The late Sam Zell – the largest owner of RV Parks in the U.S. – often said “when a deal has low-risk and high-reward you should always buy it, when a deal has high-risk and low-reward you should never buy it, and the only deals you need to think about are high-risk/high-reward ones”. In this RV Park Mastery podcast we’re going to explore how to properly analyze high-risk/high-reward deals.
Episode 137: How To Approach High-Risk-High Return Deals Transcript
The late Sam Zell was the greatest real estate owner in American history. And he attained that title because he was the largest in not one, not two, but three different sectors of American real estate. Largest owner of office buildings, largest owner of apartments, and largest owner of RV and mobile home parks. Now, Sam Zell had an old saying that he used all the time. In fact, it was printed on the back of his business cards at one time and it said, When a deal has high risk and low reward, never buy it. If it has low risk, high reward, always buy it. And the only one we need to discuss here at his company are high risk, high reward deals. This is Frank Rolfe with the RV Park Mastery Podcast. We're going to talk about how to analyze high risk, high reward deals. Because Zell was 100% correct, you don't need to waste any time pondering. You can quickly shoot down or buy any deal that is so obvious it needs no further input. If a deal has horribly high risk of losing your money with very low upside, no one would ever want to buy that.
And if the deal is a guaranteed winner, if it's a home run deal with huge amounts of upside, then and very low risk, maybe there's a seller carry non-recourse note, it's zero down at a low interest rate. Unless the deal is terrible, you're going to do that deal. You don't need to do any more pondering. But where most people get tripped up and spend a lot of time and they just can't come to a decision, are deals that are high risk, high reward. So, we're going to go through and try and figure out how to put in a box the good deal from the bad deal box. Deals that have high risk and high reward. So, the first question is, why does it have high risk? Well, there's two types of risk out there with RV parks. You've got suicidal risk and you've got calculated risk. Now, suicidal risk, I would say, is when the problems with that property are things that you absolutely cannot control. So, if your RV park is in a terrible location, it's impossible to get off the highway, everything wrong about it, low traffic, no one wants to go there, it's going to fail and you don't have a whole lot of power over that.
So, I would not want to buy a deal that has high risk on things that are crushing to your business, but you don't have any control over. But then you've got that calculated risk. Calculated risk is a different animal. Calculated risk employs things that you can do to lower that risk. So, what would be an example of a calculated risk? Well, if you're buying an old RV park with failing infrastructure, roads are screwed up, water's screwed up, dump stations screwed up, these are things you can fix. You can buy those things, you can, with enough capital, fix those things. So, that's a different kind of risk than an RV park that has a horrible location. Now we can do something different. Or if it has horribly high risk because that RV park has so much vacancy, well, you can fix that. That's why you're buying it, is you're going to turn that risk and turn that into opportunity. So, when it comes to calculating the risk aspect of high risk, you have to acknowledge your limitations and figure out which category we're talking. Are we talking things I can fix or things that I can't fix?
The other thing about risk is understanding how risky are your plans to fix it. So, if we acknowledge that we only want to stick with high risk deals that we have some control over, then what's the plan to fix it? And on any good plan to fix whatever that potentially deal killing moment is, that's going to help you formulate a plan B, a plan C, maybe even a plan D to muddle through whatever these potential outcomes might be. So, we can actually then take that risk and take it from just a term down to an actual scientific measured item of how big the risk is, and what happens as far as us mitigating it, and then what the plans are for each rung. If we fail in plan A, then we move on to plan B. So, Zell would want you to try and figure out, not just use the label, hey, this is a high risk deal. But let's break that down into meaningful scientific baby steps of, okay, what is the risk? Let's measure what this actual risk might be. Then it brings you to high reward, though. So, if we know it has high risk, how do we measure what is high reward?
Well, high reward to most people is always going to revolve around how much money you can make. That's a key part of it. So, for many RV park owners, when you talk about making money, they're pretty greedy. They want to say, well, this RV park can make me a million dollars. And that's not really a bad target. That's a pretty common target for most RV park owners. So, I would say in general, if we run a game show and we're talking about a high risk, high reward deal, I would assume the buyer's going to want to make a million bucks with it, probably. But let's break it down instead and maybe to a return of investment perspective. Think of it this way, if you could get a three-point spread on an RV park, a three-point spread yields a greater than 20% cash-on-cash return. But that's the norm that most park buyers are seeking. So, we say high reward. It's going to have to be more than that 20%, because that 20% is just the average. Sometimes people look at these high risk, high reward deals and they're completely unrealistic in what they think high reward might be.
High reward is numerical. It's a number. A one-point spread gets you about a 10% cash-on-cash return. A two-point spread gets you about 15%. A three-point gets you up to about 20, 22%. Three point spread is imperative in buying an RV park because you got to hit numbers like that to make it worthwhile to take the time and effort and risk to buy the RV park. But on a high reward deal, it has to be even greater than that. Now you might say, well, how do you get greater than that? How do you get better than a three-point spread? Well, if you buy something at a very low price or if you buy something that's been horribly underutilized by mom and pop, it is achievable. On top of that, the way you structure the financing can have a lot to do with that. Many RV parks which have high risk attain the high reward through seller financing. Sometimes the way the seller financing is structured with the amount down as well as the interest rate, which will be lower than average. That's what propels you to these new lofty styled returns.
Now, one great way to look at most RV parks to figure out what the reward is is to go to the end of the movie and work backwards. Say, okay, if I buy this RV park and I get it all fixed up and I do all these many things, what is it worth then, years into the future, and then what is it worth today? And then do the comparison. Often that one action. By looking at what it can be based on what it is now and knowing what the steps are to achieve that level of success, you'll have an immediate gut instinct of whether this is classified as a high reward deal, and therefore worthy of that high risk. But the most important thing you always have to remember in doing all this is most of it is based on your own internal goals. So, we don't all see things the same either on the risk or the reward meter. I'm not an oil wildcatter, not at all. I'd never invested in oil and gas in my entire life. But if you talk to people that do oil and gas, you'll note they have a much different idea of risk reward than the average American.
They're willing to take horrible risk, things I would never think of in a million years, for what appear to be reward numbers that are ludicrously high. And that's how oil and gas is. And people in that industry, that's what they're used to. That's typically what they're thinking. You, however, probably have a whole different idea of what you consider high risk and high reward. It may vary from what I think, but the general concept of Zell is simply you've got to put a lot of thought into those situations. When something has low risk and high reward, you should always buy it. If it has high risk and low reward, you should never buy it. And you should spend all your time pondering if you're going to be pondering deals to buy on that high risk, high reward level. This is Frank Rolfe with the RV Park Mastery Podcast. Hope you enjoyed this. Talk to you again soon.