There are several valuation methods that appraisers use – and we’re going to review each of them on this episode of the RV Park Mastery podcast. Between the cost approach, comparable sales approach and income approach, each has its place and some are more important than others. Since the goal of buying an RV park is to arrive at the fair price, understanding appraisals and their methods is a key part of the purchasing process.
Episode 15: RVP Appraisals Transcript
Three different valuation methods. And only one of them is probably accurate. This is Frank Rolfe with the RV Park Mastery podcast. We're going to be talking about the three elements of an appraisal, how they work, which one's accurate, which ones are not. So you're buying an RV park and you order an appraisal. And the appraiser typically follows three methods to come up with the value.
The first one is called the cost approach. So under the cost approach, the appraiser looks at the value of the land and all the improvements that were made. And then he depreciates those down based on their age and condition. So if he's looking at a hundred space RV park and he says, "Well, this land costs $10,000 an acre," and let's assume the property is on 10 acres. So he'd say, "Well, there's a hundred thousand dollars of land." And then he'd say, "But the improvements, that's going to be about $6,000 a space. So 600,000 there." So now you're up to $700,000. And then he says, "But the park, it's 30 years old. So I'm going to knock that down. And I'm going to say, it's worth about $450,000." Okay, well, that's his cost approach. So that's one method.
What's the next method? Now he's going to do comparable sale. He's going to do the sales comparison approach. So in this example, what he does is he looks at all the other RV parks that have sold around there and he tries to look and figure out how much they sold for, per lot, and then he will allocate that price to yours. So if he says, "Well, I looked at a lot of different RV parks and it looks to me like they've been selling for about $10,000 a space. So let's see. On this hundred space, well, that'd be about a million dollars." All right, so you're at four or $500,000 on the cost to build it. And you are at, let's say in this case, a million dollars based on comparable sales. So where does that mean? Where are you at now?
Well, so far, you've got your worst case, which is going to be the cost to build it less depreciation because that doesn't take into account such items as the value of the permit or good will or the business itself. And then the next approach, well that's going to tell you what the other one sold for. But you don't really know if those other sales are accurate or not.
So basically you fall into the final and that's the income capitalization approach. Now in this method, what they'll do is they'll look at the revenue and they'll look at the expenses and they'll try and figure out how much money the RV park makes. And then they'll apply a cap rate to that.
Now, which of those three methods do you imagine is the most accurate, the cost of building the RV park, less depreciation, the cost or the comparables of other sales, or the income approach? And hopefully you said the income approach. That's the winner. Yes, you're exactly correct. That, to me, would be the winner. That's the most important one because you're buying this as an investment.
If you overlay this to other types of assets, let's say you're looking at a classic car. You can have somebody who put way too much money in building that classic car, bringing that old Chevrolet SS coupe back to life. So that method's kind of not really accurate. And then you could have comparable sales, but other people buying that same collector car, they might've been out of their minds when they made those auction purchases. So that isn't really accurate.
What's really accurate in our industry is it's all about the income. That's why we're in the income property business, thank heavens. We're not land speculators. We're not speculating on collector cars in an auction. We're buying this RV park because at the end of the day, we want it to hit certain levels of income. We're trying to get what's called the cash on cash return on our down payment. To get that, we're looking at the metric of the cap rate, which is the income divided by the cost of the RV park. These are the important numbers to you as an investor. Money, it's all about the money. And so when you're looking at valuations on that appraisal, I don't think it really is going to matter to you if you're only into the money, historically, what people paid for similar RV parks in the past, or from a history perspective, what it costs to build originally. The most important thing of all is the income.
So as a result, is that appraisal really of any value? Well, the appraiser does the three methods because they're trying to double-check their numbers. We've often said you can never check your numbers enough. So if you're looking to buy an RV park, yes, you should definitely run the numbers over and over. Well, they're not only doing that, but they're putting a structure to it just to make sure everything all ballpark ties together. So if the numbers seem abnormally strong in the net income, and then they look at what the other ones are selling for and they're lower, they'll say, "Well, there must be something wrong with these numbers. Maybe the seller is lying about the actual revenue or lying what their actual expenses were."
So it's kind of a fail safe method that they're using. And they'll take those three values. They'll ponder them and they'll kind of average them together, give you the final value. But here's the thing. You can do pretty much the income approach yourself. Right? If you follow the correct guidelines, you can figure out how much revenue you have and how much cost you have and what your net income is. You don't really need someone to tell you what that is. And I'm not really convinced on the other two that it really matters to you. I've really never seen an appraisal based on comparable sale or on cost approach that I was really that impressed. Typically the appraiser just has to go with what they can get.
If you're in a full disclosure state where they have to give out the price that they paid, then at least you have a rough idea of what people are paying. But if it's a non-disclosure state such as Texas, no one ever says what they paid, so the appraiser is either guessing or is relying on people who bought the properties, telling him what they paid. Well, no one's going to tell you what they paid because that might influence their property tax. Or if they talk to you, they're probably going to lie to you to begin with. So the system is very, very flawed.
That's why we buy RV parks, we typically don't get an appraisal unless it's required by a bank. If I'm going to buy something and the seller is going to carry the paper on it, I'm not going to go get an appraisal. Why? I don't want to spend the money on it because I'm not entirely certain it's going to give me what I need from an accuracy perspective. However, if I'm going to buy it with bank debt, then yes, they're going to demand an appraisal. I don't blame them. They're trying to get another additional set of eyes on the numbers to make sure that you're not overpaying. And then therefore they're not making a loan of something that will go bad. It makes complete sense.
The problem is the appraisal is not free. If the appraisal was free, everyone would get an appraisal, but of course they're expensive because the appraiser has to get paid for their time and knowledge. So typically it's up to you whether to get an appraisal or not. But considering the fact that the income approach is really the accurate, the most accurate part of the entire process, and that's something that you can do yourself, it seems kind of silly to have somebody else do it.
Now, what else can you do to verify your value? Well, it wouldn't hurt to have somebody else look at your numbers, even if it's seller financing. Have a friend who's good at real estate, or has a background in financing, talk to a bank and pretend you want to get a loan just to see what they come up with as a value themselves.
But again, the appraisal itself is probably not going to backstop you if you're going to make a terrible buy. At least it's not going to be guaranteed to stop that. When you look through the appraisal report, the first thing you want to go to, in our opinion, is that income capitalization approach, one of the three approaches. That's the important one. The other two are great from a historical narrative. They may give you even more peace of mind on what it'll be worth when you sell it down the road. You'll say, "Well, the one across the street sold for this and the one 20 miles away sold for that. And that makes me feel better." But the real one, at the end of the day, that will tell you whether your purchase was smart or stupid, is going to be that income capitalization approach. That will tell you the return levels. That will tell you what kind of money your investment has netted.
Now also, don't forget. When you look at that appraisal, one more item, you've got to factor in any additional capital you have to put in. The income capitalization approach, they will typically do that tied to what you're paying. But if that thing needs some additional cap ex projects, you've got to add that in also. That's the only way to truly tell what's your cap rate and your cash on cash return will be.
But again, appraisals are great. They're important. They're a part of our entire financial network. They've been around for hundreds of years. They're effective. They keep people safe. They keep them sane. They make lenders able and happy to make loans. However, if you had to pick and choose through that appraisal, in our opinion, the income capitalization approach, that is the most accurate. That is the most important. And the good news is if you're buying a property that does not require an appraisal, if the seller is financing the property, you don't need to have an appraisal necessarily because the one of those three options that you are fully vested and prepared to make a valuation opinion on is in fact, the income capitalization approach.
This is Frank Rolfe, the RV Park Mastery podcast series. Hope you enjoyed this. Talk to you again soon.