Real Estate 043: Turn-Key Properties, too good to be True?

What is a Turn-Key property?

There is no formal definition of "turn-key", and its meaning can differ from region to region, company to company. However, I can better explain this by sharing what I believe is a turn-key property and you can make  your own informed judgment.

To me, turn-key properties mean that they are generally older homes that have been restored and are considered "rent-ready" by you or the property management company. During the initial purchase of your turn-key property, you should receive a seller's disclosure and statement of work (SOW) from the seller informing you of the items that were replaced or serviced during the rehab.

Typically, if you have purchased a "turn-key" property from a legit provider, you should have received a property with little to no deferred maintenance (i.e. big ticket items that cost $1-5K or more such as roof, HVAC, hot water heater, furnace, etc. with useful life less than 5 years).

BENEFITS

As mentioned in my previous post, if you work with a TurnKey Company, you will eliminate 3 (acquisition, rehab, maintenance/management) of the 4 steps of the investment property process. These are very beneficial for people who do not have time to conduct the research, oversee the rehab, and manage their properties.

Acquisition: 
The TurnKey provider identifies the distressed property (REO, foreclosure, etc.) and purchases the property. They own the title. If they do not own the title, you are working with a middleman/marketer!

Rehab: 
The TurnKey provider will perform the rehab and replace CapEx items and make them "rent ready". Be very wary of "lip stick on a pig" where bad turnkeys will purchase a property, apply some paint, clean the floors, and sell them as "turnkey". These properties may look nice and show good returns on paper, but they will cause maintenance problems down the road and bleed you out slowly. Make sure you talk to other investors, ask for the Statement of Work (SOW) of what was replaced/seller disclosures, and ask about the warranties on the rehab (most places give 90 days, good turnkeys give up to 1 year).

The last thing you want is to buy a lipstick on a pig thinking you have great numbers and a beautiful property during year 1, only to find out that there are thousands of dollars worth of work needed in years 2-5 that will put you in the red.

Simple illustration (Bad Turnkey): if you have purchased a property for $100,000, downpayment and closing costs of $24,000 and rent is $1,100 (1.1% rent to value ratio), now take into account mortgage estimated $400, insurance $70, management $110, taxes $70, vacancy $88 and maintenance $88 for total expenses of $826. Your Gross rental income of $1,100 - total expenses $826 = $276 which is a 13.8% cash on cash - awesome, right? 

Not so fast. $276 a month will equate to $3,312/year, but a lipstick on a pig may result in replacement of the HVAC $5K, roof $5-10K, hot water heater $1.2K, furnace $3-5K. In addition to these major repairs, the $88 reserve/month for maintenance not be enough to cover  routine maintenance calls on plumbing, toilets, etc. if they were not properly reviewed/rehabbed from the beginning. Hope I didn't scare you as this is an extreme example and one to ensure that you do your due diligence before working with TurnKey providers.

Management/Maintenance: 
The Turnkey providers will typically charge 8-12% of the monthly rental income in fees as well as have other fees such as lease up fees (marketing/placing a new tenant), lease renewal fees, and other fees. In exchange for their fees, they provide services such as finding a tenant, periodic check up on your property, proper bookkeeping, and answering maintenance calls, to name a few. I feel that these services alone are well worth the fee. Its less headache for you and more time for you to enjoy doing things you love and spend time with loved ones.

Maintenance calls vary by property management company, as they may have an in-house handyman or outsourced contractor. They may charge only cost of the repair + markup, or cost + standard $40/hr (example). Typically, property managers will maintain a $500 reserve for each rental property and will approve repairs below this threshold, anything above this amount is communicated to you (owner) for approval of the repair.

DRAWBACKS

Now that we have covered some of the benefits of turn-key providers, let's dive into some of the cons of using a turn-key company.

1. You are paying market price: 
If you work with a turn-key provider, the fact is that you will be purchasing the property at market price (little to no equity). There is a saying that money is made in real estate when you buy (low) or sell (high). When you are buying at market value, you are technically going in knowing that your transaction costs alone will keep you from selling the property before 5 years at break even (exit plans are limited). You will need to hold the property for at least 10-15 years for you to break even (unless there is crazy market appreciation - this will not be true for linear markets in the midwest). However, not to fear, if you have analyzed the property carefully, it should cash flow, and that is what buy & hold investors, like myself care about.

