July 5, 2023

JF3226: The Playbook for Value-Add Mobile Home Park Investing ft. Chad Freeman




Chad Freeman is the founder of MHPinvestors, which purchases undervalued and mismanaged mobile home parks and brings them back to life. He is a returning guest to the podcast, and in this episode, Chad discusses the advantages mobile home parks provide as opposed to other asset classes and how his business plan has evolved over the past year to accommodate for lower deal flow and higher interest rates.

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Chad Freeman | Real Estate Background

  • Founder of MHPinvestors
  • Portfolio:
    • 150 mobile home spaces
    • 47 RV spaces
  • Based in: Jacksonville, FL
  • Say hi to him at: 
  • Best Ever Book: Scale by Jeff Hoffman and David Finkel
  • Greatest Lesson: Nothing beats great due diligence and consistency.

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Slocomb Reed: Best Ever listeners, welcome to the best real estate investing advice ever show. I'm Slocomb Reed, and today I am here with Chad Freeman. Chad is a returning guest of the podcast. Last time he was on aired August 10th of 2022, episode 2899, "Revitalizing undervalued mobile home parks, featuring Chad Freeman." He's based in Jacksonville, Florida, and his company is MHP Investors. Current portfolio includes 150 mobile home spaces, with 47 RV spaces, and he works as an airline pilot. Chad, can you tell us a little bit more about your background and what you've been working on this past year?

Chad Freeman: Sure. Well, you mentioned airline pilot... So when I was a young airline pilot - I guess I'm still kind of young, but when I was first starting with the airlines, I knew I needed something besides just airline income to rely on, especially because it's such an unstable area as getting into, a career. So I started in real estate, and I knew right out of college that I wanted real estate, so I started in residential real estate... And then fast-forward to 2017, a couple of years later, that's when I got into mobile home parks.

So for the last six months or so since we've talked, we've been busy implementing some systems and operating procedures, and just trying to deal with the portfolio that we have, and do infill and just make it the best properties that we possibly can, and fill out those plans while continuing to look for properties to purchase. We've got a syndication now open, so we've got active investors, and we're raising money and purchasing more properties... And I've found it's been pretty slow until just recently; I noticed a lot more activity picking up, and talking to bankers and other brokers and whatnot too, they're also feeling the same.

Slocomb Reed: I want to ask you what the last year has felt like, Chad... So let's just put a pin on just recently, right now, so that our listeners whenever they're listening know what time period we're talking about. When is it that you started to see the market pick up with more opportunities and more brokers calling you?

Chad Freeman: Just last month or so maybe. We were really slow on offers, because we just weren't running into a lot that made sense...

Slocomb Reed: So we're talking the month of May 2023.

Chad Freeman: Yeah, just recently I've noticed more.

Slocomb Reed: Gotcha. And you have one of those under contract, it sounds like.

Chad Freeman: Well, I've made quite a few offers lately for us, and then it sounds like we're gonna end up with a partnership deal from just being on social media, I think, and just trying to increase our online presence, I've found people are starting to reach out to me more.

Slocomb Reed: It's interesting, Chad - I am going to rag on a lot of multifamily investors at least, a little bit, at your expense, as you're the one who has to be across from the interview, hearing this from me... I've been calling myself an apartment owner-operator on this podcast since late 2021; operators in the title, I feel like I've been focused on operations the whole time. I hear a lot of investors nowadays saying that they are focused on their operations, and it sounds like a cover for "I can't find anything to buy and I'm worried about my capital reserves and making it through whatever is coming." Does that resonate with you at all? Have you experienced the same thing in your conversations?

Chad Freeman: No, we're ready to buy. It's not an excuse. If anything was an excuse is because we didn't have enough deal flow. But the mobile home park sector - it's a different animal than apartments. I know a lot of people are having problems with all the frenzy of last year, and the speculators, and people making the front page of the Wall Street Journal with defaults... That's not going on in the mobile home park sector. In fact, I just called our bank the other day, or one of the base we like, and I said "We're making a bunch of offers. Are we still going to be able to get a loan?" And the banker's answer was "It's business as usual. We've never had a single mobile home park loan go bad, ever." So they're happy to do more.

