RV Park Mastery: Episode 3

Types of Debt and How to Get Them

To hit impressive rates of return, all real estate is contingent on the use of sensible leverage. So how do you get a loan to buy an RV park? In this episode we review the various types of financing available for RV park acquisitions and discuss how to successfully obtain them, as well. Since debt is an important part of every purchase, the sooner you know the options and how to select the correct one, the better.

Episode 3: Types of Debt and How to Get Them Transcript

Debt is a four-letter word. That's only because it has four letters though, because debt's really a good thing for you if you are an RV park buyer. This is Frank Rolfe, The RV Park Mastery Podcast Series. We're going to be talking about debt at RV parks, how to get it, what the variety is and the good and bad aspects of each one.

Now there's effectively three types of debt in America when you're buying an RV park. The first one is seller financing. This is our favorite. This is the classic of the industry. What you have with seller debt is you have mom and pop who when they sell you the RV park, are going to carry the paper and this is a great win-win experience for everyone involved. They're going to get a really nice interest rate on their money. You're going to get a loan without the terror of going to a bank and the rejection of going to multiple banks, going through loan committees, et cetera. You also have the ability to close quickly after the end of your due diligence and it always gives you great piece of mind when mom and pop are carrying the paper because if the RV park was not a good deal, why would they carry the paper? It would be suicidal. You'd be right back after them in the first month saying, "Wait. I'm not meeting any of your projections. You lied to me, you committed fraud." So seller financing is in fact everyone's favorite form of financing.

So how do you get that? How do you get seller financing? Well, here is the short form for getting seller financing. It's all about the seller and their own selfish interests which fuel them to do seller debt. So what I am talking about? Well, let's just look at this factually. If I buy an RV park from mom and pop, and I give them a suitcase full of money and they run down to A.G. Edwards and say, "Hey A.G. Edwards, I've got a suitcase full of money and I want to invest it." So how does that work? Well they will say to them, "Okay, are you a conservative investor or not?" They'll say, "I'm a very, very conservative. I am afraid of my own shadow. I don't want to lose a single penny." So the stockbroker will say, "Well in that case all I could put you in are treasuries and CDs and those pay about 1.5% interest."

Now at the same time, with the seller finance note, they'll get about 5% interest which is anywhere from three to five times more than they will get at A.G. Edwards. So basically every dollar that they sell or finance with you, they will get an interest rate that is typically two or three times higher than what they'll get at any form of investment. So when sellers carry debt, they're not always doing that out of altruism although that does have something to do with it because sellers do typically like the buyer and want to help them, but equally important, they love the fact that they're getting a high rate of return. Another factor is they also love the collateral. The collateral is the RV park that they built from scratch typically, owned and operated, have known for years, and as a result, that gives them peace of mind that if anything bad should ever happen, well it's okay because they can go ahead and just take the RV park back over just as they did in the olden days.

When they invest in something foreign to them, such as a bond in John Deere Corporation, they have no control over that bond, they know nothing about the collateral of the bond. They know that if the bond stops paying, it's probably worthless. So for these very many reasons, sellers actually prefer to carry paper, but you have to be easy for them to do it with. You must always treat them with the utmost respect and timeliness because if they don't feel that you are someone who can be trusted, even if it manifests itself just over if you're late to a single meeting, then they won't want to make the loan because they're afraid you won't make your payments on time, so another issue is you need to bond with the seller. Sellers love creating paper for those that they like and trust.

Spend time with your RV park seller, both on the phone or in-person. The more that they spend time with you and like you, the more easy it will be for them to carry debt for you because then they'll know who you are, what you're all about and the fact that you will make a payment every month. Now another item on seller financing is the down payment. Typically the down payment on a seller note is going to be 20% but we've done 12-0 down and we've done plenty of 5% downs and 10% downs so there's no set amount as far as the down payment on it. The amortization is typically 30 years, that's good. The note term, that's the part that's very variable and let me give you a few words of advice on that.

Now we think that any node on any form of real estate, particularly RV parks, you need to start addressing that note renewal or expiration at least one year ahead. That means if you have a three year note from mom and pop, you only have two years of happiness before you're out there trying to replace them as the note holder, and we don't think that's enough time because you also want to seize on your improvements over a few years. So really you need at least a five year note is the bottom line. That would give you two years to improve the operations of the RV park, two years to season that number prior to financing and then gives you one year to replace the note. Even then, five years to us isn't as much as we would like. We would rather get longer than five.

We always shoot to try to get a ten year note. If we can't get a ten, we'd be happy with a seven, a seven would be great, that would give me five or six years before I have to worry about refinancing but never get in the trap where mom or pop want to carry only for a very short time like a one or two year note. That will not do you any good. In fact that will get you into more harm than good. When you have a shot, short loan from mom and pop, what always happens is you really are not tested in the world of banking yet. What if you go out to the banks to replace the note and you find the park for whatever reason is not bank material and they won't make a loan on it? You would have been better off not buying the park in the first place, correct? So a seller note to be a worthy note has to be longterm orientation.