You will notice that the appraisal of the property will come in at or slightly above purchase price. In situations where the appraisal comes in lower than the purchase price, I highly recommend you re-evaluate the deal to negotiate with the seller to reduce the price, or walk away/find another deal. There are simply too many deals for you to bring cash to the table to close, simply because the property is not appraising for the asking price.

2. Requires large capital: 
As mentioned in the previous post, there are many ways to obtain financing for your rental properties. The most common approach is conventional financing through a portfolio lender. Portfolio lenders are lenders who specialize in working with investors and offer conventional products such as the Freddie Mac/Fannie Mae loans. Portfolio lenders typically have rates 1% above the current interest rates that you may be able to obtain for your primary residence (i.e. 4.25% + 1% = 5.25%). However, these lenders are well versed in working with investors, turnkey companies, and market realtors and can provide guidance in financing your first 10 properties with Fannie Mae.

Note: your first 4 properties require 20% down payment, but properties 5-10 require 25% down payment. This is something you may want to think about when strategizing the purchase price of the first 4 homes. For example, if you buy low end homes at 50K for your first 4, its a 10K downpayment per home. However, if you planned to acquire homes in the 100-150K range, that could result in an additional 5-7.5K downpayment per property.

I believe that scaling your rental portfolio carefully and quickly is critical in your success. I like to use the Pareto principle/Law of Averages and assume that at any given time, 20% of my portfolio may losers and 80% may be winners. That is, 20% may have bad/trouble tenants, high turnover, maintenance, etc. However, if I am careful, the income from the other 8 (out of 10) should be more than enough to cover the issues found in the 2.

3. Lipstick on a pig: (sub-par rehab)

I hope this helps you understand the key pros and cons of using a turn-key company (I used one for my first rental). Some questions that you might want to ask yourself before choosing to go the turn-key route are:

• Does it make financial sense (rent to value, cash flow) to invest in my local market

• Do I have the right team and knowledge to do this on my own?

• Am I willing to manage my own property in a local market?

• How passive do I want to be (Note: Turn-Key does not mean its fully passive, however, a good turnkey company does mean you have the support of an experienced provider at your fingertips to provide guidance)

• What are my exit strategies? (Sell on MLS, sell to an investor, re-sell to a turn-key, owner finance sell to a tenant)

Whatever you decide to do, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Advisor before making any investment decision.  Work with people who have vested interest in your success! 

Good Luck!

Real Estate 042: Picking an Investment Strategy

Everyone is different. We come from different backgrounds, jobs, financial status, and most importantly, we have different goals. As mentioned previously, part of getting educated in real estate is clearly defining your goals and creating a strategy to achieve those goals. This is a very important step because a ship without a clear direction, is basically sailing towards nowhere. Note: As you continue to read books, network with investors, and listen to podcasts, your strategy, tolerance for risk, and method of execution may evolve, and that is perfectly fine.

There are a couple different strategies that I have seen that are used by investors on BiggerPockets and other successful real estate investors that you may have come across on Youtube or HGTV:

Wholesaling

There are many people who are getting educated on real estate but give lack of money as an excuse for not getting started. Brandon Turner, Co-Host of the BiggerPockets podcast, summed it up perfectly: "To succeed in real estate, you only need to have two of three things: Time, Money, or Knowledge." Wholesaling will require time and knowledge. Wholesaling real estate basically means placing a distressed (needs TLC or major rehab) property under contract and re-selling the property to another investor. You may have seen signs in your neighborhood that say "we buy homes, all cash". These are your wholesalers who typically purchase homes in cash, lines of credit, or other private funds. Wholesalers are not in the business of buying property, but to quickly re-sell them to investors for a profit (aka finders fee).  A good wholesaler will maintain an active buyers list and purchase homes that are in the buyer lists criteria and re-sell them prior to closing on the original contract. 

For example, let's say there is a house in Independence, MO that you put under contract for 30K. If the home has a repair budget of 25K and after repair value (ARV) of 80K, an investor may be willing to purchase the home for 35-40K. In this example, you would quickly sell the contract to the investor for 35-40K and profit 5-10K on this single transaction. Wholesaling is a great way to build your seed money if you are looking to expand into flipping properties or purchase buy and holds for rental income.

