There is continual talk of greater inflation on the horizon, which then begs the question “what would the potential impact be to RV parks?” In this RV Park Mastery podcast we’re going to review what inflation would do to RV park investing – both good and bad – and what investors can do to mitigate the risks. With the government continually printing more money, it’s a topic that should be on all RV park investors’ minds.
Episode 24: Understanding The Impact of Inflation on RV Park Investing Transcript
With the US government spending so much money and printing so much money as well, it's important for most RV park owners to seriously consider the potential impacts of inflation on the industry. This is Frank Rolfe, the RV Park Mastery Podcast. We're going to be talking about inflation, that dreaded word, and what it could theoretically mean to RV park investing.
Let's start off with what inflation is. Inflation as we all know is just a continual rise in prices. Now, it's been part of the US economy since virtually inception. It's nothing to be truly feared. We typically have a target in the US of inflation of running around 1%, 2%, 3%. But some people, and it's reasonable to ask, beg the question what happens if it goes higher? What if suddenly even though we assume inflation of just a few points a year, what if that was to double or to triple? What would the true impact of that be? And it's happened before in American history. So let's review what would happen with a typical RV park investment in the environment of higher inflation.
Let's first start off with one of the key things that everyone needs to know about real estate is that it performs extremely well in inflation. I was an economics major back at Stanford and I recall in my textbook, bear in mind that was back during the era of Jimmy Carter and stagflation, that there were two things that did well during inflation: one, gold and other precious metals, and two, real estate. Real estate is a very tangible asset. It's just like gold or silver, although even better yet it can be income producing, particularly when it's an RV park. So the very fact that you're having inflation or higher inflation actually benefits real estate.
Now why would it benefit real estate? Because again, real estate is actually tangible and tied to something. You collect rent from your customers. It's a hard asset. It's not just some piece of paper, financial document you get from your stock broker at AG Edwards, so you actually have a hard thing, a precious thing, a thing that's irreplaceable. Inflation actually works very well for every facet of real estate, so RV parks definitely score well in that department.
Another good thing about real estate is if you have inflation, you can pretty much raise your rents as much as you want. If you were to have hyperinflation like Germany back in the WWII era, you could still handle that but you'd have crazy high rates if you had mega inflation like they had back then. You might go from $30 a night to $300 a night theoretically. But the bottom line is yes, you can reset your rents at any time. There's no rent control to my knowledge in the entire United States concerning RV parks, so you can pretty much set whatever rent you feel like setting. If you had high inflation you could set your rents theoretically continuously higher.
Another interesting thing about real estate inflation is most people buy real estate using debt. In fact, you'd be crazy not to. That's one of the ways you can really spike your yields is using sensible leverage. And as you have high inflation, the amount of the debt in real dollars decreases. So while you're raising rents and your values are going up on your RV park by creating more money, your bank is stuck. They don't get anything more no matter what happens in that flat amount of the loan. So as a result, their loan amount becomes eroded over time from inflation, which is another reason why inflation has actually been an asset to real estate over the years.
What else is going on with RV parks in particular? One issue you see with inflation would be typically higher prices at the gas pump. That would be a downside to inflation for RV park owners, but at the same time that's already been going on. We've already had rounds of continually higher oil and gas prices. What did it do? It kind of just changed the dynamics of people using the RVs. Today, they tend to either not drive as far or to still drive far but go to a destination and just sit there in that one spot. They tend not to travel from property to property like they did in the old days. So some of that has already been factored in.
But of all the things that inflation might cause that would be detrimental to RV parks, the biggie would be the impact on interest rates and on banking. What happens is when you have high periods of inflation, typically those are met with higher amounts of interest rate. So where you can really get damaged with an RV park or any real estate asset comes down to financing. Let's model it out for a moment. Let's assume you had a loan and the interest rate on that loan right now was 5%. Let's assume inflation went up to 6% while interest rates might go up to 8 or 9%. So when your note comes due what happens? Well, you go to get a new bank loan, only to find you're going to have to pay significantly higher interest rate. In the worst case scenario, there might be no banks open at the moment doing loans. They might be too concerned with inflation and the erosion of their loan values. They might just decide to sit it out for a while and not do any loans.