Slocomb Reed: Business as usual, just with higher interest rates, I'd imagine.

Chad Freeman: Of course. Let's talk about the fluctuations in the market. We were on this podcast, talking about a couple of value-add or turnarounds you were doing with your parks last year... It sounds like the lending space hasn't changed with the exception of interest rates. Between summer of 2022 and now, the end of the spring, early summer 2023, what has changed with mobile home parks?

Chad Freeman: Not a whole heck of a lot. I think the spreads of the interest rates and the cap rates have gotten tighter than they were pre COVID... And what that tells me is sellers are holding out, they're pricing in the future of lower interest rates; the cap rates have been very sticky, I've found, to move up... So we were originally targeting a three-point spread - that's really hard to find anymore. But with value-add properties, we're happy with about a one point spread on a lot of the properties we're seeing... But managing those seller expectations on their valuations from last year with this higher interest rate environment has been my toughest challenge.

Slocomb Reed: You were getting three-points spreads between cap rate and interest rate... Why is it that you're now taking one-point spreads?

Chad Freeman: Well, like I was saying, I think the seller expectations have priced in possibly interest rates going back down, and it looks like inflation is under control and coming back down... I saw the latest consumer expenditures went up a little bit, and it kind of freaked people out... But I think the trend is still down, and we're going to be alright, it looks like. So those cap rates have been stickier than I would have expected, and I think people are just holding their breath, waiting for a more stable environment and seeing what the Fed's going to do, and waiting to see if they're going to lower interest rates again. And if they do, then the sellers are correct. Those interest rates are temporary, and so the asset prices were harder to move because of it.

Slocomb Reed: Are you projecting that interest rates will go down from here?

Chad Freeman: That's kind of my guess, but I don't pretend to do much future guessing... The only thing I know about the future is it's uncertain. If I had to venture a guess, I would think that they might raise it again here on June 14th, another quarter point, but most of the raises have been done already.

Slocomb Reed: Chad, it sounds like there's just not as much meat on the bone for people who are looking to buy mobile home parks right now based on what you're saying... Have you seen your business plan evolve over the last year, or the return expectations that you're creating with investors?

Chad Freeman: No, I haven't, and maybe I gave the wrong impression. I think there's plenty of meat left on the bone. I think this is a fantastic sector, and we're just chugging along, trying to do the same thing we've always been doing; we've just got a little bit of a pricing adjustment with the expectations on sellers... But even at that one-point spread, everything we're looking at is mismanaged and value-add; so there's a ton of value out opportunity out there for people to go revitalize old, mismanaged parks... And that's where all the meat is at. That's where we've made our most money, is increasing NOI and adding value to the property, and that's still there.

Slocomb Reed: That makes a lot of sense. It's fairly disconnected from the day one cap rate, or the cap rate that's being advertised by brokers. That makes a lot of sense.

Chad Freeman: Yeah.

Slocomb Reed: Have you seen that the plan for how to optimize the performance of a park has changed at all? Or is it the same playbook that you've been running for the last several years now?

Chad Freeman: No, it's still the same playbook. We're just starting with a tighter margin. But the whole entire sector's undervalued like crazy, just with a lot of rents being at an average of $300 a month or so. Fair market value, if you just adjust with the lot rents from the '60s inflation, it's putting it up around $600 or so now today. So you have an opportunity to just go raise rents and bring it up to a fair market value and quickly increase that internal cap rate and get away from that one-point spread. So we just look at it on an individual basis, and there's still plenty of opportunity to return the returns that we've been telling our investors that we're targeting.

