Am I thinking about cap rates correctly?

Hey Investors -

Hoping you can help me out.

I took the boot camp earlier this year, and read many articles on applying cap rates to your valuation in the MHP industry.

One thing that stood out to me is that there was no right answer for what rate to apply to your valuation.

The lone widely accepted criteria was apply a rate that achieves a 3 point spread between cap rate and finance rate and you will achieve 20% COC return. Also - don’t always get hung up on day one purchase cap rate. You may be able to achieve 20% coc return and the spread with an initial rent raise, cost cutting etc.

With all that said for rough NOI valuation I am just using a plug number of 8% cap rate since loan rates are about 5% (3 point spread) as starting point for my MINIMUM cap rate. I see many people doing this.

From there I try not to focus too much on the cap rate, but my investment criteria and work backwards.

So if my criteria is:

20% COC Return
Double Park Value in 5-7 years.

That will translate to a cap rate of X and valuation of Y based on what I believe I can do with the property (raise rents, cut costs, sub meter utilities, etc.)

This method seems to fail when I see parks offered for cap rates above my minimum - why not just buy them - they are above 8% and you can get the 3% spread?

Obviously the answer is risk (vacancy, etc.), but I have also reasoned that it may be because while they are 10 or 12% out of the gate - there’s no reasonable hope to improve them. I can get my 20% cash on cash return - but I’m not able to improve the property and increase value because it’s undesirable and my overall return wouldn’t be as good. So in that case it sounds like cap rate is just one factor. I should look at the big picture on each deal, factor in my investment criteria and work backwards from that criteria to apply a cap rate that meets it.

Am I thinking about this correctly? is 8 cap reasonable minimum cap rate for a plug number in my initial NOI valuation?


I think you are looking at correctly if you have those two goals together. Remember, If I recall correctly Franks 3 point spread/ 20% cash on cash return theory includes the mortgage pay down amount each year.

Your goal of doubling value means you either have to be able to raise rents enough, cut expenses enough, or fill enough vacant lots. Find a park where you can do that, that also checks all the boxes of a park you would want to own, and then make your offer to meet your desired cape rate goals whether they be day 1 goals or end of year 1 goals.

I think starting at an 8 cap is reasonable in today’s market but it also depends on location of park, how nice it is, size of park, age of homes, occupancy, infrastructure, and so on.

@Travis_H & @JCas06 I agree with you both that yesterdays 10 CAP is today’s 8 CAP. The most difficult situation we are ALL in today with any value add above an 8 CAP is if that value-add requires a lot of infill. The most challenging aspect to MHP investment today is infill and will require some creative strategies to overcome this challenge.

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@PFM & @JCas06 thanks for your feedback.

Yes originally Frank and Dave had the 10/20 method which was buy at a 10 cap sell at a 20 cap. I heard Frank say that the new model is more like buy at an 8 and sell at a 16.

@PFM yes during the bootcamp Frank did include mortage paydown in his COC return calc.

@JCas06 - when you use the term “in fill” do you just mean filling vacant lots with homes? What are the biggest challenges you see to this?

Where I get hung up is how much I should add to the cap rate for various negative park characteristics. Maybe there is no right answer.

Depends where you are buying.

I look at larger, high quality parks and we often underwrite to buy at a sub 4% cap and underwrite selling at 4%-4.5%. It’s all relative.

What size parks are those? And if you don’t mind, what IRR do you underwrite to and over how many years is that?

$10M+ purchase price. We underwrite to IRRs in the 10%-15% range over 7-10 years.

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Cap rates are all over the place.

Frank and Dave’s rule of 10/20 is extremely difficult to meet these days, hence in Bootcamp, they mention the 3 point spread over the interest rate on the loan to achieve 20% COC. That way you get a return on your investment in 5 years, and from there on it’s infinite returns.

The 10/20 rule these days, is more like a 8/16 rule. The 10/20 rule was there because back in the day interest rates were 7% or so. Where as now, you can get loans at a 4-5% typically, sometimes even lower. The rule changes on what the interest rates are.

So if you get a loan at 4.5%, and you’re buying at 7.5% cap rate with upside, you’re doing well (in my opinion of course).

Cap rates are also difficult to judge, because they depend on area and size of the investment. There’s guys buying 10 million dollar parks with 3% or even lower loans, at a 3 or 4 cap in California or Florida. Those guys are playing a different game, with fund money, and have completely different investment metrics and goals.

For the guy buying a typical park in the midwest or similar, a 3 point spread is the starting point to a good deal, where he hopes to have a healthy spread over his loan, have accessible upside on the deal (raise rents or fill lots or submeter utilities) and then is able to get his money back in a few years from strong COC and then refinances and pulls the equity out and moves on to another park. That’s the gist of the game essentially.

Thank you! Really appreciate the insight!

@Travis_H RE: In-Fill…yes…you are correct…filling vacant lots with homes. Most all manufacturers in America if you were “able” to order a new home now - you would not receive it for about a year. When I say “able” I mean most if not all the manufacturers are allocating homes to their largest customers so smaller street dealers are closing their doors and community dealers are being shut out.

Over the past 10 months, new home pricing has increase some 30+% and there is no sign that pricing will go down. As such, EVERYONE is searching for existing inventory which is driving up the prices of used homes and is very competitive. So, on new acquisitions, your options are fixing deferred maintenance that costing you money, getting rents to market and passing through all other expenses such as water/sewer, trash etc. However, if part of your business plan includes major infill in the current environment and that can make or break a deal, just be prepared for a longer ROI.

Ditto. Hard to find these days. Waiting around patiently like a vulture though.