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Could mobile home parks be the perfect (recession-resistant) Opportunity Zone investment?
Sam Hales is CEO of Saratoga Group, a real estate investment firm focused on investing in affordable housing, specifically through mobile home communities located in Opportunity Zones. On May 27, Sam presented his MHP investment thesis to the OpportunityDb network.
Click the play button below to listen to the condensed audio recording of the webinar.
- Why Sam believes that mobile home parks (MHPs) are the “perfect” Opportunity Zone investment.
- The advantages of mobile home community (MHC) investing, including simplified management, high tenant moving costs, fragmented ownership, risk-adjusted returns, and limited supply.
- How same store NOI growth remained positive for the MHP asset class during the previous recession.
- The differentiators among different Opportunity Zone real estate property types, including idiosyncratic risk, diversification, current cash flow, future cash flow, and recession resistance.
- How mobile home park communities offer the multifamily residential concept, but with social distancing.
- Financial projections of Saratoga Group’s Opportunity Zone Fund investment portfolio.
- Examples of impactful capital projects in the communities within Saratoga Group’s portfolio.
- The locations of Opportunity Zone properties held by Saratoga Group’s Opportunity Zone funds, and why they’re willing to go out to tertiary markets, provided they have good economies and population growth.
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Industry Spotlight: Saratoga Group
Founded in 2011 by Sam Hales, Saratoga Group owns and operates 26 mobile home park communities with over 2,000 lots. They are currently closing their second $15 million Opportunity Zone Fund.
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About the Opportunity Zones Podcast
Hosted by OpportunityDb.com founder Jimmy Atkinson, the Opportunity Zones Podcast features guest interviews from fund managers, advisors, policymakers, tax professionals, and other foremost experts in opportunity zones.
Jimmy: Hi, I’m Jimmy Atkinson with the Opportunity Zones Database at opportunitydb.com, and welcome to today’s webinar, Mobile Home Parks: The Perfect Recession-Resistant Opportunity Zone Investment. Let’s find out. Today’s sponsor is Saratoga Group. And some of the things that we’ll be talking about today include the economic advantages of mobile home park investing through an Opportunity Zone fund, how mobile home parks or MHPs, as we’ll abbreviate throughout today’s webinar, offer a simplified management solution, why MHPs may offer superior risk-adjusted returns. And then, we’ll also spend a little bit of time comparing MHPs to other asset classes commonly held by Opportunity Zone funds, and why MHPs may outperform during recessions, and then most importantly, how you may be able to incorporate this type of investment into your portfolio.
So now without further ado, I’d like to turn it over to today’s guest, Sam Hales. Sam is founder and CEO of Saratoga Group, a real estate investment firm focused on investing in affordable housing, specifically through mobile home communities. Sam founded Saratoga Group in 2011 and has successfully managed over $200 million in assets. We’re very pleased that he is here today with us to share his expertise. So please, Sam, take it away.
Sam: Jimmy, thank you so much. It’s a pleasure to be on here today. And I hope that each of you find a lot of value through what we’ll be sharing today. So the title is Mobile Home Parks: The Perfect QOZ Investment. Of course, perfect is a tough word, right? And we’ll certainly be talking about all the economic advantages of mobile home communities in Opportunity Zones. But part of the reason this word was chosen is because of the original political intent for the OZ legislation, which was to help disadvantaged communities. And as I often tell people, probably almost every mobile home park or mobile home community has the demographic of people that really should be included in an Opportunity Zone investment.
First thing here is in terms of the advantages of MHC or MHP, MHC, meaning mobile home community, they’re kind of used interchangeably those terms, but of investment in these sorts of communities. First one is simplified management. So, if we think about this is what’s called a land lease community. So we own the land and we own the improvements on the land, which are gonna be the roadways. It’s gonna be electrical distribution, you know, just kind of common area lighting. It’s gonna be sewer lines, water lines. But other than that, typically, the residents own their own homes. And so when you think about… You know, if we’re comparing this let’s say to an apartment building, where we’re gonna own all the walls, and if the roof leaks, we gotta fix that, and the windows leaking, and just all those issues that are gonna crop up, we don’t really have those issues in a mobile home community. And so that kind of simplifies our management.
