The turnkey world was explained in this previous post. If you are going down this passive investing path, here are some questions to ask. This is not an interview, but simply a conversation starter. Use the salesman to educate yourself and exercise your BS-Detector. A lot of people ask me who the people to work with are. I am afraid for those who think like that because they will not go through this important education phase.
- Can you break down the structure of your company for me? (Let them explain)
- Tell me how your process works from start to finish? (Let them explain)
- What does “turnkey” mean with your company? (Let them explain)
- Do you own properties close to the one you’re selling to me? (Determine if you are working directly with the TKP or middleman)
- Will there be a tenant in place before I close on the property? (There are pros & cons)
- Can I use financing to purchase the property? What happens if my financing falls through? (Determine if you are potentially overpaying)
- Is the home required to pass inspection and appraisal before I close? (Determine if you are potentially overpaying)
- Can I hire my own appraiser before closing on the property? (Determine if you are potentially overpaying)
- Do you use other companies to help you provide turnkey properties? (Understand where their deal flow comes from)
- What is your role in the sale of the turnkey properties? (Get a sense of the size of their operation, are they the sales guy, rehab guy, or everything?)
- Who are the “boots on the ground” in these areas? (Are you talking to the actual guy who manages the crews or just their sales person who never leaves the office)
- Who owns the homes? (Understand where their deal flow comes from)
- Who rehabs the homes? (Clarification on the buying process)
- Am I expected to pay for the rehab? (Clarification on what you are buying)
- Who manages the properties after the sale?
- How long have you been in business for?
- Is there a warranty on the property after the sale? (Beware if they provide vacancy assurance or warranties on work. They sound good but the provider could just be covering their work with a 3rd party insurance company)
- Can I see a scope of work with expenses for one of your rehabs? (Check out markups and what is fixed)
- How many properties are generally in your inventory month by month? (The more properties means better economies of scale but can also mean more bloat and more competition from other buyers)
- What sets you apart from other turnkey companies?
- What are some mistakes you make when you started out, and how are you doing those things differently now?
- Do you invest? If so what?
SPC Git Er’ Done Action Plan:
- Make a list of Turnkey providers, markers, agents to have a conversation with.
- Send out emails to providers and schedule discussions.
- Get on the phone, learn, and exercise your BS-Detector.
- Email (Lane@simplepassivecashflow.com) me a screenshot of your iTunes review and I will send you the spreadsheet with some of the most popular Turnkey Providers to start your call list.
Why the heck are we talking about, a board game?
When people in the very final stages of their life were asked, “what they regretted,” the response that often came up was that they wished they ‘played’ more. (Also in the top responses was a regret of spending so much time at work) The point is, although we are making investments and working hard, we should not forget to ‘play’ or have fun. I had a friend that played hours of video game baseball. Other than the fact that nobody plays baseball on video games, I always gave him crap. Now a little wiser, I realize that he was right… it made him happy and that was important (Side note: I do not condone mindless World of Warcraft addictions). Read on for the second lesson from this board game.
For the past decade, one award-winning board game called “Settlers of Catan”, has built up a huge, cult-like following, garnering hundreds of 5-Star reviews on Amazon and played by normal people unlike the Magic Gathering Card game or Dungeons and Dragons. In other words, females play this game and guys, who could probably save their lives by throwing a football play it too. If you have not heard of this game then you probably have never heard of BiggerPockets.com and you live under a rock. The strategy-intensive game, is intended to last less than 45 minutes. During that time, players collect resources and use them to build roads, settlements, and cities on their way to victory.
Check out this well made 4 minute documentary on the game.
The board game presents players with many decisions that parallel those facing many experienced real estate investors. In Settlers of Catan, there are 5 resources which include sheep, lumber, ore, brick, and grain. In the beginning of the game, sheep and wood are sought after, whereas in the dramatic ending of the game, ore is needed to lock in a win. Side note – I actually have a t-shirt that says “Nobody wants your F-ing Sheep” because as a typical occurrence in every game there is always one unfortunate player who is lagging behind and still trying to peddle their surplus of sheep.
The life cycle of an investor starts with typical equity building with rentals that utilize leverage (sheep/wood) and progress to larger deals (brick/grain). As the investor reaches the second half of their progression and surpassed the “critical point” where they have amassed enough equity build-up to live off their “dividends,” the investor will look to convert their portfolio to a more cash flowing portfolio via de-leveraged rentals, private lending, or notes (ore in Settlers of Catan). This stage is often called the end-game strategy. So often I see newbie investors with low cashflow/low assets with shiny object syndrome and want to get into notes or land contracts because that happened to be what Guru seminar they attended.
