Rates of Return Explained

We're going to be talking today about the different rates of return in an RV park, what they mean, and what you can estimate they would probably be. Let's start off with the cap rate. Now cap rate is a slang term for capitalization rate. That's simply a fraction. It's the net income of the property on the top of the fraction over the cost of the property on the bottom of the fraction. You divide the top by the bottom and that gives you a number.

And if you're buying an RV park or any property for that matter, the higher that number is, the better. So a five cap is always inferior to a nine cap, and a nine cap is inferior to a twelve cap. In fact, you can never be too high when it comes to cap rates. But that's what a cap rate represents. It's just the net income from the property divided by the price of the property. So you might say, well, why is that important? Why should I care? Well, you should care a lot.

Because that cap rate has a lot to do with how your property will perform. The big item in RV parks, mobile home parks, every other kind of real estate is the thing called the spread between the cap rate and the interest rate. And the bigger that spread, the higher your return level will be. So if you're buying a property that has a cap rate of eight and an interest rate on the loan of five, you have a three point spread.

And again, when you're buying an RV park, the bigger that spread, the better. And in fact, you can never have a spread that's too big. Now, what are the typical RV park cap rates out there? Well, RV park cap rates are you're gonna typically be found to be roughly about eight percent for a really, really nice property that has a great reputation in an amazing location. Probably the average in the US is going to be more along the lines of ten and twelve percent.

And then on properties that need a lot of work in turnaround mode, lesser locations, you're probably going to be up there maybe even into the mid-teens. Now there's two kinds of locations in the world of R V parks. You have overnighter, where people just park as they're going down the highway on their way to somewhere else at a destination where people want to stay. And you'll also see differences in cap rates based on whether you're an overnighter or destination type of RV park.

The destination is more valuable, the destination is more desirable. Hence the destination will have probably a lower cap rate than the overnighter. But despite that, that's probably what you're after. So if we were on a game show trying to guess here's a good solid destination RV park in America, what would the cap rate be? I would probably guess around ten percent.

I think ten percent is a very fair price. It lets the seller get a good price for their sale, but also allows the buyer to buy something that can make real money.

Now let's move on to cash on cash return. We talked a minute ago about spread and the importance of spread. But the main thing that spread ties back to is your cash on cash return. And what is that? That tells you how much money you will get back from your down payment. You put in X dollars of cash. How much can you be expected to get back from those X dollars of cash? And in the RV park industry, the goal of most buyers is to attain twenty percent cash on cash return.

So at twenty percent cash on cash return, what does that mean? Well what it means is if I put down a hundred thousand dollars on my RV park, a 20% cash on cash return means I would get twenty thousand dollars per year back out. Pretty amazingly good when you consider if I put that same money in a C D down at Charles Schwab, I might get about a point and a half or roughly fifteen hundred a year, but with the R V park I'm getting twenty thousand.

So it's a big number. It's the kind of number you could actually build financial security from that. So cash on cash returned in the industry is predicated on the level of that spread. Now, what are the things that harm your cash on cash return? Well one thing that really kills a lot of R V park buyers are number one, they don't budget properly, so they don't really know

what the net income will be when they're buying. But another item is when they cheat themselves by not taking into account all of the capital improvements necessary to get the RV park in good operation and putting that into the bottom part of that fraction going back to cap rate.

So if I have a cap rate and I'm estimating that based on a property at a price I'm paying, but then I'm gonna pour in two hundred thousand dollars of additional capital to fix the roads, to fix the pool, to bring it back to life.

I'm not buying it for the price that the seller is asking. I'm buying it for the price the seller is asking plus two hundred thousand dollars. That can massively impact your cap rate. And once you do that, it massively impacts your spread, which impacts your cash on cash return. So always be sure when you're trying to come up with these various levels of return on your investment that you be honest with yourself.

I like to tell people I think the most important thing you can do when you're looking to buy an RV park is to wear mentally a white lab coat. Don't taint things based on emotion. Look at them factually. Imagine a drug company that's tried to test a new medicine. They want it to work so desperately bad because they need that product to bolster their sales.

They want to have a product, they want to believe they can beat cancer, but they can't let that emotion get into the actual scientific analysis of success. Because if they're wrong, people might get injured. If they're wrong, then people won't be cured. And no different than that with an R V park. You have to look at it without any passion at all. You have to look at the numbers and say, okay, what do these numbers say? And embrace those and be honest with them.