Second thing is what’s referred to as the high tenant moving cost. So, we call these mobile homes or manufactured homes. Mobile homes was kind of a term that’s been used predominantly in the past. And, you know, it’s changing a little bit in the industry, but they’re really not that mobile. And so, if somebody is, let’s say living in a community, they own their own home, and they wanna move to a different community, that can cost from $5,000 to $10,000. By the time they get the large truck to move, you often have to get permits to do it. You’ve got to then reinstall your skirting. You’ve got to install a new deck, stairs, all those sorts of things, and so it creates a sticky tenant base. The average length of residency being 12 years compared to, you know, kind of 1 to 2 years maybe on apartment dwellers.
The next is fragmented ownership. So, there are approximately 50,000 communities in the United States, and less than 3% of those are owned by the largest public owners REITs, such as Sun Communities or Equity LifeStyle. And so, what that means is because it’s so fragmented, there’s a lot of kind of what we call mom-and-pop owners that have owned these communities and a lot of times don’t reinvest into them, also don’t get to keep the rents up to market. And so there’s a lot of buying opportunity because of that fragmented ownership. So in terms of risk-adjusted returns, kind of a typical operating expense ratio for a mobile home community is going to be in the 35% to 40% range. If we compare that to maybe a multifamily apartment building, that’s gonna be 5% to 10% higher than that.
And finally, is a limited supply. So I mentioned, you know, 50,000 communities or so in the United States. And what’s interesting about that is there’s kind of a little bit of a moat built around this industry. Every year, there are more communities that are redeveloped into other things like a Walmart or some sort of commercial investment versus the number that are new and get built kind of straight out of the ground. It’s very difficult to get a mobile home community approved and built.
So we started out doing single-family home investment 10 years ago in Northern California. We’ve done a number of other different real estate investment transactions and, you know, manage those sorts of opportunities. And what really attracted me to this asset class was the fact that it does well in both good times and bad times.
So let me explain this chart. First of all, in blue, this is showing across each type of commercial real estate or really an aggregation of all types of commercial real estate, for publicly traded REITs, what was what’s called same-store NOI growth over the last 10 years? And you could see that it’s generally been positive, meaning each unit, each apartment, let’s say, or each office has become more valuable. But here we are in the Great Recession from 2009 through 2010, and as you would expect, you know, each unit became less valuable because it was generating less income, maybe there was more vacancy, maybe rents came down. Of course, we we’re probably staring into a similar situation right now. But what you’ll notice is that 10 years ago when this happened, although the NOI growth has slowed, there was less growth. It was still growing. And it’s not just each year, it’s actually every single quarter, these mobile home spaces have become more valuable on these publicly traded REITs.
So, they’re generally, well, three different types of Opportunity Zone funds, at least from my experience. What I’ve seen is there’s quite a few on the hotel development side, Class A apartment development side, QOZ business and, of course, I’m presenting today a mobile home park fund, which is certainly quite a bit different than each of these.
So I just want to spend a minute and talk about some of the differentiators, first being the idiosyncratic risk. So, if we’re investing in a hotel and it’s a ground up development, there’s all sorts of kind of risk that goes up. It goes into the lease up as far as, you know, how long does it take us to get our occupancy rates up? You know, how is that particular market going to perform relative to a mobile home park fund, where, and I’ll get to this in a minute, but we’re basically purchasing an asset that’s already cash flowing. And of course, QOZ business, if you think about a startup company and kind of the risks associated with that, it can be very risky.
