2015 Stock Market Risk & Alternative Investment Opportunity

2014 brought us another year of unbelievably low interest rates and another banner year for the stock market (the S&P 500 was up 13.69% in 2014). What will 2015 bring for our financial markets?
The Fed assures us that they can control inflation with a smooth and orderly rise of interest rates starting this year. The majority of economists predict strong GDP growth, fueled by lower gas prices and an improving job market. The  the talking heads on CNBC predict the current bull market, despite being a bit long in the tooth, will continue to surge ahead. 
Frankly, we put about as much faith in the Fed and economic / market forecasts as we do in Congress’s ability to lead this great country through effective legislation. What we do believe is that six years of near-zero short-term interest rates have artificially boosted the stock market with unforeseen (but forthcoming) longer-term consequences.
The Fed’s continued low interest rate stimulus has flooded the economy and consumers with cash, thereby boosting corporate earnings. Stock market investors are increasingly willing to pay more for each dollar of those earnings. The price to earnings ratio on the S&P 500 is currently a sky-high 19.67 (yikes). Worse yet, Robert Shiller’s cyclically adjusted P/E valuation is nearly 28. The last three times this adjusted P/E was this high were just prior to the 1929, 2000 and 2007 market crashes(1).

Artificially high earnings coupled with nosebleed high earnings multiples (P/E ratios) is not a great combo for value investors.  

We expect the stock market will run further into bubble territory before crashing (as it always does). While we cannot predict when that will ultimately happen, rest assure…it will.

In order to achieve superior results, an investor must find asymmetric opportunities: investments where the upside potential exceeds the downside risk. We don’t think investors putting new money into the overall stock market will achieve the returns necessary to justify the risk of meaningful capital loss over the next 5-7 years. However, we are confident mobile home park investors will achieve outsized returns relative to equities over that same period while assuming less risk (there has not been a dramatic increase in values or earnings multiples in the mobile home park industry).
If you’re overexposed to our overvalued stock market, we recommend taking some chips off the table and starting 2015 with a new investment allocation to low volatility, high cash-flowing assets such as real estate and more specifically, mobile home parks. 

(1)  http://www.multpl.com/shiller-pe/

The Diminishing Supply of Mobile Home Parks

It is widely estimated among industry experts that 1% of all mobile home parks are demolished every year for higher and better uses. While we wish there was reliable mobile home park research that would provide us with the exact statistics, we can still clearly see this trend. We frequently hear and read about park closings and almost never come across new mobile home park developments.

Reason being, there are extremely high barriers to entry for new mobile home park developments. Most cities won’t permit new mobile home park zoning or issue the necessary entitlements to build new parks. This is largely due to negative stereotypes and misconceptions associated with mobile home parks and their tenants. The blatant prevention of mhp developments is baffling.
Of course, as owners of existing mobile home parks, we’re not complaining. It is extremely difficult to find a business that doesn’t constantly worry about new entrants / new competition. Yet, 99.9% of Mobile home park owners will never worry about a nicer, newer mobile home park development that might poach their current and tenant prospects.
Apartment building owners do not share in this luxury as hundreds of thousands of new units are built each year and – after a lull during the great recession – new apartment building construction starts are now approaching a 25-year high.
This boom in apartment construction does not bode well for existing owners of older apartment buildings. The increased supply of apartments inhibits landlords’ ability to raise rents and will eventually lead to modest declines in apartment occupancy as tenants have increased apartment options. 
Yet, the increased supply of Class A apartment buildings has little affect on the mobile home park industry. We simply do not compete for the same tenant base. New apartment buildings can actually improve our pricing power and investment returns as multifamily developers occasionally purchase mobile home parks only to demolish and build luxury apartments. This benefits the mobile home park owners in two ways 1) the developer will often pay well above market and 2) the inventory of parks in that market declines, increasing the demand for existing parks. This happens more than you would think:

Keep in mind that these are just a few recent news stories detailing the redevelopment of mobile home parks. We suspect we’ll continue to see a steady stream of these mobile home park demolition headlines and fewer and fewer “New Mobile Home Park Development” stories over the coming decade.
We’re not economists (thank goodness) but we’re pretty sure that the declining supply of mobile home parks coupled with growing demand for affordable housing will work in our favor. 