Flipping

Flipping real estate properties is a method of purchasing distressed properties (bankruptcy, foreclosure, REO), adding value through rehabs, and selling them for a retail profit. You may have been exposed to flipping on hit HGTV shows such as flip or flop, masters of flip, or brother vs brother. Normally, these investors purchase the properties from wholesalers, courthouse steps (foreclosures), or from banks for cash and "force appreciation" of the home through value add rehabs such as new kitchen, bath, backyard, rooms, paint, HVAC, etc. 

Using the example above, the flipper may purchase the distressed property for 35K and put in rehabs of 15K for an "all-in" cash of 50K into the project, and sell it for 80-90K (market value) for a 30-40K profit. This method is riskier than wholesaling and buy and hold due to the high usage of capital and the risk of properties not selling quickly in a downturn market.  Further, there is also a large risk of miscalculating the rehab costs that can quickly exceed the ARV, in which case the project is no longer profitable.

For example, the flipper buys the home for 35K with an estimated rehab of 15K. However, during construction, it is identified that the foundation needs work (10K), and HVAC needs to be replaced (5K) on top of the original estimate. Now the flipper has an addition 15K of unforseen costs for an all-in cash of 65K into the project. Their profit on this deal has now been cut in half.

Buy and Hold

This is my current strategy of working with real estate investments and if done correctly, this can be the most passive form to generate income and overall wealth. There are normally 5 different steps for this strategy, but you will notice that you don't have to be actively involved in all 5 steps. Like Tim Ferris emphasized in his book "4 hour workweek" you can outsource these steps, at a price, of course. Take a look below and decide the opportunity cost for yourself:

1. Pre-Approval/Financing: 
This is a key step in the real estate investing process. There are many ways to finance a deal: Savings (from W2, Wholesaling, Flipping), Private Loans, Syndications, Partnerships, FHA, or conventional financing (most common). If you are going the conventional financing route, it is important to be pre-approved with a lender who works with investors AND the market that you are investing in. Just because they are in that market, doesn't mean they have experience with the nuances with working with out-of-state investors, nor does working with investors mean they understand the market that becomes more important during the underwriting/appraisal process.

Pre approval is critical because as a buyer, you want to know your exact buying power, so that when you make an offer, the seller knows it is solid. You might wonder why the lender is asking for many documents such as tax returns, bank statements, etc. simply for a "pre-approval". However, this will eventually save you time in the back-end as these same docs will not have to be re-submitted.

2. Acquisition:  
You have many options when it comes to purchasing a property. You can find a realtor to represent you in the market you are analyzing (they have access to the MLS, and good realtors have built a network to obtain "off-market" deals, often at a discount), you can work with a "turn-key" company (more information below), or work directly with the owner/seller's agent to negotiate on sites such as Zillow, Redfin, Trulia, etc. I would highly recommend working with a buyer's agent as their commissions are paid by the seller and they can give you objective third party advice at no additional cost - more protection for you (note: some buyer's agent may have a broker's commision -  a fixed fee paid by the buyer, and other fees that will be disclosed to you prior to working together).

There are many subcategories to acquisitions: Neighborhood Class, Cash Flow, CapEx/Rehab, Cap Rate/Cash on Cash, Type of Property, Choosing a Market. I will discuss all of these in a separate post.

3. Rehab: 
Rehabbing might be fun for some, but a bag of worries for another investor. In my experience overseeing the rehab of my parent's primary residence, rehabs always tend to take longer than expected, and cost more than expected. If you are the type of person to loss sleep when you uncover unexpected costs or delays during a rehab, I would recommend you outsource this step to another party (i.e. TurnKey). However, if you want to build "sweat equity" and realize savings through your own rehabs or by using a licensed contractor, make sure you do your research and create an accurate budget with room (10-15%) for contingencies. Network with other investors in the local market from BiggerPockets, Real Estate Investor Association (REIA), or Facebook Groups and obtain recommendation for contractors with a solid track record and interview them thoroughly. I have heard too many horror stories on contractors running away with investor money, or providing pictures of rehabs of different houses, only to have the investor make a surprise visit and see that not everything was done as promised. I want to re-emphasize the importance of getting yourself educated so that you know how to ask the right questions and make judgments for yourself instead of relying solely on other people's advice. Remember, no one has your interests in mind like YOU.

