Typically you want the seller to make the first offer so that you don’t pay more than you needed to. But sometimes the seller refuses to throw out a number and you are suddenly put in the position of being both negotiator and appraiser. So how do you make that first offer? That’s the focus of this RV Park Mastery podcast.
Episode 83: The Science Behind Making First Offers Transcript
There must be a first for everything and that even includes offers. This is Frank Rolfe, the RV Park Mastery Podcast. We're gonna talk about the science behind making successful first offers. Now, typically what you want to have happen in any negotiation obviously, is the seller throws out the price and you start there. But it's very scary when the seller says to you, Well, how much would you give me for my RV Park? So what do you do when that happens? How do you come up with the number? How do you come up with the best number? Well, there's basically four considerations that you have to take when coming up with what that number might be. The first consideration is what is a bank or an appraiser gonna say the value will be. Because if you're going to finance that RV park, which you certainly are, then you can't go beyond what that bank is going to say. There's just no way it's gonna have to appraise at or more than the price you have on that contract.
And the bank and the appraiser, they're going to use an income approach to that valuation. So you gotta find out from the seller before you can even make the offer. And he should be able to give you the number just the same as he wants you to throw out the number, what his approximate net income per year is, what's his NOI, what is the revenue, less expenses for the RV park annualized. And then you're going to apply a cap rate to that. So that's a first start and that gives you one limitation. And then the next consideration is what is the spread you are after. The spread, meaning the difference between the cap rate and the interest rate. One point cap rate to interest rate spread is worth about 10% cash on cash return. A two point is about a 15% to 16%, and a 3 point is about 20% more. So if the interest rate in the loan is gonna be seven, then you'd have to be buying this thing at a 10 cap in order to hit a 20% cash on cash return. If you say, Well, I'm happy with a 15, 16, well then a two point spread. If you say, well, I'm just fine with a 10 point or a 10% return, then a one point spread might do.
But you have to see what you need to hit your goals. So what would that price have to be to align with what it is you are trying to invest to achieve to begin with? And then you gotta think about what would the price be you would throw out that would allow the seller to rebut that with a higher price to ultimately come to the price that you want to pay. So what's the negotiating, just the game of negotiating price where you wanna begin, so you can back and forth and back and forth and get to the price that you want. And then finally, based on that number of where you want to start off, what would the price have to be to get a counter? Because if you don't get a counter, you've achieved nothing. If your first offer is so laughable by the seller that he won't counter, that was a very unsuccessful first offer. The whole point of the first offer is to give you a benchmark, a start to that traditional back and forth and back and forth with negotiation. If you don't get that, well then you've completely failed. Nothing came of you talking to the seller. You're never gonna be able to buy the RV Park unless you later recants and wants to go with a lower price.
So let's just put this into an actual example, into a real framework, 'cause this all sounds great theoretically, but you may be saying, so give me an example of how this works. So let's go through the example together on establishing those four different price points. So let's say when you ask the mom or pop owner, Well, how much money does the RV Park make per year? And let's assume they say, well, it makes about $80,000 a year. Well, we know from experience that the bank is going to wanna go ahead and have a fairly high cap rate because they have to cover their risk and the coverage ratio of about 1.2 times the mortgage payment. They wanna see that you've got not just enough to cover the mortgage payment, but a little additional on top of that, either 1.2 or 1.25 that for them to feel comfortable with their loan. So if we're assuming a 10% cap rate and an NOI of $80,000 a year, then the bank is going to say the price should be $800,000 approximately. So now we've established that we know we can't go above $800,000 because if we go above that then we won't be able to get the bank financing. And then let's assume in this example, we want a 3 point spread.
We want a 20% cash on cash return on this deal, and we know the loan's gonna be at 8% interest. So we need 3 points, eight to nine, nine to 10, 10 to 11, and we need an 11% cap rate to give us that 3 point spread over the interest rate. And if I run an 11 cap on the $80,000 of income, then I end up with $730,000. So that's my target price, which is lower than the bank's maximum price because I wanna make more money than the bank is worried about. The bank's just worried about covering their debt. I'm trying to do way, way better than that. So the bank is saying 800 is the limit, and I'm saying 730 is my target, but if I wanna go ahead and get to 730, where do I begin? Well, you might say, Well, let's think about this. Let's start maybe at 650. If I start at 650 and they counter it 900, then in the back and forth and back and forth, maybe I can end up at my target of 730. Okay, well that sounds good. But then we also have to think about what do I have to do to get them to counter? And you may say, well, 650 I think sounds kind of low. So maybe I should start at 700, even though 650 might be my ideal start for that bantering back and forth and back and forth, I don't think I can get the job done at that price. So I think I need to be instead making my first offer at 700.
And when you look at those four pieces of evidence, you look at what you'd have to do to get them to counter versus how low you'd have to be to give it room for the counter, for you to counter back and counter back and to put your price and your goal at 730 and the bank's goal of 800, Then you might say, "Well okay, I need to start at 700 I max out at 800, and my target is 730." Now what happens if the price comes in higher than 730, 740, 750, 760? Do you walk it? No, not necessarily.
You don't really know enough about the RV park yet, because the one part that's still left off here is what happens in due diligence, on any RV park you ever buy, you've got to have in the contract the due diligence provision and the financing provision that allows you to actually gather all the information to see if mom and papa are telling you the truth. Not that they don't always mean to, but they may not even know it. And the way they operate it may be so poorly that you can't even use their number as a reliable figure. So you may have to adjust your numbers based on what you find that NOI to be. Maybe it's not $80,000 a year, maybe it's less, maybe it's more.
And then of course, you may say, well, even though it doesn't hit my initial three point spread that I wanted, I can still pay more because I know that I can increase the occupancy through better online marketing or I can increase the revenue by charging higher rates. So you have some degree of flexibility on top of that. Then you may even find when you get a new diligence that the NOI number is wrong. And that mean that the bank may come up with an appraisal that is higher than the 800. But the key to it all is there's a science to it. It can't just be random. Some people think they just go look at an RV part from mom and pop and when he says what do you want or what will you give me? Then you just kind of threw out these random numbers kind of like an episode of Pawn Stars or American Pickers and it doesn't work that way.
You've got to have a scientific way to look at what your high end and your low end range is, as well as the target. That doesn't mean that you'll always hit it, but it means you can adjust things as you go that you actually have something you are shooting for. You probably have a GPS thing on your car. Even if you don't have a GPS, you've probably at least got a way you can set your phone as your GPS and you'll notice if you take the wrong turn, What's it do? It tells you to turn around and go back. Because the car should always be pointing towards that ultimate destination. And that's exactly what you're doing here. You're trying to figure out, roughly what am I trying to achieve? But that's not to say it's a perfect world. And in negotiation, going back and forth and back and forth, you may not hit your target, but the key is you have a scientific approach to hit it. This is Frank Rolfe, the RV Park Mastery podcast. Hope you enjoyed this. Talk to you again soon.