Top 10 Mistakes To Avoid When Investing in Mobile Home Parks

Real Estate Investing for Cash Flow Podcast

The Real Estate Investing for Cash Flow Podcast, hosted by Kevin Bupp recently interviewed Jefferson in a show titled the "TOP 10 mistakes to avoid when investing in mobile home parks".

But wait there's more! Jefferson ended up throwing in an extra 2 mistakes (12 total) made over the course of his 7+ year MHP investing career. Of course, Park Street Partners and its investors are now the beneficiaries of hard earned these lessons learned. Thanks Jefferson! 

The TOP 10 mistakes to avoid when investing in Mobile Home Parks - Part 1 

The TOP 10 mistakes to avoid when investing in Mobile Home Parks - Part 2 

Bloomberg Article on Mobile Home Park Investing Featuring Park Street Partners Co-Founder

The following article, which features our very own Jefferson Lilly, was posted on Bloomberg.com on April 10th and was included in the most recent issue of Bloomberg Markets Magazine.

Bloomberg article on mobile home park investing

Jefferson Lilly - Photographer: Nolan Conway/Bloomberg Markets

Jefferson Lilly - Photographer: Nolan Conway/Bloomberg Markets

The reporters reached out to Jefferson for some initial guidance / education on the industry and ended up traveling to two of his separately managed Oklahoma properties to get a first hand look of mobile home park operations. 

We feel that the authors did an excellent job presenting a balanced viewpoint of the industry; giving equal weight to both the opportunities and challenges associated with mobile home park investing. Of course, we'd argue that the ability to achieve outsized returns more than compensates an investor for such challenges, but then again...we (look at the pride in Jefferson's eyes in the picture above) might be just a little biased. 

Passive Real Estate Investing vs REITs

Direct real estate investments offer passive investors superior tax benefits, improved portfolio diversification and far less volatility then REITs. 

Benefits of passive real estate investing vs REITs include:

  1. Superior tax benefits - ability to defer 100% of taxes until sale. Direct owners of real estate can also transfer their tax basis to another property via a 1031 exchange. 
  2. REITs are extremely difficult to value
  3. Private real estate investments typically offer higher cash flow yields - most REITs pay 2-5% in yearly dividends, whereas a typical mobile home park investment returns 12-20% average cash on cash yields.  
  4. REITs (over the short term) behave more like stocks than real estate and are highly volatile. 

For a detailed discussion of the benefits of passive real estate investing, you can review our guest blog post on BiggerPockets: Passive Real Estate Investing vs REITs

Lack of Affordable Housing is An Unspoken American Crisis

If you’re viewing our site and researching potential real estate investments you probably aren’t too worried about how you’re going to pay the rent this month. Approximately 21 million American’s are not so fortunate. A recent study conducted by Harvard University’s Joint Center for Housing Studies found that the supply / demand gap for affordable housing hasn’t been this severe in decades and is getting worse. Furthermore, the percentage of renters that are “severely house burdened”, paying more than 30% of income on housing has doubled in 50 years.

Adjusting for inflation, rental costs have dramatically outpaced renter income growth

Adjusting for inflation, rental costs have dramatically outpaced renter income growth

Here are some highlights / excerpts from the Harvard Affordable Housing Study:

  • The recent deterioration in rental affordability comes after a decade of lost ground. The share of cost-burdened renters increased by a stunning 12 percentage points between 2000 and 2010, the largest jump in any decade dating back at least to 1960.
  • After remaining almost flat through the 1990s, rents climbed 6 percent in real terms between 2000 and 2012. Meanwhile, real median renter incomes fell over much of this period, ending 13 percent lower in 2012 than in 2000. As a result, the gap between rental costs and renter incomes in 2012 was wider than in any year except 2010.
  • For every 100 extremely low-income renters, only 36 units were both affordable and available to meet this demand.
  • The cumulative increase in the incidence of housing cost burdens is astounding. In 1960, about one in four renters paid more than 30 percent of income for housing. Today, one in two are cost burdened.

The need for our product, affordable housing, has never been greater. Park Street Partners, and its investors, hope to make a small dent in this problem by acquiring parks that have meaningful vacancy and infilling new homes for families that desperately need respectable, clean shelter at a price point they can afford.

Harvard Affordable Housing Study: