Seller financing is a great way to handle the banking on an RV Park – or it can also be a trap. In this RV Park Mastery podcast we’re going to review the fine points that separate a successful seller carry transaction from an unhappy buyer’s mouse trap.
Episode 134: The Seller Carry Mouse Trap Transcript
We have long been big fans of seller financing. In fact, it's our favorite type of banking tool when buying an RV park. But sometimes that seller note can go from being an asset, a tool, a helpful way to finance that RV park purchase to what is effectively a mousetrap and you're the mouse. This is Frank Rolfe with the RV Park Mastery Podcast. We're going to talk about when a note is not really a note, when seller financing goes from being highly attractive to being very dangerous. Now, let's talk first why we love seller finance. We love it because it offers you the ability to get a loan without having to go through that arduous banking process of credit checks and financial backgrounds and giving forth your financial statements, because sellers either like you or they don't. And if they like you, you're typically already approved. If they don't like you, it wouldn't matter who you are. They're never going to approve you. So when a seller offers seller financing, it's pretty much a sure thing that you are going to make the cut. And seller financing also gives you the ability to buy an RV park with a lower amount of down payment. In fact, we've done five zero down deals in our career. And even if it's not zero down, lower amounts. My very first deal, Glenhaven Mobile Home and RV Park, was only two and a half percent down. Banks never do stuff like that. Banks normally want 20 to 30% down, but sellers will often do things like five percent and 10% and 15%. So that's another reason we think seller financing is terrific. And then, of course, you have the fact seller financing is always non-recourse. And I think we would all agree we all prefer non-recourse debt to recourse debt. So that's, again, a huge positive. And seller nodes can go longer than traditional bank loans. Sometimes banks want to do very short term loans, maybe five years. But seller deals can be 10 year, 15 year. So there's every reason in the world as an RV park buyer why you would want seller financing. But the problem is not all seller financing is created the same. So let's go over the things that make a seller node a real problem. The first one is a shorter term than roughly five years. Herein lies the problem. You're probably buying the RV park with the intention of improving its net income and then possibly down the road then refinancing or selling.
But the way the system works is you have to do the necessary steps to get the net income up. Then you have to season it for a while, proving to the lender or the buyer that you've attained this NOI not as a fluke, but on a recurring basis. Then, of course, if it's refinancing, you have to go out to the marketplace and find a new bank, go through the loan committee, get all the legal work done, all the third party reports, and then close. And if you lay that out on a timeline, let's say you could turn that RV park around within two years and let it season for a couple years and then give yourself a year to find a replacement lender. Well, that takes five years. But here's the problem. Many sellers, when they want to carry the paper, they don't want to go five years. They want to go two years, one year, or three years. And that type of short term like that is a mousetrap, because what will happen is you'll buy the RV park and then when it comes time to refinance, you will not have the time to get the replacement loan. You'll then default. They'll take the property back and they'll keep your down payment. I would steer clear of seller notes that are shorter than five years. I don't see any reason why if someone is going to carry the paper, they cannot carry it at least five years. And I would fight to try and get 10 years if you could. And if you can't get 10 and the guy will only do five, see if you can get the right to have a two-year extension. That's when you pay some amount of money towards a principal payment in a lump to buy that addition to extend for a couple of years. The next problem with some seller notes is they want to have a big down payment. They want to have more than 20%, sometimes more than 30%. I've had people tell me, oh, I have the seller deal, but it's 50% down. That's ridiculous. Why would you do that? How could a seller expect you to put more down than a bank? If banks are 20 to 30%, there's no way it's fair or equitable for the seller to carry paper under even more amounts of capital down.
You need that money to be able to put back in the business. You need the money for liquidity. You need that money to buy another RV park if you also see a second one after you buy that one that you think is very advantageous. Don't let the seller try and force you to put in more down than a bank would require. Another problem is when the seller's interest rate is significantly higher than banking rates. I don't mind paying a little bit for seller carry because it's so much better than any other form of debt. But if right now a loan at the bank is at 7%, you might pay 7, 7.5, maybe even 8%. But some of these sellers will say, yeah, I'll carry the paper, but I want 12%. That's highway robbery. That's not usurious by legal definition, but it certainly seems in bad faith. There's no reason why a seller should have a higher rate than a lender. Remember that the seller post-closing, if you were to pay in cash, could only attain right now maybe 4% in a long-term treasury or CD. There's no way that charging you triple what they could get at their absolute best at A. G. Edwards makes any sense at all. Also, beware of situations where they have a shorter amortization length than 25 to 30 years. Lenders use 25 to 30 year amortization, that's how fast you repay principal every month with your mortgage. Sometimes a seller wants to slide in there that he wants 10 year, 7 year, 12 year. That's going to put you in a real cash flow bind. Even though a three-point spread between interest rate and cap rate can give you a 20% cash on cash return, you also have to mind the store regarding cash flow. If you start accelerating principal payment at a certain level, you can have a very attractive deal based on rate of cash on cash return, but be losing money every month with it because you're struggling to pay such a heavy burden of principal. So a good seller note should have at least a 25 or 30 year amortization. I don't think you really can go shorter than 20 without causing significant cash flow binds as the buyer. Finally, do not let the seller try and trick you into signing on for personal recourse. That is something that is best left in the hands of real banks because the way recourse works is it's very, very tricky.
There's certain legal hurdles that the lender has to do to do it. There has to be an auction, all kinds of items the seller is not in any way equipped for. And most importantly, since the seller is not really a bank, you don't want to entrust that type of thing to someone who's a rank amateur who may not protect your own legal interests in that matter. And it's a good thing, a selling point to tell a seller who's demanding recourse, look, the worst thing you can do is have recourse because if I default, if I can't make the payments on a non-recourse deal, I will happily deed it back to you because I have nothing more to lose than my down payment. But if you have recourse, I'll have to fight like a dog. I'll have to throw the property into Chapter 7 or Chapter 11, tied up in court for years and massive legal fees to fend off the fact that you don't know how to do recourse. And because of the ramifications of the recourse, it could cause me lots of financial damage. We have never signed, to my knowledge, a recourse note in seller financing. Something, again, that we would discourage. The bottom line is on all of these items, the danger is that the note that's getting you to buy that RV park actually is like the piece of cheese on the mousetrap. It's getting you in the door, it's getting the deal done, getting your hard-earned money down as the down payment. But only then, like a trap, springs forth at the worst possible moment. It makes you potentially lose both your down payment and the property. Seller financing is terrific. We're huge fans, but it has to be appropriately constructed. If you have any questions on what you're doing in your seller note, be sure to consult with an attorney. Make sure that that seller note is the attractive thing that you hope that it is. This is Frank Rolfe, the RV Park Mastery Podcast. Hope you enjoyed this. Talk to you again soon.