, you’ll find that they can be of high quality and very nice! But there can be real risks which lie in the underlying monetary and market mechanics behind the industry, and some can be truly detrimental to owners.
While we believe that investment is needed in society to keep the economic engine running, we also are working to help create a win-win between all parties, and this is what I’d like to try to tackle here.
Lingo – Mobile vs. Manufactured vs. Prefab vs. Modular?
We all have a general idea of what a mobile home is, but what’s the difference with these other words? Here’s how the market generally uses them –
“Mobile” and “manufactured” basically mean the same thing, in that they are the types of homes that are in the mobile home parks around the country. Nowadays they conform to the basic HUD code and come in single or double wide sizes, and are on wheels.
“Prefab” and “Modular” are used interchangeably to represent a typical standard house that sits on a solid foundation, but the house itself is built in a factory and transported onsite.
While all the words mean that the house is built off-site and in a factory, the differences are quite stark, and so can be the monetary consequences of how we use them as homeowners. Proto Homes, Clayton Homes and Dryside Property also had some nice detailed writeups on these terms if you want to dig into it more.
Today we’re just talking about mobile/manufactured homes.
For starters, in the video he outlines some interesting facts on the mobile home park world:
- 20 million Americans live in mobile homes, or 1 in 18 people.
- Over 100,000 home sites (pads/lots) are now owned by giant private equity groups such as Carlyle Group, TPG, and Blackstone.
- Interest rates can reach 15% when buying a mobile home, with shorter term periods than traditional home mortgages.
- Rents are being significantly raised as soon as the new investors take over, to as much as 60% higher.
It becomes quickly clear that this is actually a huge segment of the population and real estate market, and effects us significantly as a whole country.
Why Investors Love Mobile Home Parks & How The Numbers Work
Supply and Demand
Mobile home parks are generally going away and are in less supply, or at least more are not being built. Cities and counties don’t like them, and there’s the whole NIMBY factor (Not In My Back Yard). The simple laws of supply and demand mean that there are less pad lots to go around, and demand is actually going up for this type of housing. This is due to the unfortunate shrinking of the middle class, wages not increasing vs. costs of living, and many other macro factors, and that means that the value of this type of property/asset class generally goes up.
At this time in the spring of 2019, at arguably the top of this business and debt cycle in the economy – valuations are sky high. Stocks, bonds, and most real estate are all at all-time highs. What that means is high yield and attractive investments are very scarce. Multifamily, single family, industrial, office, retail, and other real estate asset classes are delivering very low returns if you were to buy now, compared with historical averages.
So what does that mean? To find the highest return – you go after stuff that you normally wouldn’t go after. Enter mobile home parks, which is where a lot of the big private equity and real estate funds have found the highest return today. Laws of economics also mean that the higher the return, the more risky an investment is. But this is where we are in the cycle.
Commercial Real Estate Valuation
Investors want the highest ROI (return on investment) possible. And what is the main factor that basically all commercial real estate value increase is based on? Higher rents. Unlike residential housing, where the sales price goes to highest bidder based on a number of factors, commercial real estate is based on numbers, with the biggest one being the net profit that the property generates after expenses, just like any other business.
So how does it work? Let’s say a Mom & Pop owner has one pad/lot to rent out. They have been earning $200/month after expenses to have your mobile home sit on it. Someone else owns the mobile home that sites on top of it, and they’ve been there for 10 years. Mom & Pop are happy with their revenue and haven’t raised rents for a long time.
A private equity group comes in and buys the park, and immediately raises rents 30% to the market rate, to $260/month after expenses. Commercial Real Estate (CRE) uses what’s called a cap rate (capitalization rate) to value the property. We won’t get into details on cap rates for this piece, but let’s assume the market rate is 8%. The valuation of the property before the PE group bought it is:
An Example – The Calculation
$200/mo x 12 months (1 year) divided by .08 (8% cap rate) = $200 x 12 = $2,400 / .08 = $30,000 value for that lot.
Now let’s look at the new valuation once we raised rents –
$260/mo x 12 months (1 year) divided by .08 (8% cap rate) = $260 x 12 = $3,120 / .08 = $39,000 value for that lot.
Wealth is Created for Investors
So by raising rents, the lot is worth 30% more, and they made $9,000. This is how all commercial real estate works on a basic level, all other variables staying the same. Multiply this out on a mobile home park that has 100 lots, and that’s a $900,000 gain (100 x $9,000 each lot).
This is great for the investors, but what about the homeowners? Well, if you’re renting a lot now you just have to come up with another $60 per month, or $720 per year. This can be really tough, and in the video he describes how some people have to leave the park and abandon their home that they own, because they can’t pay the huge cost to actually move it (up to $20,000). This is financially catastrophic – because now you have to move and lose your home, which you are still on the hook to pay for, or have to sell at a huge loss.
Money Mechanics of Owning the Mobile Home Itself But Not the Land Under It
Investors generally don’t want to own the mobile homes themselves, because they lose value, just like a car. That’s not a good investment. Why is this? Because it is essentially a mass-produced commodity, which is a liability. Assets are defined as something that is generally scarce in supply, like land, or land with a dwelling affixed to it.
But if you own a house without the land under it, you own the piece of the housing that loses value, while the investor owns the piece that appreciates over time. This means that the homeowner in this situation loses net worth over time, and is always fighting a financial uphill battle.
This was the point of the John Oliver’s whole segment. In this model of mobile home park ownership where certain pieces are split up, the burden falls on the homeowner due to the dynamics of assets/liabilities and how the monetary system we live in works. If you’re paying pad rent that keeps increasing, along with a high-interest mortgage on a home that loses value, you are losing wealth over time.
So what can we do? We have no problem with conscious investing, and are advocates here for a win-win in wealth creation for everyone. In this above scenario the investors win and homeowners lose.
The first part is just understanding how the system works. John Oliver outlines the three different versions of how to go about it –
- Just rent the home – In this scenario it’s not bad because you don’t own a depreciating liability. You just pay rent like in any other home rent situation. To build wealth the idea is that you want to own assets that appreciate over time, and minimize the liabilities (anything that loses value). But over time in this scenario you still are not gaining in net worth because you don’t own assets.
- If you are buying the home – Make sure to own the land with it. Have it sit on a solid, immobile foundation. This is probably the biggest key to all real estate asset and wealth creation. You have effectively created a scarce resource, which is a nice house sitting on top of land, which you cannot reproduce. And it generally increases in value over time.
- Buying a house but renting land from someone else – What to try not to do. This is the wealth killer that John Oliver explains in the video. It’s the opposite of the second scenario above – the house is now a commodity that loses value, and you don’t own the land under it that goes up in value.
In the video he calls for a way to create a partnership where all investors and homeowners within the park can work together for a piece of ownership, and also lists some groups that are working to create member-owned parks, so that all residents can share in the ownership, and thus wealth creation over time. Here are some of them:
- ROC USA – Resident Owned Communities
- Northcountry Foundation
- Community Loan Funds – Many different chapters in different states.
There are a ton of factors that we couldn’t cover above, and a lot more to consider. So what do you think? We would love to hear your comments and stories below. As always – our mission to work together to create a financial win-win for all parties involved, and we think John Oliver did a great story on the subject in the end.