So if you don’t care about this fricking game and skipped ahead to the conclusion here it is. Whatever path you take in investing keep the end in mind… the end game… the goal. Have a series of if/then exit strategies in mind with everything you invest in. A few examples:
- A lot of people talk to me and say that they are tired of investing for appreciation and want to go for 100% cashflow to hold on to indefinitely. Having a few years of experience I realize that nothing is forever and things happen. Those investments that you bought, might have gone up in value 20% and it makes sense to cash out or you find another investment that is so much sweeter. But at the time of purchase, you did not think of these potential decisions when you bought the low 40k homes or a duplex/triplex/quad that are inherently harder to sell to a retail buyer as your exit strategy. Perhaps buying a higher price single family home would have been a better way to go (forgoing optimum cashflow).
- You have that meeting with a lawyer who sells you on this elaborate corporate structure but it might be a bit overkill since your dreams of building a 50 home portfolio transitions to other investments.
- You waste your time and money creating a small network of contractors to serve as part-time staff to service your 3 duplexes in the area. However, now it looks like you should sell and you wasted all that sweat equity in creating that system.
- You heard about the wonders of the Self-Directed IRA from a local Real Estate meeting and rush out to make the conversion and deploy your cash into a Real Estate notes. Now you realize that you have lost your leveraging ability but more importantly you are unable to use your IRA as cash reserves to get Fannie Mae loans.
SPC Git Er’ Done Action Plan:
- Don’t let this article give you an excuse for analysis paralysis, but inspire you to find that mentor who can help. You will never know all there needs to know by yourself.
- If you have implemented your Real Estate plan and looking for something fun to do, go out and enjoy life and buy this game! (Help support the site buy via Amazon affiliate link)
Do not buy properties all cash. I don’t care even if you are in the endgame part of your strategy. The real risk in having so much equity in your properties. The real security is having cashflow.
Warning – Paradigm shift ahead! In the old Caste System people were split up in ranks to keep lower class people from rising up and keep those in power where they are whereas today, money/mindset is the real separator of the masses.
When I first got started in Real Estate investing I was lucky to have a good job and was able to skip right over the wholeselling/birddogging roles and go right into a buy and hold rentals with the conventional 20% down payment. Little did I know that I had just vaulted over about 80% of my local REIA members who had little money and not making any deals. To be in that 80% group was a terrible place not because of the endless books, seminars, training for the wholeselling/birddogging strategy but competition was fierce – imagine the start of a triathlon as the athletes jump into the first stage of competition -the swim, even the best athletes struggle to distance themselves from the pack as the pack pulls and sabotages those who try to distance themselves.
“Mindset of the best Performers”Continue reading
I’m going to take you back to high school math class for a moment. Remember the 4 Quadrants, they are labeled Quadrant 1 in the North East quadrant and Quadrant 2 in the North West…etc. The above graph only shows Quadrant I. To put it simply these markets in Quadrant 1, have median home Rent to Value ratios above 1% (a 100k property rents for more than 1000 per month – 1000/100,000=1%). These are the markets that investors like as cashflow investments because the income typically covers the mortgage and then some.
“The Real Cashflow Quadrant – Turn Key Rentals Heat Chart 4/2016”Continue reading
“We are almost paid off our property and cashflowing like crazy!” – an Unsofisticated investor
Don’t take it from me take it from a Forbes article – Three Financial Metrics Investors Must Monitor To Evaluate A Property’s Success
Download the worksheet to calculate the return on your deployable equity.
Wait I thought Seattle/San Francisco was a hot market with double-digit appreciation and an up and coming tech market?!? Return on Equity = Profit (Cashflow) / Total Deployable Equity if your sold (Don’t forget to include selling commissions)
“every month that goes by you are losing $300/month per $25k you have of deployable equity”
As a real estate investor or any investors consider your Return on Equity (ROE) as a means to evaluate the highest and best use for your capital and to be able to make adjustments to your portfolio over time.
The saying “buy and never sell” will work but “buy and evaluate your ROE prudently” will yield high returns and safer capital preservation.
There are many metrics that Investors use to quantify the quality of their investments. COC, ROI, ROE, are to name a few.
Cash on Cash Return on Investment (COC Return)
The pre-tax year-end cash flow divided by the actual amount of original investment you have invested.
