Buying an RV Park – like buying any asset – is a stressful experience filled with doubts and concerns. However, there is an easy way to get around this hurdle and make informed, accurate decisions that you can feel good about. In this RV Park Mastery podcast we’re going to discuss a simple method we developed years ago to make buying an RV Park a scientific decision based on math and risk assessment and not just gut feel. If you’re buying an RV Park, you want to learn this method.
Episode 17: The Simple Way To Make Good Decisions On Buying An RV Park Transcript
It's one thing to put an RV park under contract, to do all the necessary due diligence on it, to even go out there and find a loan for it, but the real stressful moment is when you have to make that final decision whether to go forward with it or not. This is Frank Rolfe of the RV Park Mastery podcast. We're going to talk about how to take the stress out of the decision of whether or not to go forward and buy that RV park or not. How do you do that? How do you take what could be a life-changing moment and make it something that's very practical and simple to comprehend. We call this a best-case, worst-case, and realistic-case analysis. What does it mean? Well, you take your deal with all the information you've derived out of the due diligence, everything you've seen with your own eyes, and then you put your deal into three categories.
Category 1: Best case. What can this property generate as far as income? How much would it be worth when you get done bringing it back to life? How do you drive that? Well, we all know the drill on that. You've already worked on that doing your numbers for due diligence. How much are you going to get in total revenue per month? Aggregate that to annually. What will your costs be based on your best estimates? Of course, this isn't just guessing. Doing good due diligence, you're going to come up with the actual cost, or three bids, on the items you can't quantify. Then, what is your net income from all that endeavor? Realistically, what is your net income going to be if you ran the thing at a very high level of performance. Using virtually full occupancy, using virtually the highest rent you could get, how much revenue will it make less the actual costs?
Now, of course, costs could always be worse than you guess. You could have that dire moment. You could have the tornado blow through, but that's probably not going to happen. That's going to come in a different sector in a moment here. What's your best you can do, and then value what the property is worth at that rate of net income. Apply a cap rate to that. Divide that net income by what you feel the prevailing cap rate would be. If you say, "Well, I think this RV park in great shape might sell for a 10% cap rate," then divide through and see what you come up with in value. This just gives you an idea of what you're fighting for, how much money there is to be made if you were to buy the RV park.
From there, we move on to the diametric opposite of that. That's the worst case scenario. Now, what is the worst case scenario? Well, let's not get too technical in the idea of worst case because if you want to go truly worst case, your worst case would probably be on the way to the RV park you're killed in a car wreck. Then later the same day, a brush fire blows through and burns everything to the ground. Okay. That's worst case. We're not going to go with that scenario. It's possible. The odds are relatively small. Instead, we're going to say, let's assume we can't really get any traction on our efforts to improve things. We're stuck with Mom and Pop's revenue picture, their occupancy, their rents. Meanwhile, on the cost side, these dreams we had of cost cutting are wrong. We can't do any better than they did.
Then let's just make it even worse. Let's say that even then something else pops up and our occupancy, and our rents, our revenue is down an additional 10 or 20%. Let's say the costs go up another 10 or 20% there. Where do you end up then? In your worst case scenario, where are you? The key question here is, is it survivable? Could you still service your debt in the event that everything went down the drain? In some properties the answer is yes. It wouldn't be very pretty, but yeah, you could still service the debt. In other properties it'll be no, I couldn't service the debt based on that, but I could handle the negative. Even though I can't fully make the revenue cover the expenses and cover the mortgage, maybe I can still have it where it's not too bad.
Maybe it negatively cashflows $500 or a $1000 a month. Then the question is, "Okay, can I personally cover that?" If I can personally cover that, for how long can I personally cover that? I'm wanting to see my worst case scenario if this is truly survivable or not. I don't want to get into an RV park deal where if that deal goes bad, my life is destroyed. I'm buying the RV park trying to make my life better, not worse.
Then I'm going to go to the middle of those two categories and that's called the realistic case. The realistic case means I don't really hit my best case, but I don't necessarily hit my worst case either. I'm somewhere in between. Let's assume your worst case scenario was you would have given occupancy and rents, 50% of the revenue that the thing could derive. My best case is 100%. Then my realistic case might be 75%. It's somewhere right there in the middle. Now the expenses don't swing quite so wildly. You're not planning on probably reducing expenses as much as you are hoping to increase revenue. Nevertheless, my realistic would be somewhere in between my best case and my worst case on expense. Then I look at that number and I say, "Okay, what did that number do for me? Is that number positive enough that I'm happy with my decision, or is it still not that exciting?" A realistic case is realistically what you're going to have.
If that's your day to day scenario, are you going to feel good on that day to day scenario? Does it give you the rate of return you hoped for? Does it give you adequate coverage over your debt? Does it give you adequate final value of the property when you go to sell it years down the road?
Now, why are these three factors so important in making my decision? Well, let's go back a step. There's a guy named Sam Zell, and Sam Zell wrote a book recently called Am I Being Too Subtle? He has been obsessed his entire life with risk versus reward. It's taken him places because he's the largest owner of office buildings, apartments, and mobile home parks in the United States. His whole life has been based on this one theorem that if something has high risk and low reward, you should never buy it. If it has high reward and low risk, you should always buy it. Based on that theorem, what we're trying to do is we're in some ways trying to quantify that. A high-risk deal would be one in which my worst case scenario would bankrupt me, and yet my best case isn't that impressive. A healthy deal would have a very, very strong best case, and worst case isn't that bad.
What you're doing is in this exercise, you're basically trying to help make that decision for you of whether the reward outweighs the risk, and how much the risk is, and how is this thing going to perform. At neither polar opposite of best and worst, are you still going to be happy with it? Now let's look at a deal that would be one you'd want to buy. Let's assume you ran your best, worst, and realistic case. In the worst case scenario, you can cover the mortgage. In the best case scenario you do phenomenally well, and you're realistic case, you're very, very happy. Well then that's when you'd want to buy. You have very, very low risk, very high reward, it's all good. There are RV park deals out there that don't show those traits. Instead, what they've got is my best case scenario really isn't that exciting. My realistic case scenario, that's not very good at all. My worst case is it would bankrupt me. You would never want to do that deal, right?
Oftentimes, once you've identified out your best, your worst, and your realistic case, the course you should take is very, very painfully obvious. Also, even if it's not on the first round obvious to you, it will be obvious to other people. Now that you've quantified these three elements, now you can ask the advice of other people, your neighbor, family members, your banker, whoever, and they can help you come to grips with whether or not, based on those three scenarios, you should go forward or not. Those three scenarios may also lead you to other conclusions. One part of doing the worst case scenario is how do I hedge those risks? How do I make sure that worst case never occurs? It may help guide you as far as perhaps renegotiating the deal, perhaps obtaining insurance and things that scare you the most, maybe doing some more analysis on the things that scare you to see whether or not your decision on that is really accurate or not.
Often as you derive these items, it presents more questions, more points for review. Those are all great points and things you definitely want to do your research on. At the end of the day, the bottom line is you should only buy deals that you can survive the worst case, that you'd be ecstatic about the best case, and you'd still be very, very happy, if not thrilled, with a realistic case. Any deal that does not fit those scenarios, you should step back for a moment. Now you might still go forward with it, but you're probably going to want to renegotiate it. You're going to want to figure out how to hedge your risk. You have to do a lot of soul searching. A good deal, that's pretty much the way those three elements will lay out, and that makes for a very easy decision to go forward or not to go forward. This is Frank Rolfe of the RV Park Mastery podcast. Hope you enjoyed this. Talk to you again soon.