A lot of people have been asking for an expose’ of the turnkey investing world, so and here it is. Remember, buying the property is only part of the battle, but efficient operation and systems are what make it work. So please subscribe for good times and stories with SimplePassiveCashflow.com!
Passive Versus Active Investing
Turnkey Investing Defined
Turnkey investing is a form of passive investing. The definition of turnkey (TK) investing at the very least is buying a property from a seller called the Turnkey Provider (TKP) that is rent ready. The TKP typically does a rehab of the major components (roof, floor, plumbing, electrical, paint with sturdy tenant grade materials, such as no carpet, no garbage disposals, laminate flooring. etc). The TKP may purchase these at a discount with a part of their company made up of wholesalers or auction buyers to buy the properties at a discount. Also, the TKP may have property management in-house to manage it for a fee after the sale is complete. The TKP may fill the property with a tenant prior to closing the sale – although this verifies the market rents, there is no safeguard that prevents the TKP to just sticking a warm body in there. A lot of buyers like the fact that the TKP is vertically integrated because if the property does not perform you know who to go after. I personally don’t see the advantage of having a vertically integrated TKP as a clear-cut benefit since it brings up the potential for conflicts of interest. For example, if the TKP has a property management side, the property management can cover up shortcomings in the rehab.
“Hey, property management Paul, why is my property getting these 100 dollar repairs like every month?”
“Well, I don’t know it was an excellent rehab (done by my company) so it must be that dang tenant again.” says Paul.
My opinion of “vertically integrated” is that they do everything but also suck at everything… Rather than having a jack of all trades, wouldn’t you want an ace at every position?
How Do I Buy?
In every market (say Birmingham) there are typically two TKPs who are perennial good outfits. And that third TKP seat is constantly being indicted by some sort of FBI investigation… I’m just being funny. But this is where things get tricky from an outsider’s perspective. Who are the good guys and who are the fly by night operations? Good question! My best answer is to use references of disinterested parties – which are different from the uninterested friends/family/negative Nancy’s/nervous Ned’s.
Out of this pain-point, a middle-man layer called the “marketers” have arisen. These are the guys who typically do not live in the local market (most likely California) but do a good job at finding most of the reputable sellers. The marketers put on Meet-ups, podcasts, webinars, troll BiggerPockets, and find buyers who are looking for real estate in their portfolio. The trouble is, they are not doing these services for free, and you as the buyer will pay for it via a markup to the property one way or another. But overall the system works well. The TKP (small company) is good at what they do and are able to focus on finding distressed property and rehabbing. The TKP utilizes the Marketer to sell the inventory and create a profitable business based on volume.
There are some very reputable TKPs out there, but the trouble is sometimes they have so much demand for their product they can charge their buyers (you) a premium price. Pair this with the marketers bringing in lazy money in the form of inexperienced investor itching to get into real estate creates a micro sellers market. Some TKPs have buyer queues where you wait for a property and you have a limited amount to time to buy it or it gets moved on (to the next sucker). These scarce sales tactics are not a place you want to be. Another trick is that a TKP may require you pay cash for a property which basically takes away your ability to do your due-diligence on the property. I always buy with an appraisal contingency and inspection contingency to protect myself. Some will offer guaranteed rents or warranties which are seemingly good but could also mean that the TKP is just buying a $500/year insurance policy so you buy their property and they plan on just using the outside insurance to pay your inevitable claim. I’m going to stop there before I scare folks too much, but these are some of the pitfalls of working directly with the TKP seller (after all Real Estate is their profession).
A lot of folks jump on BiggerPockets and search or post on “Turnkey” and they will get bombarded by vendors being super helpful. I don’t know about you but I have never gone to the bar and been given free beers by other helpful patrons. Well if that’s the feeling you’re getting when you networking on BiggerPockets, make sure you background check who you’re direct messaging with. How are they getting paid? The folks you want to listen to (yes actually have rentals) and merely want to help out another Bro. I’ve used a marketer before but I did not get any value and I will not do it again, especially since it is not hard to find all the reputable sellers with a little bit of digging.