And a lot of times when people get in trouble with cap rates and cash on cash returns, they violated that rule. They told their friends, hey, I'm buying this RV park, or more importantly, they told themselves, hey, I'm buying this RV park. And then when the numbers say you shouldn't buy the RV park, or that you should at least try and get a price reduction, they can't.

They just can't do it because they have morally, emotionally already committed to the deal. And that's the worst thing you can possibly do. All right, so cash on cash return, again, you want to get about a three-point spread between interest rate and cap rate. And that will get you about a twenty percent cash on cash return. Now, is there a level at which cash on cash return is so unattractive you would not buy the RV park? That's all up to you.

There's no banking regulation. There's no U.S. law that says that you have to do X, Y, or Z when it comes to buying an RV park, or any real estate for that matter. But for most people that what they're seeking is that laid twenty percent return with the potential to go even higher. I think if you looked at how you can really build wealth in America today, how you can really build financial security and a significant income stream, 20% is the magic number.

That number is so much higher than anything else out there, it makes the effort worth it because you're not going to get twenty percent in any other form of investment. And let me also throw out, because I see the headlines as you do, and let me just burst the bubble here on this whole idea of the stock market going to be the engine of making twenty percent going forward.

I'm an old economics major from Stanford, and I can tell you, and you can look it up easily online, the stock market since inception has never done better than a long term average of ten percent. So when it goes up twenty or thirty percent, that means it is going to drop. twenty or thirty percent to go back to its consistent ten percent level. We have not ever going to be able to defy the laws of economic

And gravity. And the way the market works is you have high peaks, then you have collapsing valleys, which bring you back to 10%. So when I'm talking a twenty percent cash on cash return, I'm talking one that happens every year, like clockwork going forward. I'm not talking about one where you hit twenty percent one year and then you're negative fourteen percent the next.

That's not the kind of investing that I or anyone would advocate. Now let's move on to cash flow. Now what is cash flow? Well cash flow is a little different than cash on cash return, and you need to know this so you don't confuse the two. Cash on cash return is the amount of money you get back from your down payment, but you don't always get that up front. Because the principal portion you pay down on your note counts

as cash to you. It's also known though as enforced savings because you don't get that until the end of the loan. You don't get that until you refinance the loan. So as a result, you're not seeing that in your pocket. So there's another term that was defined to show what you get in your pocket, and that is called cash flow. So what is cash flow? Cash flow is basically the revenue of the RV park minus the operating expenses. And then you also have to additionally take out your mortgage payment.

both the interest and principal. Now the interest is money you would never get back, but the principal you would in the cash on cash metric. So what you're doing with cash flow is you're additionally subtracting the principal portion on the mortgage. So your cash flow will always be lower than your cash on cash return. How much lower? Well, it all depends on what you're doing as far as how fast you're amortizing the debt on the RV part.

If you're amortizing the debt on, say, a 30 year amortization, which means you pay the debt off in thirty years, you will have much less capital that's paid back on the loan each year than if you're doing it on a fifteen or a ten. But the cash flow really is in many ways what you see right now most immediately in your pocket. Now, RV parks have one extra trick, which is that for most, or not for most, but for many RV park buyers, they self-manage.

As a result, the management costs in the numbers of the RV park, those also flow back to the owner. So they already have one built-in significant cash flow coming in, and that's if they self-manage, they get the money that would typically go to the manager.

But the other thing about cash flow to remember is if you buy any old RV park that's stabilized and it can cover its note with principal and interest, a lot of your cash flow will stem from you doing a better job of operations, from you filling those vacant lots. From you doing a better job of making money on every dollar that comes in the door. So often cash flow is a reward given to you. It's the carrot that is dangled before you to do a better job than mom and pop did.

When you bolster that occupancy, when you keep costs low. These all have big rewards in form of cash flow. In fact, many people look at cash flow kind of as that daily driver for them working harder because they get immediate gratification. Every time they open the cash register, the money that they're taking in beyond the initial budget of when they bought the RV park, that flows straight to them. So the cash flow is basically kind of like a daily Christmas present based on how you do.

So those are basically the three top metrics in the RV park industry cap rate, cash on cash, and cash flow. And as you can see, they're all very, very interrelated. So it's very, very important on every deal that you do, you analyze those three ratios to decide if this is something you want to invest in or not. This is Frank Rolf of the RV Park Mastery Podcast Series. Hope you enjoyed this. Be back again soon.