Turnkey Real Estate Investing Explained | PREI 004
Today’s episode discussed what “Turnkey Real Estate Investing” is and further defines what a turnkey real estate investment is. A good understanding of this is important to make smart investment decisions and help avoid common pitfalls and traps investors make when buying these types of properties.
We also discuss our 5-Point Success System to help you compare turnkey providers. Picking the right turnkey provider is not just about the property.
We’ll also provide some tips, advice and comments on due diligence, rent guarantees, unnecessary fees, and the “2% Rule”.
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Turnkey Real Estate Investing Explained
Welcome to Passive Real Estate Investing. If this is your first time here, we’re glad to have you. If this is not, then we’re glad to have you back. Today’s show is about turnkey real estate investing. This is a topic that’s near and dear to my heart because I’ve been involved with turnkey investments for about eleven and a half years now.
I started investing out of state in late 2003 and I’ve seen the good, the bad and the ugly. Back then, turnkey real estate investing wasn’t really a subject matter or term that was kicked around too much by real estate investors. People would talk about passive real estate investments, rent ready real estate investments, turnkey real estate investments. It was loosely defined and it was a general understanding of what turnkey meant. It wasn’t a topic that had that much attention.
It does today. In fact, it’s a hot topic. It’s gained great popularity over the last ten years, especially over the last three or four. Today, it sees a lot of interest and controversy in real estate forums as well as other venues like real estate clubs.
Why is this important? First of all, I want you to understand what turnkey real estate investing is as well as what a turnkey real estate property is. These are two different things as far as the way I look at it. I’m going to break that down for you today. You need to understand what it is and what it isn’t in order for you to make better decisions. That’s my second objective today, is to help you make smart decisions when it comes to passive real estate investments or turnkey real estate investments.
Let’s break it down into different definitions and get a good lay of the land and then we can connect all the dots. This will hopefully educate you to better understand this particular area of real estate investing. From there, I’ll give you five point system that we use to compare turnkey providers and turnkey companies. You can use the same system in order for you to look around and decide on who you want to work with and who’s the better choice for you to help you achieve your goals and your criteria.
Regardless of where you choose to invest, there are two opposite ends of the investing spectrum when it comes to your involvement and required resources. On the one end, you have the do it yourself model or the do it yourself investment style, what I call active real estate investing. This is essentially a business where you’re active involved, rolling up your sleeves, maybe getting your hands dirty.
Do it yourself real estate investing puts all the risk and responsibility squarely on your shoulders. Typically, that involves everything from sourcing the property, acquiring it, funding it, renovating it, maybe managing it, selling it and coordinating literally every step in the process. Of course, it’s not likely you’ll be involved in every single piece of that process by yourself, but you will be involved to some degree every step of the way. This is the most time consuming and often stressful option. But for some, it’s what they enjoy.
Do it yourself investing also requires the largest number of resources. It requires the greatest amount of time, experience, capital, that could be cash or financing, and of course contacts, such as realtors, property managers, contractors, inspectors, title companies, escrow companies, attorneys, mortgage brokers and lenders.
Often, not always, your total all in cost will be or should be lower than investing in turnkey properties. That’s because you’re taking on all the risk, putting up the capital and spending the extra time to search for, acquire and renovate those properties and then possibly managing them yourself or outsourcing that to a professional property management company. Do it yourself investing is ideally suited for those who like to buy and renovate their own properties. There are a few shades of grey within this category but it certainly is the most time intensive option out there.
On the other end of the spectrum, we have turnkey real estate investing. The word turnkey has been thrown around by real estate investors for many years without really having a formal definition of what it means. My company, Norada Real Estate Investments, was one of the first companies to start marketing the term and concept back in 2003 and 2004. We weren’t the first, but over the last few years, we’ve really seen many local sellers and competitors pop up using the term turnkey in their marketing.
What is turnkey investing? Turnkey investing or real estate investing is most often used to describe properties that are “rent ready” or tenant occupied. This is unfortunate and often misleading because it is a very narrow definition of the term.
Just because a property is rent ready or tenant occupied doesn’t mean that it is a turnkey investment by our definition. Often, there is little to no reference to the market, the neighborhood, the complete condition of the property, the tenant’s qualification or any property management. These are all very important considerations and factors that you must include in a truly turnkey investment.
Unfortunately, the word or the phrase rent ready has really been over used and it’s very nebulous. Almost any property can be rent ready if it’s habitable. That doesn’t necessarily mean it’s a turnkey investment, so be cautious about that.
Back in 2004, in an effort to raise the bar in this niche industry, we defined or maybe redefined what a turnkey real estate investment should be. This is our definition of turnkey investment property and it’s not necessarily everybody’s definition but it’s probably one of the most complete definitions that I’ve seen out there.