Diversification. So across our OZ transactions purchases of mobile home communities, and we’ll share later kind of what those have been so far, our average purchase price is right around $2 million. So, in a $15 million fund, which is like our current fund for OZ fund, we’re able to buy you know, 10 to 15 communities that are in different geographies with different demographics. And we’re able to diversify kind of geographically and demographically. I already mentioned, you know, these mobile home communities we’re buying, they’re providing current cash flow. I mean, our typical occupancy is about 55% at acquisition, and that’s true of our OZ parks as well as our non-OZ. So, there’s a lot of headroom in terms of the lease up, but there’s also a kind of a baseline of cash flow that we’re able to have when we purchase.
In addition to that, mobile home communities are known for the ability to generate really good cash flows over time. And there are a number of levers that we’re able to use, not just adding occupancy, but in the way that we operate them, maybe billing back for utilities, different things like this that allow us to pretty easily kind of move both the top and the bottom line, in terms of our income.
And finally, like this slide that I just shared, the mobile home communities in the past have done very well during recessionary cycles, you know, certainly relative to hotel or maybe Class A apartments. We obviously know the impacts right now for hotels. And it’s been dramatic and really sad in many ways. Class A has held up pretty well, at least so far. What we’ve experienced in past downturns is that Class A, over time, people start trading down from Class A to Class B, from Class B to C, and mobile home communities are kind of considered a Class C-type of asset. So that’s part of the reason they hold up well during a recession.
Jimmy: Which is very important during the current environment that we find ourselves in. Is that right?
Sam: Yeah, yeah. In fact, and that’s what I wanted to kind of speak about your next, Jimmy, is how totally not so far. So, on the left, you’re gonna see a graph or a chart showing kind of some industry survey results regarding collection. And so I’d have you pay attention to kind of that last column. So the percentage that’s reported there is the percentage of historical collections that they reported in the month of April. Right? So in other words, industrial is the top one, so, April 2019, you know, let’s call that a baseline of 100%. In April of 2020, they’re collecting, you know, close to 92% of what they would have historically. And you could see, there’s certainly some real pain points, right? Malls at the bottom, certainly all types of retail are having a very difficult time. Manufactured housing across the industry is collecting about 97% of historical, which is the highest of any of the asset classes.
An interesting point regarding mobile home communities is this social distancing. I mean, we’ve got it kind of been mandated at some level, but also many people choosing to social distance, and it can be quite difficult to do in a multifamily community, right? You’ve got elevators, you got common doors and hallways, and that sort of thing for a multifamily apartment building. In a mobile home community, each resident typically has their own driveway. They’re not sharing any walls with anybody else. They’re not sharing an HVAC system. We believe that this may just continue to increase the demand for this type of housing because of some of these social distancing rules that may be with us for a while.
The other aspect is, again, we talked about kind of simplified management, it’s becoming quite onerous for some of these… I mean, imagine owning some multifamily apartment buildings in New York City right now. Some of the rules and the procedures that they’re having to put in place, you know, one person at a time in the elevator and things like that, that make it very difficult and expensive to operate some of these communities. And we don’t really have to worry about that too much with the mobile home communities.
Okay. Well, let me share a little more regarding our financial projections. So they’re at the top. You’ll see we’re projecting for a limited partner for an investor, an IRR of around 22% over the whole cycle for actually over a 10-year horizon, equity multiple of three-and-a-half, and an average cash on cash to the investor of 11.4%. I think the graph below can explain a little bit about how the business works, how our model works, and we’ll go into…it’s more detailed in a couple of slides from now as well. But basically, the idea is when we make the initial investment, and like I said, we are buying current cash flow, but we’re then going to be able to, you know, start distributing. We basically don’t distribute that first year, we start distributing starting in that second year. And so you can kind of see those distributions go up.
