RV Park Mastery: Episode 45

Hard Money Vs. Bank Debt Vs. Capital Partner

Money is money, but how you get it can have differing impacts. Whether bank debt, "hard money” or finding a capital partner, your selection can have a huge impact on your quality of life and ultimate profitability. In this RV Park Mastery podcast we’re going to explore the options to pay for RV parks, and what the good and bad aspects are to each.

Episode 45: Hard Money Vs. Bank Debt Vs. Capital Partner Transcript

Money is money, but it's not all the same. Different ways you obtain capital and debt to buy RV parks could have a significant impact on your investment. This is Frank Rolfe, the RV Park Mastery Podcast, we're going to be talking about the different ways of buying an RV park, where the money comes from, and what the impact can be.

We all have to acknowledge on the front end, it requires capital and debt to buy an RV park. Something has to be put down, something has to pay for the balance. Now, the mom and pop seller could certainly carry the financing if they'd like. And they sometimes will do zero down, but that's very, very rare. So right off the bat on the front end, you're going to have to put some money down as a down payment. Now the US norm is 20-30% down. So where does that money come from? Well, it could come from you. Or it could come from a combination of you and a hard money lender, it could come from a combination of you and a capital partner. And then how do you finance the rest of it? Well, it could be the combination of you and a hard money lender, and there is no bank debt, or it might be in the form of regular bank debt. So let's analyze those three components, not your capital. We all know what that means. But what's the difference between bank debt, hard money, and a capital partner? Let's break that into what's good, and what's bad on all three of those different tranches.

Alright, so let's first start off with bank financing. So what's good or bad about bank financing? Well, the good things are of the three alternatives we just went over, banks have the lowest interest rates. They will always be lower than hard money lenders. And if you factor in all of the variables on equity, etc, they're certainly less expensive than capital partners. So bank debt is the cheapest. Secondly, banks have no equity in your upside. If you buy something and do well with it, and it does twice the net operating income it was doing before and it's worth twice what you paid for it, the bank gets no piece of that extra equity. So that's another great deal. So the interest rate is very low, and they have no upside in the equity, they don't take a piece of your deal, whatsoever. A third great item is they're controlled. They're controlled by the banking laws in the US. And those are very vast and very strict. So all banks out there are constantly watching their back, concerned they might do something that would be offensive in the eyes of the bank examiners or the body that governs banking in the United States. So they're also more measured in what they do and more predictable.

Now on the bad side, it's sometimes hard to get them interested, particularly in RV parks, which is not a normal thing that they make loans on. And they're used to doing single family homes. And if your RV park doesn't require much more money than a single family home loan does, then why would they even do it? So the first hurdle with a bank in the bad column is it's kind of hard to get one that will do something. Now, right now they're making loans and RV parks like never before, it's the easiest banking we've ever seen. However, not all banks want to do RV parks. Second thing is short notes. So what I mean by short notes? Typically banks don't like making loans that extend longer than about five years. And on hard money and capital partners, you can sometimes get them to go longer. Now not always, and there are some banks will do 10 year notes. But the issue with banks can often be that they'll loan you the money at an attractive interest rate, but they want to do it on a really, really short term. And what that means is you'll have to go back and refinance that park on a frequent basis. And you'll have to relive the terror of getting the loan the first time - that's never comfortable - and then worry about it all the time. Can I get a new one when that time comes up? And that's all that's all tough.

Now, what about hard money lending? Well, the good thing about hard money lenders are they have no equity on the upside typically, not always but often they don't. So even if you, again, double the value, they don't have a piece of it. Now, that's not true of all of them, but for many of them that's true. And the other good thing is they fill the gap. They will proudly go where banks will not. So the banks say nope, can't do that deal too risky, you can often find a hard money lender that will do it. Now the reason they will do it falls into the bad side. They'll do it because they charge a much, much higher interest rate, in ,many cases double or even triple what the bank charges. So because there's a higher interest rate, they're willing to take on more risk. It's a good old risk reward scenario, made famous in Sam Zell's book "Am I Being Too Subtle." They, if they're going to have high risk, they must have high reward. You can't really fault them for that because of course, you would want the same.

Now this next issue with hard money lenders can be a real problem, and that's called "loan to own." Now what is a loan to own mean? Well, loan to own means that some hard money lenders are actually hoping you default. So when you have a bank loan, the bank doesn't want you to default, the bank default is a bad thing. It's bad for the loan officer, it's bad for the bank, they don't want it one iota. But hard money lenders sometimes are hoping you don't make your payments so they can take the property away from you, keep your down payment, and then sell it as a profit. Even better for the hard money lender would be if you do this after you turn the property around. You then expended all of your sweat equity, your strategy to bring the property back to life, and then once you get it back to life, you can't quite make the payment. So what do they do? Well, they just take it away from you. So that's the bad part about hard money lending is the interest rate is very high typically. And they sometimes engage in what's called loan to own where your interests are not aligned with your lender, and that can sometimes be scary having your lender on the opposing team.

Then you have capital partners. Now, what's the good thing about a capital partner? Well, they certainly aren't going to be doing loan to own because they're aligned onto your team, they are officially part of your team. The hard money lender, well, you're not really sure whose team he's on. But you know for a fact the capital partner is on your team, so you don't have to worry about them being at odds with you. However, that can be another bad aspect is that they are potentially you might have problems done down the road. And so that could cause a problem, because there is some kind of relationship involved when you have a partner. Another thing is that the capital partner typically does not have their interest rate payment due, but instead it accrues. So some of your capital partners will have what's called a preferred distribution. And the preferred distribution is a rate of interest that you should receive and will receive over time. But it doesn't have to be paid out at any given moment. So for example, if they get 10%, preferred return that accrues and in year one, you can only afford to pay at 3%. Well, you owe them 7% for that year, which never goes away, it just rolls over into a later year or at the very end when you sell the property off.

Now the bad things about capital partners are that if they really look at it, they have the highest interest rate because they're not only taking interest on their money, but they're taking equity in your deal. So now, unlike the other options like bank and hard money, now they have equity in your upside. And it can be very expensive equity sometimes. It's not uncommon for a capital partner to get 50/50 split of the profits, which you may say, "Gosh, that just doesn't seem fair, because I did all of the effort, I found the property negotiated it, turned it around operated, why should I give them half?" Well, that's sadly how capitalism works. So there's the old golden rule, he who has the gold makes the rules. And in this case, you could not have bought the property if not for the capital partner. And they know that. So as a result, they want their cut, and they want a big cut. Once again, it's all back to risk reward. So since it's risky in their eyes, buying that RV park, typically whether you're going to kind of turn around and make more valuable, therefore they think they need to get more money back out of it at the end. The final bad part of capital partners is they can sometimes be hard to get. When you call a bank or hard money lender, they're typically pretty friendly on the phone, and they're interested, and they're easy to find on Google. But capital partners are harder to find. Often they're friends and family. The uncomfortable part of going to have a family member or a friend or family person trying to have them invest in your project and you have the learning curve issue. You have all kinds of issues. So that's the final bad part of capital partners is just kind of out of the norm. And as a result, since it is out of the norm, there's a comfort zone issue, there's a timeliness issue, all those kinds of items.

So bottom line to it all is it's three very separate choices with three very different good aspects and bad aspects. So there's not just one size fits all. There's not just one direction you should always go. It will all completely depend on your deal, the capital you have, and what your feelings at the moment are. So those are the options but which is the solution? Well, that's up to you. This is Frank Rolfe, the RV Park Mastery Podcast. Hope you enjoyed this. Talk to you again soon