Let’s just compare those two concepts. Turnkey real estate investing is a strategy. It’s what you’re going to look for and where. It’s essentially acquiring done for you properties to add to your portfolio. Whereas turnkey real estate properties are the properties themselves and the criteria that makes up that property. Investing is the strategy whereas a turnkey real estate property, you’re talking about a specific property and everything that goes along with that.
Our definition of turnkey investment property is a property that is in a stable or growth market. You want to be in a metro area where you see jobs and job growth. Jobs are the heart of a vibrant growing economy. I’m referring to local markets, whether that’d be a city or a metro area. You want to see that trend at least flat but ideally growing because you want to see people moving into that market because of the jobs.
Which leads to the second criteria, and that is positive net migration. You want to see population growth. That positive growth leads to upward pressure or demand for housing. That housing could be sales and it could be rentals. Investors like yourself can provide that housing, that much needed housing for those people.
When you get to the neighborhoods, ideally you want to be in A grade or B grade neighborhoods. Your A grade neighborhoods are more of your premium type neighborhoods, the higher priced properties for the market but not upper end. You’ll typically find higher cash flows but lower rates of return with your A grade neighborhoods.
However, you’re going to find the sweet spot usually in your B class or B grade neighborhoods where you have your middle to middle lower income demographic. These are your bread and butter communities. They’re closer to your median or probably slightly below your median market value property as well as income.
You will find your best tenants are in your A and B grade neighborhoods. They’re going to be less transient. Although we have, on occasion, properties in your CC plus type neighborhoods that come and go through our network because our investors do want some of those. It’s not my first choice. I tend to stick to B class, B grade neighborhoods.
You want your properties to be cash flow positive, obviously. I rarely see break even properties in our network but you definitely want cash flow positive properties, especially if you’re fully leveraging them. In other words, you’re putting 20% down the minimum of conventional financing and financing the balance of it.
Ideally, those properties are leased or in the process of being leased. More often than not, we find properties are leased by the time our investors close escrow on those. However, I’d say over 50% of the properties that we see through our network are leased at the time they go under contract.
Of course, you want professional property management. This is critical. You live and die by your property manager. You have to have professional property management. This is a very big factor for us and we like to screen and vet the property managers we work with. They have a long history or a good history of property management so we pass that resource onto you. They’re really already tied to our properties.
Last but not least, a turnkey investment property is carefully selected with the renters in the mind. It’s what I call investment grade property. That’s important because you want your properties to lease up quickly and stay leased for a long term.
We quantify each of this in more detail internally but this should give you a good idea of what to expect and what to look for if you’re considering a turnkey investment for yourself. I want you to notice that according to this definition that I just laid out for you in outline format, you want to look beyond the property alone. You must consider the bigger picture of the properties, neighborhood and the market that it’s within because you just can’t pick up that property after you purchase it and move it somewhere else if you decide later that the neighborhood or the market it’s in doesn’t meet your criteria.
Let’s take a minute and look at a provider and a promoter. When we talk about a turnkey provider, we’re typically talking about a local company that is rooted within a particular market. They know the market, they operate their business in that market. They may be a builder, but more often than not, they’re a company that is acquiring distress properties, fixing those properties up. They’re creating a scope of work and bringing that property into like new condition. At least that’s what a good turnkey provider will do.
When you refer to a turnkey promoter, you’re referring to a company that is marketing properties for a turnkey provider. A lot of times, they work very closely hand in hand and they’re really synergistic. A promoter doesn’t technically own the properties that they’re selling, whereas a turnkey provider is the actual owner of those properties.
Does it make a difference whether you work with a provider or the promoter? Not necessarily and usually not. However, when you work with a promoter, for example my company, Norada Real Estate Investments, we are hybrid company. We do acquire and renovate some of our own properties. We are a provider but we are also a promoter.
The key advantage, and there are several, but the key advantage working with a good full service turnkey investment company as a promoter is that they can be completely unbiased. Our company, for example, will spend time with you on our first phone call or our first engagement with you to better understand what it is you’re trying to achieve, what your investment goals are, what your criteria is if you have one, and if you haven’t define that, we’ll help you put that together.
Knowing that, we can look at the different markets around the country that meet those investment goals and that criteria and help plug you into the right resources that we have, the various providers in the market as well as the different property management companies that we work with so you are working with the right people to meet your objectives.
You see, the challenge working with turnkey providers is that they are typically married to their market. They can only sell you the properties that they have, that are in that one market. They cannot be unbiased or agnostic. Whereas a company like Norada Real Investments, we can be completely market agnostic, and we are. That is one of the advantages of working with a nationwide provider of turnkey properties, is we can find out what your goals and your objectives are. That’s what we do in our first phone call with our clients.
