Weather forecasting is all about taking past events and applying them to future conditions. In this same manner there is a tremendous amount of predictive science possible from a simple historical interest rate chart from the U.S. Federal Reserve. Let's first make some significant observations:
- Interest rates run in predictable cycles. These cycles tend to occur every ten years or so.
- Recessions lead to significantly lower rates, just as booms lead to higher ones – but not always. Although the U.S. believes in a "free market", interest rates are often manipulated by external forces, such as the Federal Reserve trying to force their hand on inflation, etc.
- The speed of the rise and fall of interest rates is brisk. Interest rate increases are typically a slower build but interest rate declines are often extremely fast – kind of like falling off a cliff. The reduction in rates from the 2007-2008 Great Recession are most notable.
- To predict the future direction of interest rates you need to better understand the economic and political environment that creates their movement. Interest rates are based on easy-to-define factors.
So what do we know about the current economic and political climate that will move interest rates going forward? Quite a lot, actually.
- The economy appears poised for recession. There are a tremendous number of data sets that are used to predict economic downturns, and all of these early warning sirens are going off simultaneously right now. The technical definition of a recession is two successive quarters of negative GDP, and the current number is rapidly approaching zero. Meanwhile, unemployment figures are increasing and consumer sentiment is weak. Based on the fact that there has been a predictable cycle of recession in the U.S. every eight years and we are almost a decade overdue.
- The U.S. has a $35 trillion deficit. This is a huge problem for the Federal reserve is particular and the U.S. government in general. When interest rates were nearly zero from 2009 to 2022 this made handling the interest cost on that massive debt survivable, but at the current roughly 5% interest rates the interest carry of that debt represents nearly 50% of the total income of the U.S. government, which is clearly not sustainable and would force the elimination of either all defense spending or the elimination of Social Security and Medicare. Rates must come down – and fast – or the U.S. government will be insolvent.
- The Fed is under pressure to lower rates before the election. Let's be honest, the U.S. government is a business, just like any other. The current administration wants to win in November and they know that high interest rates are killing their chances. High mortgage rates and car loan rates are turning Americans against the Biden administration. As a result, the pressure is strong on the Federal Reserve to lower the rates simply from a purely political perspective.
If, in fact, interest rates are destined to start moving lower in the near future, how can you harness that knowledge to make significant money in the mobile home park business? The answer is extremely simple.
- Buy a mobile home park at a price at or lower than appraised value. In other words, you don't have to make an a home-run buy but simply a base hit. Just an average deal.
- Finance it with seller carry or a lending institution at normal debt coverage ratios. This is because you need to utilize bank leverage to make the numbers more significant. The ability to obtain debt is one of the hallmarks and benefits of real estate investing.
- Let the interest rates decline. We believe that rate reduction is imminent and, once it starts, will move quickly.
- Once the rates have hit bottom, refinance the property or sell it. Based on past cycles, the decline in rates happens quickly, so let's assume we're talking about a couple of years from start to finish.
Let's model how this works out financially.
- Assume you buy a mobile home park with a net income of $48,000 per year for $600,000 at a 8% cap rate, and finance it at an 8% interest rate.
- You put 30% down – or $180,000 – and have a mortgage of $420,000, which leads to a debt coverage rate of around 1.25.
- Interest rates decline 3 points to 5%.
- Similarly, cap rates decline to 6%.
- The new value of the mobile home park at 6% is $800,000, which yields a profit of $200,000, which equates to a greater than 100% return on your investment.
But you also have the ability to hedge this risk of interest rate decline.
- Raise lot rents. The average mobile home park lot rent in the U.S. is around $300 per month at a time when single-family homes cost $400,000 and the average apartment rent is $2,000 per month – which means that lot rents could triple and still be cheap.
- Fill vacant lots and homes. Mobile home parks average around 20% vacancy nationwide, which means there is a huge opportunity to increase revenue and net income simply by bringing in new and used mobile homes into the vacancies and selling them.
- Eliminate wasteful spending. Many mom and pop owners engage in wasteful spending in typically three key areas: 1) not fixing sometimes massive water leaks 2) over-compensating managers far beyond market pay scales and 3) overpaying for routine repair and maintenance.
These factors allow you to push mobile home park net income regardless of interest rate movement and to better your position continuously.
The bottom line is that there is a huge amount of money to be made in betting on the direction of interest rates – far more than you'll find in Vegas. And unlike gambling, the direction and size of interest rate movement is based on science and is fairly predictable based on decades of data and past performance.