How Due Diligence can protect your asset
When buying anything, the seller usually portrays the typical Instagram worthy depiction of the product. The same applies to commercial real estate and in our case, RV parks. We can easily get excited about buying a park whose website shows pictures of a gorgeous pool, the sunrise over the mountains, and guests drinking coffee next to their million-dollar RV. When in reality the pool can be more of a wading pond, the mountain may be a pile of gravel in the back, and the guests in the beautiful RV may be bogged down in the mud not pictured under the camper. Now, this actually sounds like the perfect park for us to buy…as long as we know what we are getting into and expectations are set in the pro forma from day one. Mitigating surprises and unforeseen costs on the front end is crucial to our decision making process and eventually the bottom line of any investment. Due diligence can make or break any deal and is a crucial part of our RV park buying process.
The acquisition of a commercial real estate asset requires an extensive process to flush out all pertinent information about a deal. Protecting our investors’ capital is our top priority and the due diligence period gives us an in-depth look at whether we need to pursue a deal or walk away.
What is Due Diligence and Is it Different for RV Parks?
Due diligence, according to the Oxford Language Dictionary, is all reasonable steps taken by a person in order to satisfy a legal requirement, especially in buying or selling something. When it comes to RV parks, we have become experienced risk managers and have a thorough list of items to look out for. Gained through years of looking at RV parks around the US, our diligence looks a bit different than other asset classes. Typical DD periods last anywhere from 30-60 days. RV parks require a bit more diligence than other asset classes when assessing the ease of access to the park, road conditions, and the parks’ proximity to highways and amenities.
Due Diligence Priorities
While nowhere near an exhaustive list, the below are some key indicators to examine when purchasing an RV park and can protect Climb Capital as buyers and in turn our investors returns:
• Road conditions
• Availability of Amenities
• Capital and operating expenditures and budget constraints
• Discussion with current owners and management
• Personal walk through and site inspections
• Verifying # and condition of sites
• Inventory assessment
• Conducting a market analysis: IS the park in a business corridor, how will the town help/hinder the property and its value
• Researching competition and demand for your park
Factors we can not control:
• Existing zoning regulations and restrictions
• Encroachment issues and title concerns
• Proximity of park to the highway and ease of access
• Potential liens on the property
• Tax Assessments
• Insurance Costs
• Debt service and financial institutional requirements
• Surveys and environmental assessments
• Detailed rent roll, T12, and P&L statements
• Potential future development constraints/legalities
• 3rd party inspections (electrical, plumbing, sewer etc.)
So what does this look like in an active deal?
Now that you know some of the big things to look for, how does this actually translate to an active deal in underwriting? One of our recent deals had us pretty excited. The numbers looked good on paper, the pictures on the website painted the pretty Insta-worthy experience, and the park amenities seemed extensive. Since we are owners and operators, the CEO of Climb Capital and his family loaded up their Class A RV and drove out cross country (in a snowstorm) to get a first hand account of the park. Conducting site visits to an RV park while staying in said park brings a whole new level of depth of understanding to any deal and is just one of the ways we add value to our investors.
Upon arrival at the park, it was initially noted that the pictures didn’t quite depict what was represented on the website. This is generally something we can overcome with some perception upgrades, so this was not necessarily a deal breaker. Aesthetics are easily overcome in most cases. However, a few days before heading to this park, our tax professional ran an after sale tax impact analysis that projected a 300% increase per year over the rate the current owners were paying. Again, something that can be overcome by lowering the purchase price and raising rates to keep the deal on track. Once settled in at the park, we hit the ground running and did a complete walkthrough and inspections of everything from the electrical boxes, park layout, and site counts, to the outbuildings and amenities.
After sitting down with the current owners of the park, we discovered that they had just recently raised their monthly rates for new arrivals, not an overall rate increase for everyone already on a monthly lease at the park. When we went under contract for this particular deal, we were under the impression that all rates had been increased to $550/month versus the $500 monthly rate grandfathered to long term tenants. Our proforma had computed rates at $650 a month at year two of operations and a rate hike this high so soon after taking ownership did not seem plausible. This automatically affected net operating income greatly, another red flag. Being able to generate additional income from day one when purchasing an RV park is crucial to the making of a good deal. Most often this is achieved through lot rent increases for all tenants, whether long term or short term, in a park. If rate increases aren’t attainable due to the market, the location of the park, or low labor force requirements, the net operating income can be reduced too drastically for the deal to make sense.
The more we dug into this deal, the harder it was to make our underwriting make sense as a responsible investment. Upon site inspections at the park, we realized our initial capital expenditure budget needed to be increased. Most of the amenities needed an upgrade. The pool was small and in need of repair and expansion, landscaping and park clean up were in order, and an outdated and small bathhouse needed revamping. Part of our due diligence process is always to check out comparable parks and do a tour of the surrounding area that is supporting the park and drawing in customers. This particular town was experiencing an economic downturn. Buildings were boarded up, businesses closed, and a general failure to thrive in the surrounding city. Without much commerce driving consumers to this region, we were hesitant to jump all in without a booming economy or industry to back us up. For this deal, too many red flags made us ultimately back out of the contract. Many variables could have helped make this deal a sure bet. If the sellers could have met us halfway and lowered the purchase price there would have still been a bit of proverbial meat on the bone. However, the sellers wouldn’t budge on the purchase price and that coupled with the huge tax burden increase and the additional capex required to turn this park into something we could confidently add to our portfolio killed this deal for us.
Due Diligence Saved Us
We have learned some things the hard way, and we have also learned to do things the right way. By conducting thorough due diligence on this property, we saved ourselves and more importantly our investors, from a deal with very little margin and a lot of financial hardships. Had we not walked the property, stayed there and seen it for ourselves, consulted tax professionals, and had important rate discussions with the current owners, we would likely have seen very small returns on this investment. Being able to look at a deal from every angle saved us and our reputation for buying quality parks with high rates of returns. Too many variables we couldn’t change on this deal made it hard to overcome the things we could. The value to Climb Capital lies in being able to turn a good park into an incredible park. The due diligence process ensures we have no big surprises after closing, and that’s something you can take to the bank.