What's the key item to watch out for with an RV park? That is to make sure that you give yourself plenty of leeway regarding lending. So what does that mean exactly? Well number one, when you're financing an RV park always use what we call sensible leverage. Don't over leverage yourself unless you've got a plan B. so I would typically want to see on a loan today 20-30% down approximately. Now, if you get a better deal with seller financing that's great and everything, but just remember you've got to have a plan if you have to go get a different loan product for the future. You may have to put more money down to get yourself back to that kind of 20-30% down that lenders prefer. Just don't box yourself into a corner where you don't have an alternative plan if the amount down or the structure of the loan changes.
Number two, try to plan your lending way, way in advance. If you have a loan that is coming up in the next year or two years, start now. Start looking at the various options. Don't run it right down to the wire. For all you know, that's the very moment at which the banking industry will go into a crisis and then you won't have time to find another lender at some kind of rate that you can afford. There's nothing wrong with pre-paying your loan. If you get down to the last moments of your loan, maybe a year ahead, there's nothing wrong with going ahead and refi'ing it then and not waiting until the very end of the loan. A lot of borrowers instinctively wait until just the final few months; that's simply too risky.
What happens if the banking industry is in turmoil in those final moments? It's a lot safer to plan ahead. You have a five year loan, you might look at getting that new loan in year 3.5 or maybe for sure at the start of year 4. Why? It gives you plenty of room to position to find that new loan. If you can't get the loan you want, it still would give you time to sell. So it's very, very important in times of inflation, if inflation really worries you, that you try and plan your lending around the prospect of inflation. If you're buying an RV park it's also again important if you can to get as long a loan as you can as far as the term, and also a fixed interest rate. So those who can go ahead and get an RV park for example at a CMBS conduit loan right now which is a 10 year fixed interest rate product, well that's really a safe way to go because what happens is you don't have to worry about inflation or interest rates for an entire decade. Even then, I'd start a couple years before the end of it, that's for sure. But the longer you can get the loan when you have errors with the risk of inflation, the better.
Now back when interest rates were higher, not that many years ago, about a decade or so ago, smart people were trying to be a little shorter on their length because they knew there was nowhere to go but the interest rate to go down. They didn't want to get locked into a long loan particularly if there's a prepayment penalty and then suffer through those higher rates when they could have gotten a lower one. We've all seen that firsthand with home mortgages, and people wanting to refi into lower interest rates. But right now with rates at world record lows, not actually a world record but among the lowest in American history, the safe bet is that rates really aren't going to go any direction probably other than up. So as a result, you want to plan accordingly. You want to go ahead and harvest and embrace any loan you can get that has a longer term and a fixed rate. Any bank that gives you two options - a fixed interest rate or a variable - at this moment I don't think you'd want the variable. You always want to go for the fixed.
Another thing to think about is if you get a seller financed deal on that RV park is that some point you'll have to get a bank loan unless they full amortize at the end of the loan. In that case, it's always smart if you can to A, get the longest term you can on that seller note, B get a fixed interest rate, but C also see if you can buy an option to extend if you need it. How does that work? That's a onetime payment, if you need it, towards the principal on the loan and it buys you an additional period of time, typically about two years. So let's say you had a five year deal with mom and pop, with a two year emergency option if you needed it. What you would do is if you said well the banking industry is all screwed up right now, I need an extra two years of time, you would make a onetime principal payment down on the note, let's say $20,000 or something, and it buys you two years. It costs you really nothing because you're just pre-paying your note. You're not paying an actual cash penalty to them that they get to keep. It goes against your loan so it really goes to you. You're doing it to give good faith demonstration that you're not going to walk off and abandon the deal. That's why they would continue forward with you because they know you would never put more money down if your intention in fact was to walk away.
The bottom line to all of it is that RV parks are pretty well positioned for the eventual risk of inflation. We always assume inflation is right around the corner because it has been historically since the beginning of time. But RV parks are going to fare much better than almost any other asset category if and when inflation ever hits. The key is to plan and mitigate your risk regarding lending, and as long as you can hold that off, as long as you can go ahead and steer your ship to the middle of the channel regarding lending, you should be just fine regardless of where inflation rates head. This is Frank with the RV Park Mastery Podcast series. Hope you enjoyed this. Talk to you again soon.