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Welcome to the RV Park Mastery Podcast, where you will learn the correct way to identify, evaluate, negotiate, perform due diligence on, renegotiate, finance, turn-around and operate RV parks. Your host is the 5th largest owner of RV and mobile home parks in the United States, Frank Rolfe.
Getting RV park deals done has always required creativity. You have to think like a deal maker, not like a deal killer. You have to think about all the weaponry in your arsenal to make those numbers tie to what the seller is demanding on price. But there's two tools that many RV park buyers don't consider, which are perhaps among the most important. This is Frank Rolfe with the RV Park Mastery Podcast. We're going to talk about two tools that have been used in the crafting of many RV park deals. And those two tools are called escrows and earnouts. And in both cases, what you're doing is you're having the seller put their money where their mouth is. You're making them stand behind claims that they may have made by putting cold hard cash as a backstop. So what they tell you either must be true or, if they're wrong, the money flows to you. So let's start off with earnouts. So what is an earnout? An earnout is basically when the seller shares the risk with you, the buyer. Let me give you an example of what would be an earnout. Let's say someone says, "Yes, my RV park only has 50% occupancy now, but I think it's on its way to having 80% occupancy in the future." And you say, "Well, look, all I can underwrite is 50% now. All the lender is going to give me credit for is 50% now. But I'll tell you what, if it hits 80%, I'll pay you more when it hits 80%." You have to strike some kind of a deal that if that RV park hit this supposed 80% level, then you're going to go ahead and pay the seller more money, probably in the form of a second. But that's how you're going to bridge that gap between what they want and what's actually there that you can see. So earnouts have always been a staple of RV parks when you're trying to get a deal crafted because it lays bare the seller's true belief in what they have. If the seller really, truly believes that that thing is going to hit 80%, he should have no trouble doing an earnout. But if he's adamant, "No, I know it's going to happen, but pay me now," why does he have to get paid now? It's because he does not truly believe it.
So earnouts are kind of like a lie detector test that you can use in an RV park deal to see if the person's really telling the truth. And number two, it's a way to bridge the gap. Now, it's always an important way to bridge the gap because banks don't bridge gaps like that. You can't go to a bank and say, "Well, I want you to make a loan on this RV park based on higher occupancy or higher revenues or lower costs than what it really has." The bank will laugh at you. They'll think that you're an idiot. Most banks are going to come up with their NOI number based on the last three years' average NOI performance. They're not going to do it based on the last three years' NOI performance plus some made-up mystery number. So if the seller wants more than the thing is producing now in valuation, he's going to have to do an earnout. There's no other way to really get there. Now, if you're going to do an earnout, though, you have to pick out what the metric is that you are going to measure. If you're talking on the revenue side, it would probably need to be a number in revenue that you either hit or don't hit. And if it's on the expense side, the same story. It couldn't be just, say, occupancy, because what if you hit the occupancy by doing some kind of reduced rent just to get people in the door? That's not going to work. So make sure, if you will do an earnout, that you pick your metric carefully. Make sure it's the one that you truly are desiring to hit. And of course, as always when crafting a contract, you know the seller's attorney will argue with almost anything.
So expect some degree of pushback because they don't see a lot of earnouts in a lot of commercial real estate transactions. So of course, yeah, they're going to complain, but yet it's done all the time. So you can probably get them to finally understand it. And of course you will need a referee to watch over who won this game. Did you hit the metric or did you not? It can't be left up to just your opinion or the seller's opinion. And that's where typically a title company would come in. So you probably would want to have a legal agreement with the title company that they, on a specific date, are going to decide whether or not that metric was hit, whether or not the seller gets that extra money. And I will tell you, in 30 years of experience, that typically when you have an earnout, 75% of the time or more, the seller's going to lose. You're not going to hit whatever he thought, because if you were going to hit it, he would have already hit it. That's what always drives me crazy when the seller says, "Oh, yes, it's so easy to attain this higher number." Well, if it was so easy to attain it, why didn't they attain it? And the answer is often because they can't. Then we change over to escrows. Now, what's an escrow? It's the same as the earnout. You're asking the seller to share the risk with you, the buyer. Now, typically on an escrow, though, what's happening here is we're looking at risk and danger and those kinds of items that we're trying to protect against. So let's assume, for example, that there are problems in the washroom, the laundromat, any part of the amenities package, the swimming pool. And you tell the seller, "Here's the deal. I need $60,000 off for these pool repairs." And the seller says, "Oh, no, I can do them for cheaper than that." Well, that's something you could put in an escrow. And if they can get the pool repairs done for less than 60,000, then they get, whatever's left, 60,000 minus the actual cost. So it's not a bad thing to do. It's done all the time. It can be done on all kinds of issues, any repair and maintenance issues. It can be tied to any titling issues. Whatever the case may be, escrows can often be the perfect way to fix those kinds of disputes. And typically, escrows are a lot easier to measure than earnouts.
Is the swimming pool decking done or is it not? Did the swimming pool decking get the green tag from the city government or did it not? But once again, you'll have to figure out what the metric is that you are measuring to find out who actually gets the escrow. And escrows are typically much shorter in duration. Typically, an escrow only lasts for maybe a year or so, whereas an earnout situation could be years into the future. And I have found it to be easier to convince a seller to do an escrow than it is to do an earnout, because it does have a shorter timeframe and because they fully understand what it all means. I will also tell you that escrows typically end up at about a 50/50 chance of the seller scoring, which is much better than on the earnouts. Normally, when a seller thinks, "Well, I can get those trees removed for less money," or the seller says, "Yes, I can get that titling issue solved," normally they can. At least they can, roughly half the time. But again, the risk is on them. It's not on you. If you were to buy it on a deal where they just say, "Oh, yeah, I know you can get it fixed," and you can't, then what happens with them? Why did you pay them for something they could not perform on? That's the problem. And that's what escrows and earnouts are always trying to bridge the gap on. The bottom line is you have to be creative to get things done in America today. It doesn't matter what sector of real estate you're in, and RV parks are certainly no exception. But when you can't make the numbers tie and yet the seller is trying to get value for things that are not currently achieved, you've got to spin that around. You have to make them put skin in the game. You have to put the risk back, at least on them, in a portion. And a great way to do that is using earnouts and escrows. This is Frank Rolfe with the RV Park Mastery Podcast. Hope you enjoyed this. Talk to you again soon.