Find & Evaluate Manufactured Home Investments (Part II)

In my last article I discussed several ways to locate a Manufactured Home Community to purchase. In this article I will discuss the methods I use in evaluating a MH Community once I have found one that looks like a winner.

How Do I Determine What a Specific Manufactured Home Community is Worth?

I want to know how many lots there are, how many are occupied and paying, what the lot rent is, what expenses the owner is paying, and who is responsible for the water lines, sewer lines, and roads.

A good rule of thumb that I use to start with is that I take the number of occupied spaces and multiply this by the average monthly space rent and multiply this by 70 (The “70” number is an arbitrary number based on my experience in evaluating deals).

For example if the community has 110 spaces with 10 vacancies and a monthly average space rent of $200…

Then my initial value calculation is 100 x $200 x 70 = $1,400,000.

If the community is on the market for $3 million I will probably pass. If the community is on the market for $1,800,000 or less than I will probably look into it further. Remember this simple calculation is very generic and may or may not be the true indication of the value of a Manufactured Home Community.

As you will read in any appraisal handbook there are 3 basic valuation methods. However, with Manufactured Home Communities two of those methods, the cost and sales comparison methods, have some flaws that skew the results. The cost method does not take into account the business component or occupancy levels. It would value a 100 space Manufactured Home Community the same whether it has 100% occupancy or 50% occupancy.

The sales comparison method is also flawed in most cases due to the lack of quality and recent comparables to select from. MH Communities have been increasing in value over the last few years as has other real estate. With relatively few sales to draw from, an appraiser will typically use sales from a couple years ago and sales from markets 100 miles or more away from the subject property. Even if there is a similar sale in the same market and in the same condition, one MH Community can be much more attractive than the next. Differences in expense ratios, occupancy levels, and space rents can make one community worth 30-50% more or less per space than a similar community down the road.

Due to the flaws in the first two methods I put all my efforts into valuing a MH Community using the Income or Market Capitalization method. Under this method I take the Net Operating Income divided by the Capitalization Rate to come up with the Value. While this might sound like a simple process, it can be quite complex coming up with the true Net Operating Income and deciding what cap rate to use in the formula.

A simple way to think about the cap rate is that it is the return you will receive year one based on the current projections if you were to pay cash for the property. If you put $1,000,000 cash into a CD, you can expect somewhere in the 5% range for your money. Obviously, if you were to put $1,000,000 of cash into a Manufactured Home Community where there are risks and time involved in managing that investment, you will want more than a 5% return on that money. Cap rates have been all over the place in that last few years but they are once again rising.

The communities that are selling now have cap rates in the 9.00% and higher range. Determining the proper cap rate to use in the formula is arbitrary and will depend on what you are looking for as an investor. One investor may be satisfied with a 7% cap and the next investor needs to buy at a 12% cap in order to justify the risk and time involved. I do not even look at communities that I can't turn into at least a 10% cap rate. The range of cap rates on the market today fall in the 3% to 11% range with most communities falling into the 7% to 10% range.

Another factor in determination of an acceptable cap rate has to do with the requirements of your lender as well as the interest rates on the loan you use to purchase the property. If you are borrowing 80% at a 10% interest rate and are trying to buy the property at a 7% cap rate, you will have a large negative cash flow. On the flip side, if you are borrowing 80% at a 4% interest rate on a 7% cap rate, you should have a positive cash flow. So the interest rates are important to consider in the equation.

After determining what is an acceptable cap rate you need to rework the profit and loss statements you receive from the seller or broker. I call this the “Net Operating Income Reality Check” (NOIR). Your goal in this process is to determine the actual projected income and expenses for the first year after you take over ownership.

Figuring out the actual income is usually not too difficult. You can take the actual number of spaces in the community and multiply this by the actual rents being charged and subtract out a reasonable allowance for collections and you should be able to come up with a good estimate of the income. I usually use 2-3% as the collections expense. If the rents are 50% below market and you know that they can be raised, you might include a portion (maybe 50%) of this increased rent in your projections.

The next thing to do is to come up with the anticipated expenses based not only on how the community is currently operating but also based on how the community will operate with you as the new owner. For example, if the current owner is managing the community, then you need to plug in an amount for management and payroll taxes and workers comp. If the community has vacancies and there is no advertising expense, then you need to plug in an amount for advertising. And so on.

After coming up with the income that the community is currently generating and deducting from that all the anticipated operating expenses including the reserve for capital expenditures you will have what is called the Net Operating Income.

Note: Net Operating Income does not included deductions for Mortgage Interest, Depreciation or Amortization. If these numbers are included in the expenses you need to add them back to come up with the Net Operating Income.

If you take the Net Operating Income and divide this by the price you come up with the Capitalization Rate (Cap Rate). Also, if you divide the Net Operating Income by the Cap Rate you come up with the price and so on.

Other considerations on the value of the community will be the entrances, streets, landscaping, utilities, parking, lights, storage sheds, number of singles versus doubles, swimming pools, clubhouses, etc. The nicer the community typically the lower the cap rate and the easier it will to tap into better financing programs. In addition to the quality of the community considerations many Manufactured Home Communities have other factors that need consideration. This includes such things as vacant lots, land for expansion, community owned homes, and seller financed notes.

Manufactured Home Communities offer great opportunties for investors in today's market. Stay tuned for more articles on manufactured housing.