I am just wondering if the valuation formula we used 5+ years ago is still applicable in today’s MHP market. Occupied lots X Average lot rent X 12 X .6 X 10 seems to yield initial values far, far below the asking prices I’m seeing today. It seems like the market has really heated up and everyone in real estate is trying to buy a park (or several), making it a seller’s market. I’m curious if this has changed the way some of the pros on here are initially deciding the ball park value for a potential acquisition. I see this trend of overpriced parks across the board but it stands out the most with stabilized assets. Is this just the new reality of our space and we should change the formula to end with a 15 instead of a 10 or are buyers really overpaying to this extreme?
The formula is timeless. It simply says Revenue X Operating Income X Net Income Multiplier = Price. The part you have to be careful with is what numbers to use as variables. Revenue is lot rent x lots x 12 as you indicated. You assume Operating Income Ratio to be 60%, but that is not always true. You have to determine Operating Income Ratio based on the specific property, your operating model, and other factors, which are not universal. You are assuming Net Income Multiple to be 10 (10% cap rate), but you will have to dig very hard or buy lower quality properties to find cap rates that high.
Properties that are nicely run with easily achievable upside are selling at cap rates lower than 10%. The easier it is to get the upside, the lower the cap rate.
As a case in point, if I offered to sell you a park with 83 units paying lot rent of $100 and $80,000 in expenses at a cap rate of 4% (25 multiple rather than the 10 or 20 you proposed), would you buy it? You don’t have the details to answer. If I told you market rents are $250, then you should buy it. If you offer 4% cap rate ($490,000), then raise rent aggressively over 3 years, the NOI increases to $169,000 and at an 8% cap rate, the property will be worth over $2.1 million. That would be a home run. On the other hand, if you insisted on buying at a 10% cap rate, then you would offer $196,000 and possibly never get to contract.
That is why investors pay low cap rates and why you cannot rely on a formula without understanding the underlying assumptions and variables. You must develop your own variable values based on research of your operation, the property, and the market.
BTW, I am also Mike O.
Mike,
Thank you for the explanation. I guess what I meant to ask was if the multiplier is outdated, not so much the formula. Of course there are variables that will make each situation different but that’s where the research and DD comes into play. I understand your illustration of buying at a low cap rate and using the upside to increase the value. But since when are buyers paying for upside that they will have to implement? I can kind of see it if it is something easy like simply raising the lot rent but in general I thought the whole idea was to value a park based on its current condition, occupancy, and numbers, not what it could be if it was operating at 100% occupancy and efficiency. Do you know what the desired cap rate is nowadays? When I bought my park 5 years ago everyone was saying buy at a 10 cap…is 7 the new number? It can’t go too low or you won’t get the 3 point spread between the cap and interest rate on the mortgage.
Thanks in advance,
Mike
The multiplier was never intended to be set in stone. It’s supposed to reflect your criteria for necessary return. Six or eight years ago that was the “common” benchmark thrown around a lot…
That makes sense, thanks for the clarification.