Once we’ve defined what your goals and strategy is, then we can help direct you to the markets, neighborhoods and property providers within that market that will best meet your objectives. That is the main difference between a turnkey provider and a promoter. The promoter doesn’t own the properties but they’re typically involved with multiple markets, whereas a provider is local, on the ground and owns the property.
How do you go about comparing different turnkey providers and promoters? We call it our five point success system. It’s broken down like this. The first area is scope. Most turnkey property providers operate only in one market. We have a few operating in two or three, but a much smaller number of providers operate on a nationwide basis where they can offer you properties in any one of many markets.
This can be advantageous for you if those markets make sense because they can be best matched to meet your investment goals and criteria. A provider that operates in only one market may not be able to help you if their offerings don’t fit your needs.
The next area is service. What is their level of service? Most turnkey companies will only have an initial conversation with you to see if there’s a fit. What happens beyond that if there’s a key differentiator? Finding a company that takes a consultative approach, working with you to help you achieve your investment goals is important.
Too often, companies focus on getting the sale instead of building a long term advisory relationship with you. Some promoters that you meet or find online will actually just have an initial conversation with you. They really don’t provide too much value and then “throw you over the fence” to a provider that they work with in the local market and let them take over the sale from that point. This is really not providing you any service whatsoever. They’re really more of an affiliate than anything else.
The third area is what I call systems. Companies that can show you a simple proven system will help you succeed with minimal hassle and less risk than a newer company or one with few or no documented systems in place. Be sure to ask about the systems that they have in place. Is it documented? Do they have checklists? That’s going to be critical and it makes the process much smoother and hassle free.
The fourth area is support. It is common for turnkey companies to have business relationships with supporting service providers such as mortgage brokers to help them close more transactions. Ideally, you want to have an access to a large network of reputable support providers that help you with everything you need, such as property managers, mortgage brokers and lenders, home inspectors, contractors, title companies, etc. Be sure to ask what they can provide, what they can’t provide so you know what you’ll need outside of their service area or outside their network.
The fifth and final area of the five point success system is size. Larger turnkey companies will have more leverage and economies of scale, which often benefit you, the investor. With turnkey providers that leverage in economies of scale reduce their overall expenses and the cost of their materials because they can buy more in bulk. That savings is usually passed on to you because you’ll have a lower purchase price.
With turnkey promoters, that leverage and economies of scale comes with working with multiple providers in these local markets. There is a synergistic relationship where the promoter provides a lot of business to the local provider and that provider can pass those savings on and provide better and extended service to the clients from that promoter.
I want to leave you with some tips and advice when looking at turnkey real estate investing as a strategy and turnkey real estate investments as an option to build your real estate portfolio. First of all, be sure to do your due diligence. This is almost a given but it’s also surprising at how many investors actually shortcut, cut corners or skip over the due diligence process. This is dangerous and it increases your risk.
You want to verify everything. As part of our checklist and our system that we have with every investor that we work with, we give them literally, in writing, everything they need to do with and without our help to verify all the information and data that we’ve provided them.
We do verify that information, but as an extra layer of verification, we do have them go through everything in terms of verifying the numbers, the income and expenses, having a home inspection done to verify that everything on the scope of work has been completed. Nothing is left as a mystery. There is no rock left unturned. This becomes very clear as they go through this process, literally step by step and figuratively holding them by the hand. Due diligence is absolutely critical. Never skip the due diligence process.
If you’re picking up properties off the MLS of through a local real estate agent or a new source if you will, then this due diligence will uncover issues or red flags. That’s what you want. If you’re working with a reputable turnkey promoter or provider, that due diligence will just help verify what is already being advertised or marketed to you. As the old saying goes, trust but verify.
My next comment is about rent guarantees. I’m not a big fan of rent guarantees but at the same time I’m not opposed to them. We do have two providers in our network, one in Memphis and one in Houston, that do provide a rent guarantee today. It’s actually a good bonus or icing on the cake, but I certainly don’t rely on it nor is it really necessary.
In fact, I rarely see those rent guarantees being executed. In other words, the tenant is in place, they pay their rent, they stay there for a few years or longer. There’s never a need for the rent guarantee. Sometimes it’s provided and usually you can make the assumption that if you do see a rent guarantee, the cost of that rent guarantee is baked into the cake. In other words, it’s baked into the price of the property.
Not that it’s marked up unnecessarily, but it’s a conscious decision by the provider to budget for the potential or possibility of having to expense that rent in the future should that tenant vacate within the first twelve months of your acquisition of that property.
Years ago, about two years ago, my company, Norada Real Estate, provided a one year rent guarantee on every property that we offered. This really wasn’t our guarantee, it was a product by Lloyd’s of London. It was actually an insurance product that we paid the premium on for the client. They effectively had a free twelve month rent guarantee that we subsidized out of our own pocket. That lasted for about twelve months. They pulled the plug on that program and it no longer exists.