I mentioned two ways to buy a TK (TKP and Marketer) that both have their pros and cons. A third hybrid method that I have employed is to work with a licensed agent that helps you source properties and find your own construction crews to rehab the property. I have mixed opinions about this because it is a bit more work (especially being remote) and the agent is typically ignorant to what components make a good rental. An agent can find you a property that is priced well, however, they will not have the knowledge that an experienced rehabber or TKP will have (sturdy tenant grade materials such as no carpet, no garbage disposals, laminate flooring). So it’s a bit more risk/reward in the end if that’s your cup of tea or should I say Simple Passive Cashflow Latte. What has worked for me is not going with a marketer (due to absurd markup), but using a combination of off-market agents that have a Fiduciary responsibility to represent me and also working directly with the TKP for the best pricing once I had the experience of purchasing 3-5 properties and overpaying along the way.
Why the heck doesn’t the TKP just hold on to the property for themselves?
As stated earlier, the TKP does what they do well. They have the teams and market knowledge to do this efficiently. They could hold on the property but they have chosen to make profits on the volume business since they make their money by managing their multiple crews, essentially they are running a business. If you find a good TKP hopefully you get to partake in some of these efficiencies. But don’t be entitled as a TK buyer. You are not doing any work and frankly you deserve the market rate.
Which class, property value range, would be best to put on the buying list?
This is ultimately up to your investing strategy and criteria. For me to tell you what is the best is irresponsible and against what I believe because you should understand the macro (not micro) concepts for yourself and make your own best individual strategy. With that disclaimer out of the way, I personally went (my strategy changes per my overall portfolio) after B/B+ properties that rented for at least $1000 per month and had at least 3 bed and 2 bath. Some things to think of when finding your strategy/criteria:
- Although I have full intention to hold on to these properties indefinitely for cashflow, recognize that things change and perhaps I might want to trade in 1 “goose that lays the golden egg” for 2 or 3 “geese that lay the golden egg” or 1 “big ass goose that yea you get the point”. To say “I’m making cashflow” is a fallacy… what do the numbers say on the bottom of the spreadsheet and compare the two situations you are evaluating. You should always be making moves to optimize your return assuming it warrants the transaction costs.
- I was using Fannie Mae loans which are those sweet government subsidized 30-year fixed loans. At the time of this writing (5/2016) the most one person can have is 10 to their name. Your plan might be to only get one or two homes and sail off into the sunset but your plan might change and you have to change your plan for the “if” in life. To acquire a conventional Fannie/Freddie non-owner occupied property requires 20-25% down payment. There are also lender costs which I typically estimate at $5000 +/- $1000. Parts of the lender costs are variable such as an origination loan (basically it’s their fee to have to deal with you and headaches you cause them) that is a certain percentage (~1%) of the final loan that changes from lender to lender so this is something you are comparing. Other parts of the lender costs are fixed costs such as inspection costs, credit reports, and appraisal fees. It is these fixed costs that are the same whether you buy a $40K property or a $140K property. This is one reason I personally went after a more expensive property.
- By buying 50K properties that rent for $800 you’re like “Hey that’s awesome that’s a 1.6+% Rent to Value Ratio”. But I suggest reading my article about the nuances of the RV Ratio and property classes.
- Remember the goal is to maximize the profit which is the rent minus expenses. Folks get wrapped around all these metrics but do not forget the goal.
- This is totally my strategy but please think for yourself: When I was getting started I went for the higher priced properties (Not the A properties cause there is no cashflow in those). I went for properties that rent for 1100 that I could get for 100K. I would say these were B+ properties (Note: do not take the seller’s definition). My strategy was to find low hassle properties that had better tenants and properties that I could easily liquidate because they were close to the median home. There is a bit contradiction here because yes they were safer in terms of tenant quality and exit strategy but the cashflow buffer was less so I had less ability to lower rents in a market downturn. Now that I have a stronger base in terms of teams, money, and knowledge I try to go for more C properties because I feel I have the experience and risk tolerance for it (although I stated that these could be safer in terms of the buffer in the cashflow).
I am selling my home for 600k, I want to invest out of state for cash flow 200/month cash each door?
Before you do anything make sure TK investing is for you don’t just jump in cause I like it. However, I think that your per door $200 assumption is in line. There is a difference if you are buying $60K properties or $120K properties but either way, I think you will be beating the averages of the stock market and that is why I do what I do.
