The Science Behind Making First Offers

So what do you do when that happens? How do you come up with the number? How do you come up with the best number? Well, there's basically four considerations that you have to take when coming up with what that number might be. The first consideration is What is a bank or an appraiser going to say the value will be? Because if you're going to finance that RV park, which you certainly are, then you can't go beyond what that bank is going to say.

There's just no way it's going to have to appraise at or more than the price you have on that contract. And the bank and the appraiser, they're going to use an income approach to that valuation. So you gotta find out from the seller before you can even make the offer. And he should be able to give you the number, just the same as he wants you to throw out the number, what his approximate net income per year is. What's his NOI? What is the revenue less expenses?

for the RV park annualized. And then you're going to apply a cap rate to that. So that's the first start. And that gives you one limitation. And then the next consideration is what is the spread you are after? The spread being the difference between the cap rate and the interest rate. One point cap rate to interest rate spread is worth about ten percent cash on cash return. A two point is about a fifteen to sixteen percent and a three point is about twenty percent more.

So if the interest rate on the loan is going to be seven, then you'd have to be buying this thing at a 10 cap in order to hit a 20% cash on cash return. If you say, well, I'm happy with a 15-16, well, in a two-point spread. If you say, well, I'm just fine with a with a 10 point or 10% return, then a one-point spread might do. But you have to see what you need to hit your goals.

So what would that price have to be to align with what it is you're trying to invest to achieve to begin with? And then you got to think about what would the price be you would throw out that would allow the seller to rebut that with a higher price. to ultimately come to the price that you want to pay. So what's the negotiating just the game of negotiating price where you want to begin? So you can back and forth and back and forth and get to the price that you want.

And then finally, based on that number of where you want to start off. What would the price have to be to get a counter? Because if you don't get a counter, you've achieved nothing. If your first offer is so laughable by the seller that he won't counter, that was a very unsuccessful first offer. The whole point of the first offer is to give you a benchmark, a start to that traditional back and forth and back and forth of negotiation. If you don't get that, well then you've completely failed.

Nothing came of you talking to the seller. You're never going to be able to buy the RV park unless he later recants and wants to go with a lower price.

So let's just put this into an actual example, into a real framework, because this all sounds great theoretically, but you may be saying, so should give me an example of how this works. So let's go through the example together on establishing those four different price points. So let's say when you ask the mom and pop owner, well, how much money does the RV park make per year? And let's assume they say, well, it makes about$80,000 a year.

Well, we know from experience that the bank is going to want to go ahead and have a a fairly high cap rate because they have to cover their risk and a coverage ratio of about one point two times the mortgage payment. They want to see that you've got

Not just enough to cover the mortgage payment, but a little additional on top of that, either one point two or one point two five that for them to feel comfortable with their loan. So if we're assuming a ten percent cap rate and an NOI of eighty grand a year. Then the bank is going to say the price should be eight hundred thousand dollars approximately. So now we've established that. We know we can't go above eight hundred thousand dollars.

Because if we go above that, then we won't be able to get the bank financing. And then let's assume in this example, we want a three-point spread. We want a 20% cash-on-cash return on this deal. And we know the loan's going to be at 8% interest. So we need three points, eight to nine, nine to ten, ten to eleven, and we need an eleven percent cap rate to give us that three point spread over the interest rate. And if I run an eleven cap on the eighty thousand dollars of income.

Then I end up with$730,000. So that's my target price, which is lower than the bank's maximum price. Because I want to make more money than the bank is worried about. The bank's just worried about covering their debt. I'm trying to do way, way better than that. So the bank is saying 800 is the limit, and I'm saying 730 is my target. But if I want to go ahead and get to seven hundred thirty, where do I begin? Well you might say well.

Let's think about this. Let's start maybe at 650. If I start at 650 and they counter at 900, then in the back and forth and back and forth, maybe I can end up at my target of 730. Okay, well that sounds good. But then we also have to think about what do I have to do to get them to counter? And you may say, well, 650 I think sounds kind of low. So maybe I should start at 700, even though 650 might be my ideal start for that bantering back and forth and back and forth.

I don't think I can get the job done at that price, so I think I need to be instead making my first offer at seven hundred. And when you look at those four pieces of evidence You look at what you'd have to do to get them to counter versus how low you'd have to be to give it room for the counter for you to counter back and counter back and then to put your price. And your goal at 730 and the bank's goal of 800 is

Then you might say, well, okay, I need to start at 700. I max out at 800 and my target is 730. Now what happens if the price comes in higher than 730? 740, 750, 760? Do you walk it?

No, not necessarily. You don't really know enough about the RV park yet, because the one part that's still left off here is what happens in due diligence. On any RV park you ever buy, you've got to have in the contract a due diligence provision and a financing provision.

That allows you to actually gather all the information to see if mom and pop are telling you the truth. Not that they don't always mean to, but they may not even know it. And the way they operate it may be so poorly that you can't even use their number as be a reliable figure. So you may have to adjust your numbers based on what you find that NOI to be. Maybe it's not eighty thousand a year, maybe it's less, maybe it's more.

And then of course you may say, well, even though it doesn't hit my initial three-point spread that I wanted, I can still pay more because I know that I can increase the occupancy through better online marketing, or I can increase the revenue by charging higher rates.

So you have some degree of flexibility on top of that. You may even find when you get in due diligence that the NOI number is wrong and that means that the bank may come up with an appraisal that is higher than the 800. But the key to it all is there's the science to it.

It can't just be random. Some people think they just go look at an R V part from Mom and Pop, and when he says, What do you want, or or what will you give me? Then you just kind of throw out these random numbers, kind of like an episode of Pond Stars or American Pickers, and It doesn't work that way. You've got to have a scientific way to look at what your high end and your low end range is, as well as the target.

That doesn't mean that you'll always hit it, but it means you can adjust things as you go, that you actually have something you are shooting for. You probably have a GPS thing on your car. Even if you don't have a GPS, you've probably at least got a way you can set your phone as your GPS.

And you'll notice if you take the wrong turn, what's it do? It tells you to turn around and go back. Because the car should always be pointing towards that ultimate destination and that's exactly what you're doing here. You're trying to figure out Roughly what am I trying to achieve? But that's not to say it's a perfect world. And in negotiation, going back and forth and back and forth, you may not hit your target. But the key is you have a scientific approach to hit it.

This is Frank Roth, the RV Park Mastery Podcast. Hope you enjoyed this. Talk to you again soon.