Slocomb Reed: Making another comparison to apartment investing here - and I know mobile home park investing is different, and that's kind of what I'm getting at here... What We've been hearing for the last several months from apartment investors is that the deals they see don't pencil. That brokers were still sending them opportunities, and they just couldn't find the ones worth writing on. So a couple of variables there... One is the volume of listings coming from brokers, and the second variable being whether or not those properties make sense for the investor's business plan.
On those two variables, what change have you seen in the mobile home market? The volume of deals hitting your inbox, but also the worthiness of those deals as it were when it comes to giving you the opportunity to force appreciation and add value.

Chad Freeman: The volume of the deals hasn't been there, until recently; I've noticed it picking up more. And anything that makes sense for us to do, we make an offer on it. So that's where -- I've seen a lot more deals lately, when I say that deals that we're offering on, because it just makes sense to do it. So maybe it's because of the historic end of the year trend, where things kind of slow down, and pick up again in the springtime, I'm not sure... Or just people are becoming more confident, but...
Another thing that we can really compare with apartment complexes, where I think you'd have more opportunity with mobile home parks, is the barriers to entry. Because when I'm seeing apartment complexes, there's record high starts last year, and attributable to the high single family home prices, I think... Just this year alone, there was over 500,000 completions coming online, and another - some insane amount of starts, I forget. So with mobile home parks, there's huge barriers to entry. The governments won't let you build mobile home parks, basically, so we've got no new starts coming on. There's an average of 100 going away every year, and only 10 new bills. So I think that makes a big difference there as well.

Break: [00:12:07.15]

Slocomb Reed: Chad, I'd like to transition this conversation a bit and ask you... I kind of feel like I'm asking you for your secret sauce, but hopefully you can be specific enough to add value to our listeners while also being generic enough not to give away anything specific to the way MHP does things. I personally as an investor resonate with your sentiment that the opening cap rate is not as important, especially on deals where the real opportunity is how much you can increase the NOI with a new operation. When you're looking at a new offering from a broker for the first time, what does your underwriting look like? Or what does your due diligence look like? And I'm not really asking what are the things you look at necessarily, as much as what are the levers you need to be able to pull and what are the metrics that you need to know that you can move from X to Y [unintelligible 00:15:00.25] Is it "I need to be able to increase the NOI by X percent in the first one year, two years"? Is it "What are the key underlying metrics that dictate whether or not a deal is going to have enough value-add for you"?

Chad Freeman: I guess just looking at the three main areas we add value, or four really, it's overall appearance - of course, the lot rents itself, if it's got a very low lot rent, that's the easiest thing we can do. That's the biggest low-hanging fruit; you write a letter and 30 or 60 days later you're raising the rents. So that's a no-brainer. And then submetering water and filling vacant lots. Filling vacant lots is really time-consuming and capital-intensive course.

But looking at each one of those on an individual basis, as well as the economy and the age of the homes, we just take them on an individual basis. So we tailor each offering based on that property. One property in particular, the lot rents were so high I recently offered it a 10 cap, and they seemed like that was into the ballpark... And the reason we did that is because there was no room to raise rents for the next five years. They were already up above market rates, so we would have had to come in with that spread off the interest rate to get the returns that we're needing.

So if you have a different property, where the lot rents are 200, we can pay probably a negative spread on that; something that's super-easy to just increase the returns right away. But it's just on an individual basis, and looking at our whole operation... It's pretty easy to know how we're going to put together a rough plan, and then just throw some numbers on a spreadsheet and blow those out and see how it's gonna match up. And it's a really cool way to do it too, because I have two properties in mind, and the numbers never lie. One of them I thought might be better, but it was out the window, and the one I wasn't considering won the cake all day long with the numbers.

Slocomb Reed: Tell us more about those two properties.

Chad Freeman: I'd have to go dig through for the details on those two, but one of them looked lousy, and the other one, I had already looked at it before, and we were considering just about as tight as we could get it... It was just a minimal return that didn't really get us excited about too much once we ran the numbers and looked at it. And then the other one that initially didn't look very exciting got a lot more exciting, because now we're looking at 100 plus percent return on investment.