This is how it is going to work if you choose to sell and do a 1031 exchange. First, you sell the home for $600k (~10% will go to commissions etc) so you are left with $540K. This is how much you have to acquire or there are tax penalties so if you are looking at $90K properties you are going to need to pick up 6 of them. Your cash in your 1031 will be $540k minus your remaining mortgage. You can bring cash out of pocket to make up any shortcomings. Check out this article for more info on some 1031 issues and strategies.
Other Passive Investing options (REITS & Crowdfunding):
Passive turnkey (TK) investing is a slow way to building long term wealth. My track record in the macro sense is to put down $30K to control a $100K property that rents for a tad over $1000 a month. From that $30K down, I create about $200-300 a month in cashflow or $3000 a year per property. If those of you at home are plotting the day when you leave your job and take over the world, 20 homes would get you about $60K in passive income a year (tax-free) which would require about $300k of down payments.
A lot of smart people dabble in REITs or Crowdfunding deals, but typically it is the operator taking most of the profits off the top. Ideally, if you have the ability to, you want to be in control and be the operator if the numbers make sense. REITs and Crowdfunding deals are just like stock/mutual funds- you do not own the hard asset, and you are at the mercy of the operator to run it like a business and not take business trips to Las Vegas “Conventions” as a business expense. Moreover, most of the time, you also miss out on the tax benefits, such as depreciation. Isn’t this the reason why you want out of the stock/mutual funds in the first place? Plus who the heck knows how Stocks are priced? As if that wasn’t enough, most crowdfunding platforms (at least for now) require that you be an accredited investor. Most of you starting out won’t qualify.
Here are a few of links with actual portfolio analysis of these Crowdfunding methods in action:
Why go through all this trouble of a rental?
As in the above Crowdfunding links, the returns range from 6-12%. These returns suck. I mean it’s good for an institutional investor or someone with a gazillion dollars, however, I look for cash-on-cash returns of ~10% and total gains, or IRR (Internal Rate of Return), of ~20-40% per year.
For my info on total gains see this article: How We Make Money with Real Estate & the Hidden Returns
Here are some questions I often receive from readers:
- Are you visiting these locations at any frequency and for the initial purchases, or are you able to have enough trust and working relationship with other professional resources at those locations?
- I’m interested in a few out of state markets while trying to better understand what acquisition and management options are realistic. Ideally, I’d prefer not to travel.
- Hey, can you help me get started? Can you give me your providers?
I could do that, but that would be doing you a huge disservice because you will not be properly educated. Use these people as your educators.
Here is what I would do:
Find at least 6-10 turnkey dealers via googling turnkey rentals. You can also look online at Bigger Pockets, as many, though not all, turnkey companies have a presence there. Call each and every one of them, and get a dialogue going. Then, ask them the following questions (but not all of them… don’t be a machine, build a relationship:
- Can you break down the structure of your company for me?
- Tell me how your process works from start to finish.
- What does “turnkey” mean with your company?
- Will there be a tenant in place before I close on the property?
- Can I use the financing to purchase the property?
- Do you own properties close to the one you’re selling to me?
- Is the home required to pass inspection and appraisal before I close?
- Can I hire my own appraiser before closing on the property?
- Do you use other companies to help you provide turnkey properties?
- What is your role in the sale of the turnkey properties?
- Who owns the homes?
- Who rehabs the homes?
- Am I expected to pay for the rehab?
- 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
- Who manages the properties after the sale?
- How long have you been in business for?
- Is their a warranty on the property after the sale?
- Can I see a scope of work with expenses for one of your rehabs?
- 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?
Why Screw Around with Rental Real Estate when I can just do REITS and those really cool crowdfunding sites? Because these REITs are middle men. Work directly!
The Biggest Kept Secret – Hidden Returns of Rental Real Estate
SPC Git Er’ Done Action Plan:
- Sit down, take 10 minutes, and create 60 day action plan.
- If you are a bit overwhelmed I made a simple Excel Gantt chart showing the steps to purchase a property with all the due diligent checklists. I’d like to share it, so take a screenshot of your itunes review and email me with your 60 day action plan and “Gantt Chart” in the subject line. [email protected]