Time for some fundamentals.

The Cents on the Dollar Test

As I indicated in Buying Marinas for 50 cents on the… dollar?, this is a risky way to justify an acquisition price.  It seems to be used almost universally by those few players interested in buying marinas in today’s mortgage-less marina financing environment.  Just the other day I ran into a counseling situation where someone offered to buy a marina for 64 cents on the dollar based on a 2007 appraisal.  Deals should not be based on this type of indication.  The operating history of the marina, it’s financial performance for the past year and your operating projections should be the basis for a purchase decision… not how much of a discount from the top of the market the property can be had for.  Of course, that’s assuming that the appraisal was accurate at that time.  I can say from experience having reviewed too many marina appraisals that few appraisers get the operating expense ratio correct and even fewer actually go to the market to get real cap rates.

Everyone’s Second Favorite Indicator – The Cap Rate

When you have an active market where cap rates can be extracted, you have the ability to apply some baseline comparison.  Realistically, when a marina goes dark it’s almost always during a recession, so the number of current sales are few and far between.  Liquidation and bankruptcy motivations abound making much of what does sell skeptical.  Still, the cap rate is another indicator I’ve seen used by investors for dark marina acquisitions.  Discussions are something like “buying it at a 10 percent cap rate based on my projections is a bargain”.  ‘Sorry to hear it.

There are several inherent problems with this:

• Once again, many investors look at the cap rate in comparison to what it was at the top of the market… just like they do the Cents on the Dollar test.  A 10 percent cap rate is better for the investor than the top-of-the-market 8 percent cap rate, for instance, but that doesn’t really help you determine that 10 percent is market.  Maybe it’s still too low.
• The cap rate is net operating income divided by market value.  In a dark marina there is little or no net operating income.  It has to be built up all over again.  If an investor’s projections show a “lease-up” to market levels in a year, that’s highly optimistic.  As a result, the cap rate is highly optimistic.  It’s like rolling the dice at the casino – how many times can you roll a 7?
• The market value part of the cap rate is usually imputed with the seller’s asking price.  Is that truly market?  I find that 9 times out of 10 it is above market, frequently by a substantial margin.  If it’s a bank repossession, the bank may be trying to minimize a loss and get a sale price that reflects the defaulted mortgage, which has nothing to do with market value.
• What will the operating expenses be like?  You may not have any history of this.  It’s easy to underestimate.
• What about start-up expenses?  Expect higher advertising at the very least.  How about your personal funds that need to be set aside to cover the negative cash flow you’ll experience (unless you paid all cash)?  It may be a marina, but ask yourself this question:  if you started some business today, would you need to cover negative cash flow for a year or more?  Absolutely.  And that answer applies to good markets as well.

ROI is Not a Toy!

Since you’ve quantified risk, it’s time to go back to return on investment (ROI).  I’ve noticed a trend during this “great recession” that affects your ROI projections.  Most people would think that sale prices would go down and the spread between asking and buying would decline.  Actually, the opposite is happening – the spread has gotten even greater!  Here’s why:

• Simple supply and demand works to raise ROI.  Fewer buyers and far more sellers means investors can pick those properties that return the highest ROIs.  It’s a buyer’s market in this respect.
• Marina owners don’t want to discount their marinas much from the peak of the market.  It seems like money lost right from their pocket.  They aren’t making any more waterfront land, right?  Sorry… doesn’t work in a recession.
• Banks want to recoup as much of their deficient mortgage as they can.  The lower the sale price, the more of a write down.  Someone has to take the heat for that.
• Marinas compete with other properties for funds.  If you’re going to buy a special purpose property, you’re going to need a higher ROI than a triple-net leased office building or shopping center.
• The management aspect alone should justify a higher ROI, although since many buyers view it as a lifestyle investment, ROI is too frequently put on the back burner.  Even in these circumstances, the higher the ROI, the more cash flow you will have and the easier it will be weather recessions.  The higher the ROI, the less money from your own pocket you will need to invest in the business and the more money you will be able to take out each year.  Make ROI your close friend, not the distant cousin you see every 20 years.

Let me ask you this – if you were to buy defunct XYZ company knowing that:

• You’ll have start-up expenses to pay out of your pocket;
• You’ll be investing tons of time in the business and can expect 70-80 hour work weeks;
• You’ll have to offer initially lower-than-market slip rates to get occupancy and;
• How much you were going to sell was a mystery…

Wouldn’t you want to buy it at a deep discount with a high ROI to justify risk?  A dark marina should be no exception.

The Grass is Always Greener on the Other Side

One thing I failed to mention is that no matter what you have to stay objective.  You need to be able to walk away.  The numbers have to work in your favor.  I’ll give you three very good reasons why.  First, our friend supply and demand.  You can always look for the next one.  With patience you’ll find what you want at the price and ROI you need.  Second, there is plenty of other real estate out there that is up for grabs in this soft economy.  Just about all of it will require far less management effort on your part.  Third, when you buy it, you won’t be able to get out of it so easily.  Marinas are seller financed at a higher percentage than regular commercial real estate because fewer lenders lend on them.  Again, supply and demand to the rescue.  You may have to carry a note on the place for a decade or more, so in this respect you may not be out of the deal for the longest time.

You don’t get a second chance to buy a property at the right price.