Slocomb Reed: Chad, do you all underwrite to the roughly five-year hold period?

Chad Freeman: Well, right now, we've been trying to push it out to about eight or ten years, especially with the interest rates.. And we are losing a deal, because the sellers - they are insisting on seller financing, but they won't go past a five-year term... And it's too scary for us in five years we might have to re-finance, and a higher interest rate could possibly put you upside down on the property. So just for safety, and with the interest rates, I really dislike a five-year term right now.
Slocomb Reed: Underwriting to an 8 to 10-year hold still means that in order to deliver on your business plan and the returns that you're projecting, you're gonna sell the property, right?

Chad Freeman: Yeah, sell or cash-out refinance.

Slocomb Reed: Gotcha. Globally speaking, what kinds of returns are you looking at during that hold period? Or what is it that you're targeting?

Chad Freeman: Well, for our investors we're targeting first year 10%, and then it goes down to 9% and 8% preferred return. And we're going to do a 50/50 equity split for whatever value we create, plus 50/50 cash flow split. So if you throw in the numbers on our last property that we bought, it ends up being a little bit more than 20% cash on cash return... But our minimums are that, 10%, 9% and 8%, and the equity and cash flow split. So I think if we just keep doing what we've been doing, everyone's gonna be really happy with our performance on that. And like I said, anything that makes sense on us, we're offering. And part of that equation of making sense is hitting those returns that we're telling people we can get.

Slocomb Reed: Yeah. Chad, I think my question here is, in order to hit those projected returns and sell for what you're going to need to sell for, purely from a financial perspective, what is it that needs to be accomplished? What's the metric that you're measuring? Is it obviously a shift in property value, and that shift in property value comes down to NOI? Is there a certain percentage that you know that you need to move the NOI during a hold period in order to know that you're delivering your returns?

Chad Freeman: No, not off the top of my head. Like I said, we plug that into a spreadsheet on an individual property basis... But it's a lot to do with lot rent, and projections where we think the fair market value is, and how long to get there... Because we also only do $50 at a time rent raises; we don't want to create a hardship for our residents... So it can take four or five years to get there if you're on a really undervalued property.

Slocomb Reed: $50 at a time on an annual basis? What's the time interval?

Chad Freeman: Every spring.

Slocomb Reed: Every spring, gotcha. So if they're $400 behind, it takes eight years.

Chad Freeman: Yeah, if it was $400 behind, I'd probably consider doing a larger jump than $50. That is insanely low, so... The residents would know it, too. I think a couple $75 moves or something like that to help get up there would be quite appropriate.

Slocomb Reed: That makes a lot of sense. You were quoting lot rents in the six hundreds and lot rents in the two hundreds. I know if we were talking apartments, I'd have to ask what markets you're in. I know you have some in Michigan; how much do lot rents vary from market to market?

Chad Freeman: It's kind of throughout the Midwest. If you go out, on an extreme example, to the West Coast, California, there's parks with lot rents I think over $4,000 a month.

Slocomb Reed: Oh, wow.

Chad Freeman: But there's mobile home parks on the beach in Malibu - I just saw one that sold for 5.5 million for one home.

Slocomb Reed: Oh, wow.

Chad Freeman: Right? But throughout the Midwest, it's very common to see lot rents in the high two hundreds. If you go to some lot rent-only states, where you see a lot of that from Louisiana to Georgia, where everybody else [unintelligible 00:21:07.10] lot rents can be just stupidly low, like $75 or $125 a month. But most of where we operate, 300-ish is very common, to pick up parks for around $300, or just see that's what they're charging. And then about half of a two-bedroom apartment rent is a rough rule of thumb on what you can charge for lot rent. So when we look at an economy initially, we want as high of a three bedroom apartment rent as you can get, and the minimum we're shooting for is about $1,000 a month. And that gives you that income disparity or that big difference, and it also drives the demand for affordable housing, too.

