From what I have read, CAP rates historically follow interest rates. Interest rates are now rising, and will likely continue to rise for some years. It seems that this is good news for MHP purchasers, who will be able to buy the same park at a higher CAP rate, but it is very bad news for sellers, who may have to sell their park for a higher CAP than they purchased it for. I am concerned that any park I purchase today, given all else remains uncharged, will sell for less in the future because of higher interest rates. I have not seen much chatter about this, and I am interested in others thoughts.
The idea is to buy the park at such a value that the increasing rents will take care of the CAP rates. For example, if the current CAP Rate is 9 and you borrow at 5.5%. As you slowly increase your rents to market as well as every year, your CAP rate is much higher. Even if the interest rates trend higher, you will be fine.
I would not buy a park if you don’t feel comfortable in raising lot rents every year and improving the expenses as that would freeze your CAP rates and wouldn’t be good if the CAP Rates trend higher forcing you to take a loss.
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The model Frank and Dave teach is value add properties as well where you can buy at a certain cap and improve the income and expenses as @DallasMHP shows. This will insulate you somewhat on spreads but will also need to take into what your long term/short term goals are.
If you were buying a market rent 5 star park at a 5 cap that might be a different story but if you are looking for an 8-11 cap park with upside ( expense control, revenue growth, lot infill) that will be a different property when you are done with it than what you bought it at.
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Consider not selling for at least 10 years.
Don’t count on a refi in 5 years.
Plan expenses to rise at 4% a year, rents at 3% a year max.
Plan a higher exit cap rate than you bought it for.
Keep the property updated, clean, comfortable and inspect-able.
This applies to all of us.
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Makes sense. I just wanted to be sure that my logic was not flawed. Thanks for the input.
The answer depends on the condition of any park that you are looking at buying now, what the cap rate you are paying for the park and any additional value you can bring to the park to increase its net income. If your park income does not change, then clearly, as interest rates rise, it will sell for less, due to increase in prevailing cap rates. If your rental rates are increasing, depending on how much interest rates rise, it may still sell for less than it is worth currently, sell for the same or sell for more. The hard to impossible part is predicting how much interest rates are going to rise over the next decade and how fast they are going to rise. What you can be relatively certain is that they are not going to improve significantly.
You should be able to predict how much your rents will increase over time and project out your income in the future as MHP_Investor wisely suggested. This will let you create what/if scenarios regarding interest and cap rates to make reasonable guesses at what any given park will be worth in the future.
Although generally, I am a buy and hold investor, and like having income producing properties, I unloaded a large amount of property because, although net cash on cash return was increasing 5%yearly, the cap rates for selling were so ridiculously low, my net profit was so high, it was virtually impossible that rising rental rates would come close to increasing the value of the property to overcome the profit by selling at the cap rate being offered.
I continue to be bullish on parks at what I feel are true 9 and 10 cap rates, especially if they have significant upside. I am not a buyer at a 7-8 cap unless I can see significant upside that will increase the value more than what might be lost with cap rates reverting to more standard norms as interest rates rise. If a person has parks that are full with rental rates at or near market max and ready to sell, now is a great time to be a seller. Just reading today’s Wall Street Journal article regarding the GOP proposal to eliminate the interest deduction should be enough to give any real estate investor some increased level of concern about predictability on their investments total returns after taxes. Gringorick has good reason for concern. I am sure that less cautious, overzealous investors will get hurt by rising interests rates due to paying to much for their properties.
It’s fundamental real estate investing 101. ALL rental / investment property valuations will fluctuate with interest rates, no way around it.
Same as bonds or any other investment that is linked to interest rates.
From Forbes:
The value of any investment asset (real estate property, share of stock, or bond) is the sum of the future stream of cash flow, discounted by the interest rate. With higher interest rates, the discounting reduces the present value of those future income streams. A simpler way to think of it is that at higher interest rates, investors are less likely to see a property’s cash-on-cash return as justifying the investment.
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