And that says we do do a few different things. Number one, we’re in filling the parks. We’re bringing in new homes. Number two, we’re operating them much more efficiently. So, I think I mentioned a little bit ago, a lot of times we’ll buy a community and there might be on the expense line, you know, $6,000 or $7,000 a month being spent on water and sewer. And those costs are not being recaptured from the residents. And the reason is the residents don’t have a meter on their home to say, “Well, how much should they get charged.” And so we’ll go in and we’ll install sub meters at each home, and then people start paying just like all of us who don’t live in a mobile home community would pay for the amount of water that we use.
So anyway, then you see in year 5 and year 10, these big spikes, and let me kind of explain that. A mobile home community, it’s pretty simple in some ways. It’s valued based on a multiple of the net income. And so as we do these things, and as we add occupants, as we increase our efficiency, as we raise rents, one I didn’t really mention, then they become more valuable. And as they become more valuable, we have an opportunity to recapitalize the communities.
And so, what you’re seeing here is in year five, you know, the way we operate these, we’re buying these value add communities, and our intention is that within first five years, we’re gonna recapitalize our portfolio and return to the investors their original investment. It doesn’t mean that they no longer have shares in the company, right? They bought shares and we still own these, the preferred return goes away, but they continue to own those shares, and they continue to get their profit percentage of the cash flow that’s generated. And then the same thing in year 10, because by year 5, we’re not done and we’ve added a lot of value. But, you know, we might only be at 75% or 80% occupied across the portfolio, there’s still a lot of room to add value. And that’s what we’re projecting there in year 10 as well.
So, let me talk about maybe a little bit of this is on the social impact side. But here’s some examples of some capital projects that we’ve done. So new driveways. We’ll put new asphalt down in the communities. We’ll build a new children’s park. We’ve got some kind of barbecue pavilions going in. We’re doing new signage at basically all of our communities, kind of standardizing that, you know, grading for new lots. Again, so a lot of this is kind of centered around improving what’s already there. Right? So it’s development to some degree, but it’s really improvement of what’s already existing.
And, you know, one thing I’d shared with our team, a little analogy, I suppose. I don’t know how many of you rode the bus to middle school, but I did. And it wasn’t always a pleasant experience. And so I have what we call the bus test for our communities. And that is, when you think about a kid in fifth grade or maybe he’s in middle school, and he’s getting off the bus, at our community that we own, if the kids are making fun of him because of where he lives, we’re not doing our job. And honestly, most of the communities that we purchased, they probably did get made fun of.
So that’s kind of the idea. We’re looking to improve these communities, make it a place where people are proud to call home and are happy to be there. And it really, in the grand scheme of it, doesn’t cost that much to do some of these improvements. And just the stories over the past few weeks with some of these projects that have just been getting completed, have been really inspiring and really fun. Okay.
So here are the QOZ properties that we’ve purchased so far. First two are in fund three, which is also a QOZ fund. But the others are in fund four. You know, you can kind of look down the list and see sizes, and number of lots, and how many are occupied? How many are vacant? A couple of things I wanna point out.
So first of all our locations, right? So we’re in Bloomington, Indiana, home of Indiana University, Greenville, North Carolina, home to East Carolina University, Daytona Beach, Florida, Lakeland, Florida, Rockdale, Texas, which is outside of Austin, kind of on the way to College Station. And then Las Vegas, Nevada. So we have filters around, “Hey, this is where we’re gonna invest. These are the types of communities, type of demographics we’re looking for.”
You know, one thing to keep in mind about mobile home park investment, it’s not like we can pick a market and say, “Hey, we love Charlotte, North Carolina. We love Raleigh, North Carolina. We like Nashville, Tennessee. We’re only buying in those markets.” Because if we did that, we wouldn’t be able to really find investment opportunity. So we kind of have to be willing to go out into some of these other markets that are maybe, you know, tertiary. But, again, they’ve gotta have support. We’re not gonna buy something in kind of rural Georgia or rural Mississippi, where there’s not an economy to support people living there or, you know, you think about maybe some of the Rust Belt states where people are leaving. We’re not interested in those states, either. I mean, we’re looking for places where there is economy, there’s population growth, and there’s solid numbers to…
In fact, this was research done by Dr. Charles Becker out of Duke University, and what he found is really the only metric we need to look at in terms of replacement housing for mobile home parks or for mobile homes is a three-bedroom apartment in that same MSA. So that’s the key metric right there. We look at that ratio, and its gotta support the kind of lot rent that, you know, we need overtime to make it economically viable.