Also make sure with any seller that you have that you use a good seller note form, not something written on the back of an envelope. The note should be identical to that of an actual bank, so what does a seller note need to look like? Well go get an actual bank note. Now take out any term that you don't like. Take out the ability for them to call the note and all that kind of thing so it just needs to be a payment every month at a certain interest rate but make sure you also have protections. You want to make sure the title is in your name and that the seller is acting simply as a bank. So it's very important that you have an attorney look at that seller note and vet the note to make sure the note gives you everything that you need. One final item seller notes have always historically been non-recourse, which means the worst case scenario you have on the property is if you screw it up, all you lose is your down payment, but they have no ability to come after you for any loss on the note. So non-recourse is another attractive portion of seller note.

Now let's move on to banking. Banks, we all know what they are, we drive by them every day, big banks, small banks, banks with branches and banks without branches. For RV parks traditionally the best banks to hit are the small banks, the ones that have one branch or two branches and not the ones that have 20, 30, 40, 50. Because most banks don't really fully understand RV parks to begin with and the small banks, they're more open to new ideas than the big banks which look at everything as being a cookie cutter item that just goes on one kind of box or another. When you're looking for a bank for an RV park, choose a bank that's in the area of the RV park itself.

If you're looking at an RV park in the Omaha, Nebraska area, your number one bank will come out of Omaha. That's because a bank in the area already knows the area. They already know the collateral and typically they already may even know the RV park, so try and stick close to home. Small town banks are just great. Those smaller banks typically are just like mom and pops. You've got one or two people often that own the entire bank, they make the decision and then it's back to mom and pop 101. If they like you, if they bond with you, they'll do the deal with you and if they don't like you, they won't. So banks can be perfectly fine financiers of RV parks and let's go over the typical terms.

The interest rank on a bank loan right now in the U.S. is going to run between 5 and 6%. That's not bad, that's very reasonable, I was around during the Ronald Reagan era when it was 17% so I think 5 to 6% sounds pretty darn good in my opinion. The amortization is typically 25 years to 30 years, so that's perfectly fine, but the one item you have to watch out on a bank loan is the link to the loan. Because unlike mom and pop who can set at anything they want, bankers have their own regulations and internal guidelines. Seek out loans that are longer term in nature. Try and find bank loans that go out 10 years if you can, and if you can't get to 10, sometimes with banks you have to settle for five, but once again, don't do one or two year terms. That won't do you any good. You'll be living in ultimate terror at all times, having to find a new loan almost as soon as you sign off the old one.

Also banks typically have recourse, which means if you default on the loan and there's a loss in selling the loan off, they can come after you personally for the amount of the loss. If you say, "I don't want to do recourse debt." Well you still have the option with regular small bank debt to often do non-recourse but it will change the amount you put down. Almost every bank will do non-recourse if you put 50% down. Some will do it if you put 40% down. A few might do it if you put down 30%, but talk to the bank if you hate the idea of recourse and just see what you can get done and you may find there is an option out there that meets what you want.

The final way to finance an RV park is called conduit debt, also known as CMBS or commercial mortgage-backed security debt. So what is conduit debt? Well, it's basically a bank loan that gets compiled into a big pile of loans, then these are sold on Wall Street through a process called securitization. Nothing wrong with them although you're saying, "Wait a minute, the 2007 Great Recession, wasn't that triggered by the collapse of single family CMBS debt?" and the answer is yes it was, but that's not what we're talking about here. We're talking commercial debt. Commercial debt has never caused a national recession to my knowledge. It's very different than your single family home loans. These loans come in piles where each loan itself is in the millions and millions of dollars, unlike those single family securitizations which were often in the hundreds of thousands of dollars.

At any rate the good parts of the conduit note are number one, they're typically a 10 year term, we like that, they're non-recourse, we like that. They're 70% loan to value, which means they get an appraisal to 70%. So it's not really a set amount down. It might be 30% down or it might be 18% down. It's all going to depend on the appraised amount, so that's good. Now some unusual parts of the conduit note that you need to know. Number one is how to get them. It's very, very difficult unless you use a loan broker. If you use a loan broker of which we like MJ Vukovich at Bellwether, we also like Security Mortgage Group. If you use a loan broker, they do all the work for you. They go out, they obtain the loan, they come to you and say, "I found a loan. These are the terms," or sometimes, "Here are the terms on three different lenders. This is the one I would recommend." It makes your life so easy and more stress-free, so that's one important item.

Another one is when you do a conduit loan, you cannot prepay that loan. If you have a 10-year note, you are not going to be able to afford to prepay that until you get near the end, and that's because in a conduit loan, you have to pay what's called a feasance which is a penalty which can be very, very high. I've seen them as high as 30% of the entire loan just as the penalty. They do that because these are not bank loans. They have no ability to prepay the American public, so they have to keep making the interest so what happens is you have to buy enough treasury bills as the borrower for the sum of all the payments till the end of the note plus the principal. Very, very, very expensive stuff, so if you're going to use conduit lending, that's more longterm debt. You would never do that if you intend on buying and selling the property in a very short time window.

So those are your various types of debt out there. You've got seller, you've got bank, you've got conduit. Don't forget, debt is a four letter word but it's a great four letter word. It's a very positive one. What makes real estate an attractive investment is the ability to obtain leverage and leverage is debt and debt is good. This is Frank Rolfe of The RV Park Mastery Podcast Series. Hope you enjoy this segment. We'll be back again soon.