The bottom line with rent guarantees is if you buy right, in other words you buy properties in the right markets, in the right neighborhoods, in other words, the properties make sense the day you buy them, there really isn’t a need for a rent guarantee. It’s really more of a feel good product that is sometimes thrown in as part of the purchase to help ease the pain of people who have a fear of investing in properties.
The third item are fees. There’s really no need to be charged a fee if you’re working with a turnkey property promoter or provider. In other words, their services are typically value add and there’s no need to be charged a fee before, during or after that process.
I know with our company, we don’t charge a fee ever. We get compensated by our local market providers and that allows us to remain agnostic because we have the same compensation or same deal with every company that we work with. However, there are some turnkey companies out there that do charge a fee. Sometimes it’s upfront, sometimes it’s at the closing, but in both situations, it’s coming out of your pocket. I don’t see how that is necessary. In fact, I scratch my head and I wonder why they’re even charging that fee.
There’s also another type of fee that I’ve seen more recently and that is a fee that comes piggy backed on top of the property management fee. In other words, the local property management company is charging you their normal eight to ten percent monthly management fee. What you’ll see is you’ll see one to two percent tacked on top of that as a manager of the manager fee for being involved in the process on your behalf.
I see this as being ridiculous and completely unnecessary. My suggestion is you don’t need it, it’s unnecessary. There are many investors who actually manage their properties from long distance, from out of state, very successfully. I know many of them personally. I’ve done it myself. I’m not recommending that. One of my rules of successful real estate investing is to never manage the property yourself unless you have experience and you’re a professional manager yourself. But there is absolutely no need to pay extra on the property management fee.
Lastly, is this so called two percent rule. Don’t be blindsided by this two percent rule. What the two percent rule is, for those that don’t know what it means, is that your property, when you purchase it, will rent for about two percent of the purchase or acquisition price. In other words, if you bought $100,000 property and it is in like new condition, in other words a completely turnkey property, that property would be renting for two percent.
This is not only very unlikely and unrealistic, but you will be very hard pressed to find a property that is kicking off $2,000 a month on a $100,000 acquisition. That two percent is only realistic if you are an active real estate investor, as we explained in episode one. You are doing everything, from acquisition to renovation and managing it yourself. That’s when you can hit that two percent number.
I rarely see that happen in turnkey properties. Is it achievable? Sure. It is doable if you do all the work yourself. However, realistically, and you can verify this by looking at turnkey properties all around the country, if you’re investing in health markets, in good neighborhoods, more often than not, you will find that you’re going to rent your properties for about one percent of the acquisition price. That $100,000 property will rent for approximately $1,000 a month.
We do have properties within our network, for example in markets like Indianapolis and Kansas City, some of our properties in Memphis, some of our properties in Atlanta, that will have higher than a one percent rent to value ratio. We’ve seen them as high as 1.5%, which is outstanding in terms of a turnkey investment property in a healthy market.
The floor or the baseline, if you will, is one percent. When you see that two percent rule, realize that that is a truism for some active rehabbers, active real estate investors, those that are acquiring and rehabbing the properties themselves. Don’t be blindsided like that and don’t let that be your guide to filtering great quality investment properties that you can add to your portfolio just because they don’t meet that two percent rule. It is not realistic. Use one percent as your baseline and go from there.
Let me give you a quick example. We just posted a new property in Kansas City on Main Street. This three bedroom, two bath home is $130,000. It rents for $1,300 a month. Once you deduct all your expenses, you have a net operating income of just under $1,000 a month. The rent to value ratio as you’ll see here is one percent. It rents for $1,300 a month and the purchase price is $130,000.
What’s nice about this is it produces about 9.4% capitalization rate and a cash on cash return of 16.4%. That’s a fantastic rate of return. I don’t know where else you’re going to get a rate of return like that. Don’t try that in the stock market, you’ll probably not get it.
With a $26,000 down payment plus your closing costs, you can acquire a property like this that kicks off about $4,700, $4,800 a year in positive cash flow. That’s after your debt service, in other words, after an 80% loan, meaning that this property is fully leveraged. That’s about $400 a month. Again, a 16.4% cash on cash return. That is fantastic. That is actually a fairly typical investment property and rate of return because again, I look at that rent to value ratio of one percent.
I ran through these concepts, definitions and items fairly quickly but I wanted to give you a better understanding of what turnkey real estate investing is, what a turnkey real estate investment should be and how to compare various providers and properties so you can make better, more informed and smarter decisions in building your real estate portfolio.
In wrapping up, I want to encourage you to go to our website and submit a question or a topic suggestion. You can go to our website at PassiveRealEstateInvesting.com, submit your question or leave us a voicemail right there on the website. If you are listening to this podcast and you haven’t subscribed yet, please do so. Our content’s 100% free.
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