The old adage “it takes money to make money” is true in real estate as most properties require some form of down payment. And if you don’t have the needed funds, what can you do? In this RV Park Mastery podcast we’re going to review the methods of raising capital to buy RV properties from investors as well as lessons learned on the right and wrong way to approach this important topic.
Episode 40: Raising Capital For Down Payments Transcript
We've all heard the old adage, "It takes money to make money." And that's, of course true in real estate because you typically have to put out a down payment. And it's certainly true of RV parks as much as any other real estate sector. So how do you raise capital to get those down payments? This is Frank Rolfe, the RV Park Mastery Podcast. We're going to talk about the theory behind raising money, and the reality of how you do it, and what you need to do to be successful at it.
So let's first start with the theory. Now you want to buy an RV park, you don't have enough capital for the down payment to buy the RV park. There's certainly nothing wrong in any possible way with acknowledging that, and proudly going out to the world saying "I'm trying to raise money to buy this RV park." Many people think that everyone in real estate is wildly rich. And as a result, if you don't have the money for the down payment, there's something wrong with you. I can tell you, that's completely false. Everyone in real estate started off with basically nothing unless they inherited something. And many people who inherit something don't go on to buy anything whatsoever. If you look at the largest real estate investors in the US, Sam Zell is number one, largest owner of office buildings, largest owner of apartments, and now largest owner of RV parks and mobile home parks. He began with nothing, zero. He started out as an immigrant, you should read his book Am I Being Too Subtle, a fantastic book. He bootstrapped his way up from the beginning, starting with properties, scrounging the money for down payments, borrowing money from people. So there's certainly nothing wrong in any possible way. So if it's holding you back from getting the money together for the down payment, then you need to stop that behavior because there's nothing to be embarrassed about.
What happens when you raise money for a down payment is as long as you do it properly, everyone benefits, that's a true win-win. The investor is going to get a good rate of return on their money, you're going to get a great rate of return on your effort, and your intelligence and strategy in buying the property. The seller also benefits and if you're a good operator, so do the customers. So what are the mechanics of it? How do you raise money for down payments?
Well, let's talk about raising money for a moment. One thing that I have learned over the many years I've been in the industry of RV parks and mobile home parks is, it's a whole lot easier raising $50,000 from four people than to $200,000 from one. So if you're going to look for a capital partner to buy an RV park, don't try and get one person to put in a huge amount unless they've got a huge amount and that amount is not very important to them. Because it makes people very uncomfortable when you're trying to get huge amounts of money. If you borrow, for example, from someone who has a million dollars in savings, if you borrow $50,000, you're only borrowing 5% of that money. If he were to lose the whole amount, it wouldn't bankrupt them. But if you start borrowing larger amounts, if you wanted to borrow $500,000, when that's 50% of their money, that's going to frighten them, it's also going to drive you nuts, because they're probably going to be calling you every day to make sure you haven't lost their money. So think about doing it in more moderate fashion for maybe a series of investors.
Now, I don't know the limit right now of how many you could have in a partnership because they change the laws constantly. And I'm not a lawyer. But I believe you can raise money from up to 20 people in a standard partnership structure. If you go beyond that number, I believe you have to utilize what's called a Reg D 506. Now, Reg D 506, is a wonderful invention under the Jobs Act brought to you during the Obama administration. But the problem is it will cost you roughly $15,000 just to form one, they're very formalized, you have to go through the SEC. So for most people, that's not where you would begin. Maybe after you're trying to build a portfolio of RV parks, would you then venture into the idea of doing Reg D 506. But until that time, probably more than likely, you're looking at a partnership either from one person or a handful of people. And here's where it gets really important if you really want to raise money for the down payment, you have to look at everything, everything from the investor standpoint, and not from your own standpoint. So let's start off with what a healthy structure looks like.
Typically, if you have someone put up the money for the down payment on the RV park, here's how it works. First, you acknowledge how much they put in. That's their capital at stake and that is considered extremely precious. That is in a first lien position over anything else other than your bank debt. They must get their capital back. Number two, they get a preferred rate of return, this is an interest that they get on their capital. And it again, goes before any other payments of profits to you, as the originator of this deal.
So let's just put that in modeling form. Let's assume someone loaned you $200,000 as the capital to buy the RV park. So the capital is $200,000. And let's assume the preferred rate of return in this instance is 10%. That means they have to get their capital $200,000 plus $20,000 per year for however many years they had their money in. And after that, you get what's called the profit split, which is also known as the waterfall. Now, there's no rules and regulations on that. It's a free country, but typically, profit splits are roughly 50/50. So that being the case, after they get their capital back, and their preferred rate of return, you then split everything else 50/50. Now along the way, you for putting the deal together, typically get an acquisition fee, and you get a management fee, but where the big money is, it all comes from that final profit split. And in that way, you and the investor are perfectly aligned, because you have a common goal. And the better the investor does, the better you do. So that's what I would call a very, very healthy structure.
Now, if all goes bad, if the deal does not work out, remember, the primary item that must be paid back is the capital. So if the deal fails, you really won't make any money whatsoever. So it's very important that you realize that on the front end, you're not in the business of just raising capital and buying any old RV park. The whole purpose is to raise money and buy one that is a winner. Also, if you want to attract investors always focus on the worst case. Anytime you buy an RV park, you should look at the worst case, the best case and the realistic case. The worst being what happens if nothing goes your way, the best case if everything goes your way, and the realistic if a few things go your way.
What the investor wants to know as their money will not be lost. So talk to them in that perspective. Sure, upside is great. But you don't have any mat money in the deal potentially. So all you're out if it goes badly, is your time and your dreams, but they're left holding the bag. So what they want to hear about is how do they get their capital back. Of course, they want to hear the good stuff too, because there's no reason to invest unless there's good stuff. But they want to hear about the bad stuff. Many people make the mistake of only wanting to talk about the good stuff, try to sell the sizzle but without talking in any way about what could happen if things went bad. It's a terrible plan. If you only talk good things, the investor will immediately realize perhaps you're a little too focused on the good, and that you're not trying to protect their investment on the bad and therefore they may pass on the deal.
Also, if you want investors you have must have a very, very fact filled package, something that has everything they would ever want to know, photos of the RV park, map of where it's located at, various budgets showing what you think it can do performance wise, both in a worst case and a realistic case and a best case scenario. If you press somebody with a deal, and you don't have all the material there, often they will decline not because they're not interested in the deal. But they're too embarrassed to say, "No, this package isn't complete." If you don't have a complete package, they're going to think, "Oh, this person is not very thorough. They're not really thinking through what could happen here. And therefore I don't want to entrust my money to them."
The most important thing you have to have in raising money is you have to believe in the deal. If you do not believe in the deal that you're trying to get someone to invest in, it's never going to happen. Because they are going to realize there's something wrong. If you don't send out the vibe, the body language, talk with enthusiasm, they're going to think, "Now wait a minute, what am I doing this for again? This person themselves doesn't even seem sold on it." Warren Buffett once said that enthusiasm equals energy, and without energy in a business, you have nothing. And that's very true. You have to be enthusiastic about what you're doing. You have to truly believe that this deal is exceptional, and a great option for the investor to make good money. If you don't think that, then move on to the next deal. Don't go out there trying to sell people on a deal that you yourself feel is average, that you yourself feel is not really worthy of the investors money. Because if that's true, then what you doing with it is you won't make any money unless it succeeds.
The bottom line to it all is just use good common sense. Be enthusiastic and always watch out for the investor. because again sometimes to make money you have to start with some money. This is Frank Rolfe, the RV Park Mastery Podcast. Hope you enjoyed this. Talk to you again soon