Slocomb Reed: Chad, I've interviewed several mobile home park investors the last year and a half on this podcast, yourself included, and this is the first time that I'm hearing that metric on how to judge where market rent should be. You said about half of a three-bedroom apartment, or a two-bedroom apartment?

Chad Freeman: The rough rule of thumb is about half the two bedroom. But then we're also looking at three bedroom prices and we want that at or above $1,000.

Slocomb Reed: Gotcha. And that carries out fairly universally then, that market lot rent is going to be about half of the rent of a two bedroom apartment? Well, let me just say, before you answer the question that I just asked, that makes a lot of sense, because from the tenant perspective, part of the reason to go to a mobile home park and own the home is the lower carry cost, the lower monthly expense of owning the home and paying lot rent as opposed to an apartment. So 50% of the two-bedroom apartment makes a whole lot of sense in a lot of ways. Does that number carry fairly universally?

Chad Freeman: As far as I know, yeah. It's just a rough rule of thumb that I was taught. But it's a ridiculous low number too, if you think about it. You get to own your own home for 300-400 bucks a month... Yet mobile home park operators are getting all this heat for raising rents, and people don't realize how much money it costs to turn around these properties and make them nice again. But they don't want to pay any higher rent, and then what's happening is park owners are repurchasing the properties and they're going away. So lot rent raises are also needed to keep mobile home parks around.

Slocomb Reed: Last question on this topic as we wind down the interview, Chad... What are your other rules of thumb when you are doing your back of the napkin math on a mobile home park deal?

Chad Freeman: Probably the biggest rule of thumb I use is expense ratios, which we enjoy over apartment complexes. I've heard they're 50% to 60% expenses... And because we don't do any rentals at all, we're just renting lots to homeowners, so that takes out the home maintenance, we have about a 30% to 40% expense ratio, depending on what's going on with your utilities. So that's an easy way to figure out your net operating income off the gross income. And then just throw whatever cap rate on it you'd like to target for your spread, or wherever you think you want to be, and now you've got an offering price.

Slocomb Reed: So sticking purely to what can be done on the back of a napkin, and not making any recommendations on how anyone invests their money... If I want to underwrite my first ever mobile home park deal, Chad, what I need to do is estimate the lot rent as half of whatever the two-bedroom apartment market rent is in the area, I should project a 30% to 40% Expense Ratio, figure out the cap rate that makes sense for me, and I'm ready to write an offer, right?

Chad Freeman: Pretty much... I'd say maybe do a little bit more than that, but at least you can get going with that. And maybe call the other park operators and see what they're charging, too.

Slocomb Reed: Of course, yes... But calling other park operators doesn't fit on the back of a napkin.

Chad Freeman: No, it's an easy formula... You know, gross, how many people are paying per month times 12, and then you take out 30% 40% expenses, and that's your net. So it's pretty simple.

Slocomb Reed: Well, Chad, I've enjoyed catching up with you. We're not going to do the traditional lightning round because you're such a recent guest... But just a couple of questions here. What is the Best Ever book you've recently read?

Chad Freeman: Recently... I haven't gotten all the way through it, but I've really been enjoying Jeff Hoffman's book Scale. I thought that was a really good read so far. I really like that guy, from what I've seen him say.

Slocomb Reed: Nice. Last question, where can people get in touch with you?

Chad Freeman: You can give me a call on my cell phone, 303-590-5590, or you can find us at MHPinvestors.com. I'm also on LinkedIn, just look up Chad Freeman, or MHP Investors.

Slocomb Reed: Those links are in the show notes. Chad, thank you. Best Ever listeners, thank you as well for tuning in. If you've gained value from this episode, please do subscribe to our show, leave us a five-star review and share this episode with a friend you know we can add value to through our conversation today. Thank you, and have a Best Ever day.

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