Today’s REI Classroom Lesson
Kevin Bupp goes explains why looking at the current cap rate of a potential deal for a mobile home park doesn’t always show the potential after you take it over and run it properly.
REI Classroom Summary
After making the mobile home park run more efficiently and getting numbers where they ought to be, the real cap rate can be established. When done properly, even if you overpaid for the park, you still came out well ahead.
Listen to this REI Classroom Lesson
Real Estate Investing Classroom Show Transcripts:
Announcer: Welcome back to the FlipNerd.com REI Classroom where experts from across the real estate investing industry teach you quick lessons to take your business to the next level. And now, let’s meet today’s expert host.
Kevin: Hey, guys, Kevin Bupp here from the MobileHomeParkAcademy.com and the Real Estate Investing for Cashflow Podcast. Today, I’ll be your host of the REI Classroom Tip, and in today’s show I’m going to discuss why it sometimes makes sense to overpay for a commercial income property.
Announcer: This REI Classroom real estate lesson is sponsored by VirtualStaffNow.com.
Kevin: And for today’s lesson, I’m going to be sharing with you a recent case study of a mobile home park that we purchased in Virginia. When we buy mobile home parks, we typically like to buy parks at a 10 cap rate, and a 10 cap rate would be based on its current income. Based on the market and the quality of this particular park I’m going to mention here today, on a 10 cap with normal operations it should have been worth about a million dollars. That’s what our assumptions were.
Well, after talking to the owner a little bit on this property, we started realizing that he was running it terribly. In fact, his NOI for 2014 was under $30,000. I think it was $28,000, which based on a 10 cap, that would have made that property worth $280,000. Now, he knew that it was worth more than 280,000. I knew it was worth more than 280,000. But realistically, based on its current operations, it really wasn’t, and so we came to an agreement to end up paying $650,000 for the property.
But the reason why I decided to overpay for it, and let me tell you, that $650,000, that equated to about a 5% cap rate. Now that is obviously half of what we normally look to pay for a property. But the things that I saw when I looked at his financials, on his expense line items, is that he was running about an 88% expense ratio on this particular park. That means 88% of his gross income was going towards expenses. And I knew based on my experience that this park should be running at about the 50% range. The items that I knew I could change, I thought that I could change them pretty quickly, which would have got this park down to about $120,000 a year in NOI versus his $28,000 a year in NOI.
We ended up paying $650,000 for this park. Like I said, that equated to like a 5% or a 5 ½ cap, which was way overpaying, but I knew that I could make these changes very quickly and make this park worth the million dollars or more that I knew it could be worth.
We got him to negotiate, attractive on our financing terms. We bought it at this 5 ½ cap rate, and within a matter of two months we were able to bring those 88% expenses down in the 52%, 53% range. And now we’re on track in 2016 to do about $120,000 in NOI, which based on a 10 cap, which is how this park is valued in this particular market, that would make this park worth $1.2 million, basically doubling what we paid for it.
The lesson here today, guys, is be careful when you go shopping for investment properties. Make sure that you don’t just base your purchase or your decision to either look at a deal or pass on a deal on the cap rate that it’s being marketed at, because once you look underneath the hood there might be some things that you uncover that you can change very quickly. You can lower the expenses and make this property worth substantially more.
And that’s all I have here for you today, guys. Thanks for listening in. Get out there and get some cash flow happening.
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