COC is used to compare your investment with other options excluding factions such as the use of leverage (mortgage), taxes, appreciation over time, and mortgage paydown over time. As time goes along and your investment goes well due to your tenants paying their rent as they should and the home going up in value due to inflation and market appreciation, COC becomes less relevant.
For example, if you purchased a property with $22,500 down payment, $5,000 in closing expenses, and $2,500 for some touch-up paint and new carpet, you are all-in for an original investment of $30,000. If at the end of the first year with your rental property in operation that you are able to profit $10,000 from cash flow after all operational expenses and debt service were paid, your COC return would be $10,000/$30,000 or 33%.
Sophisticated investors compare COC with other investments to determine the highest and best use for their liquidity going into an investment whereas ROE is used once the investment is owned. COC for mutual fund and stock investments have been known to have been in the 8-10% COC range.
Annualized Return on Investment (Annualized Return)
Annualized return is used to evaluate an investment’s performance over time. Real estate is not a get rich scheme and many times if rehab is done to the property it will require a few years to complete the construction and stabilize the rents for the next buyer to feel comfortable and pay a higher price for the investment.
Annualized return takes into account the cash flow returns received during the hold of the property and the sale or refinances of a property that takes place at the exit. The annualized return is often used to compare syndications (private placements) with different business plans but similar lengths of ownership.
For example, if you received a 8% COC return for 5 years ($8,000 per year on a $100,000 investment for each of 5 years = $40,000). And then you exited the property via a sale at end of year 5 for a gain of $60,000. Your annualized return would be a total of $100,000/5-years or 20% a year. This is calculated with $40,000 in cash flow plus the $60,000 due to the general appreciation of the property.
Return on Equity (ROE)
One of the few downsides of real estate investing is that your investment is illiquid unless you sell or refinance the asset.
As you hold on to investments you are increasing you equity position over time via the following:
- Mortgage paydown
- General appreciation from the market
- Forced appreciation from any property improvements
Say you had a great investment kicking off 20% COC a year. Your return on equity shortly after purchase on a $100,000 home that you used $20,000 to acquire is making you $4,000 profit a year. In this case, your ROE would be 20% ($4,000 divided by $20,000).
But say a couple years go by and with a hot market the property is now worth $160,000. You return of equity on the $160,000 home that you used $20,000 to acquire is now making $5,000 profit a year. In this case, your ROE would be only 6.25% ($5,000 divided by $80,000). Note: This does not include mortgage paydown.
For the minor headaches rental property ownership brings 6.25% would not be worth it. I personally believe that when you ROE dips lower than 10-15% you need to look to make a change in your portfolio via 1) Cash out refinance, 2) 1031 exchange or, 3) simply selling the asset.
There is one intangle metric that we did not talk about here which is your Return on Time (ROT). I don’t believe this is an official term but something that is near and dear to Simple Passive Cashflow Followers. At some point, you need to transition from higher returns and higher headache investments to more scaleable investments where you investing passively.
After purchasing a couple rentals in the Seattle market and being the beneficiary of some nice appreciation, I evaluated the property’s performance with a ROE or Return of Equity metric. On of my rentals had appreciated all the way to $450k and my mortgage that I owned was $200k. Therefore, I had about 250K of “lazy” equity. If you kids are at home with you calculators that 250k goes in the denominator of the calculation. The numerator is the annual cash flow which was about $4K a year. Therefore my return on equity was less than 2%=4k/250k. Frankly, 2% is very poor compared to stocks (~8-10%) or properly leveraged Real Estate (~20-40%).
Calculate how lazy your current rental investments are with this spreadsheet: Link
Video: If your interested in seeing a A-Grade rental in Seattle that does not cashflow (poor cashflow investment)
I am sure someone somewhere is trying to invest in something similar and fooling themselves that they are making money on the project. But you are smart and you subscribe via RSS feed to this blog and podcast 😉
Long story short, I decided to sell these rentals to unleash this “lazy money” and get it working again with prudent leverage. This is what separates sophisticated investors who look at the numbers and your mom & pop investors who go by warm & fuzzy feelings of “hey I’m making cashflow, life is good”. Yes, Mom you are cashflowing but that is because you are halfway to 100% cash in the deal and you are taking on all that hassle and risk for a microscopic return.
A couple graphs for the engineers.
SPC GET ‘ER DONE PLAN:
- Arrange all your properties on a spreadsheet and calculate ROE, Cash on Cash Return, etc.
- Look for the “Lazy Money” to trade in for a better performing investment.