The other thing I’ll mention real quick is, I said at the beginning that it’s very difficult to build a new mobile home community. However, what’s much less difficult is to add lots to an existing community. And we have a number of those opportunities in this QOZ fund. I’ll mention a couple. So Los Robles in Rockdale, Texas, we’ve already met with the county on this. It’s currently 84 sites. It’s permitted right now to add another hundred sites. And so we’re in the process of kind of getting all the construction permits together. So we can start that. We’re filling out the existing community as well. In fact, this is one of the ones just had new driveways and asphalt put in last week.
Another one is in Las Vegas. So, as you’ll see there, we purchased that community with 53 in place lots, and we were looking to initially kind of keep what was there and then add another 25 spaces. But we knew it was zoned for a lot more than that. And we’re now working with the county, with Cook County to do 150 units on that property. So instead of just adding 25 here, we’d be adding, you know, almost 100 units to that one. And so those are fantastic kind of upside opportunities that haven’t really been captured too much in our projections, but kind of gravy on top of that.
So let me share a little bit about Saratoga Group’s history and track record. So we own 26 communities with about 2,300 lots. So, you know, close to about 100 units per community. We’re in Florida, kind of Northern Florida, Georgia, Atlanta area, Alabama. It’s actually closer to Columbus, Georgia right across the river. We’re in North Carolina. We’re in Indiana, Illinois, Las Vegas. And then, we have a couple in California as well, and then Texas. And we have our headquarters here in Northern California, Sacramento area. And then we have some of the management spread out, geographically kind of close to, you know, some of these locations. So, our senior regional manager, Josh, is located in Springfield, Illinois. So he’s, you know, covering the Midwest region. Our COO, Luke, who’s my brother, lives in Nashville, Tennessee. And so he’s proximate to kind of things both in the Southeast and in the Midwest.
And then I wanna just kind of explain this chart really quickly. This is not fund four, this is actually fund three, which is our previous QOZ fund. But we’ve got more operating history there. And I wanted to kind of point out our experience, how it’s worked so far and how we think it’s gonna happen in fund four. So what you notice is that initially, the revenue, sometimes it dips a little more than this, but certainly, income dips as well. And the reason for that is, I mentioned most of these sellers are kind of mom-and-pop owners. I mean, they might have been the ones who built it or, you know, maybe their parents built it and the kids have inherited it. And they really have not reinvested into the communities and they don’t have very good protocol for screening the people that are coming into their communities. And so what we find is there’s often a little bit of a criminal element. There’s just some bad apples that we need to get out of the community.
And so initially, our expenses are higher, our occupancy is gonna dip a little bit. Because before we bring in the people that we want to come in, we have to clean up and stabilize what’s there. And so that’s why you’ll see a quarter or two have kind of this dip before the revenue and the income start to increase. So again, this was fund three or previous QOZ fund, but we anticipate very similar performance and we’re starting to see it already on fund four. That’s really it. And I know we wanted some time for questions. So anyway, thank you so much.
Jimmy: Yeah, that’s great. Thank you, Sam. Thanks for joining us today and sharing your expertise with us. If you’re interested in downloading the slide deck, you can do so by heading to invest.saratogagroup.net, register, and Sam will get that slide deck over to you. Actually, I think it’s on that page after you finish registering.
Sam: Yeah, totally.
Jimmy: So that’s how you can access that. Thank you, Sam. And thank you all for attending. I appreciate it.
Sam: Thank you, Jimmy. I really appreciate it. Thanks everybody.