4. Management/Maintenance: 
You will often hear that "investors live and die by their property manager". I think this is no doubt 100% true. The sales/acquisition/rehab/financing is only 5-10% of the overall picture. 90-95% of the time you will be working with the property manager to make sure that your investment is being properly tenanted and maintenances being performed.

You can manage your own properties if you are local, however, if you are investing out-of-state, this will be near impossible. Typically a property manager will request 8-12% of the monthly rental income. A couple key benefits for outsourcing property management is: 1) Not needing to respond to maintenance inquiries at all hours of the night/weekends 2) Not having to perform marketing for leases/screen tenants 3) Not having to perform timely bookkeeping/accounting records for tax purposes. I believe the 8-12% is well worth the above services. There are a ton of bad property managers, but there are good ones as well. Make sure you fully vet the property managers just as you would vet the realtor, turn-key company, or contractor. 

Final Thoughts

I will leave you with this final note. One of my favorite speakers/authors Tony Robbins said this: "The defining factor is not the lack of resources, it's your lack of resourcefulness that stops you from taking action" – Tony Robbins.

Whether you decide to wholesale, flip, or buy and hold, make sure that these strategies are aligned with your goals (building capital, or monthly cash flow). Please make sure you do your due diligence and talk to your CPA/Attorney/Financial Advisor before making any investment decision. 

Good Luck!

Real Estate 041: How do I get started?

Now that we have just discussed why I like real estate as an investment class, let's talk about how you can get started. First and foremost, I strongly believe its very important for you to get educated in the area you are investing in. I am not saying you need to be an expert in the field, however you should know the basics on real estate: finding a market, finding a team/networking (realtor, turn-key, property manager, wholesalers), defining your criteria/goals, analyzing a property, obtaining financing, just to name a few.

In this day and age, there are tons of resources where you can obtain this information. However, with the wealth of information, comes what is called "analysis paralysis". Investors have so much information at their fingertips, they second guess themselves at every turn, looking for the "perfect" deal, or go looking for gurus who can become their savior. There is no such thing as a perfect deal, and too many gurus who don't have your best interest at heart. The best way to learn is to read/listen to blogs, podcasts, and forums (just like you're doing now), connect with other investors and realtors who are active in the field, and then take action at the appropriate time.

My favorite resources to learn about real estate investing have been the following:

Forums/Networking: www.biggerpockets.com (FREE)

Biggerpockets is the largest community of real estate investors on the internet. With that network comes all the other professionals that you need to connect with to succeed. I have talked to over 10 investors from California who are active real estate investors (some have 2 properties, some have 10+), who share their knowledge of investing, common pitfalls, mistakes they have made, success stories, etc. They have truly helped me navigate through the "noise" and the "naysayers" and proceed with owning a rental property. In additional to investors, there are realtors, insurance agents, wholesalers, turnkey providers, property managers, and rehabbers who you can network with and form partnerships for projects down the road. Remember with any relationship, trust is built over time, so don't accept everything you hear/read in totality but use your judgment to make the right decisions for your situation. Remember to sign up for their free webinars every week that has a ton of great information for newbies.

Listening/On-the-go: podcasts (FREE)

Download any podcast app and search real estate investing, turnkey, passive investing, cash flow, rental properties and you will find a ton of shows. I would take a look at the reviews/subscribers just to see if they consistently put out material, are relevant (you don't want to invest in 2020 with information from 2006), and you enjoy listening to. Podcasts are great to soak in information when you are driving, exercising, multitasking on the web, etc.  In no particular order, below are my top rated podcasts:

1) Norada Real Estate - Passive Real Estate Investing

2) Keith Weinhold - Get Rich Education

3) Joe Fairless - Best Real Estate Investing Advice Ever

4) Michael Blank - Apartment Building Investing

5) Brandon Turner - Biggerpockets

6) Scott Trench - Biggerpockets Money

7) Matt Theriault - EPIC real estate investing

8) Rod Khleif - Lifetime Cashflow through Real Estate Investing

9) Matt Nusbaum - Corporate Investor Podcast

10) Dan Lane - Rental Income Podcast

Investor Mind-setting/Action Items: Books ($10-15/book)

I personally own over 30 business/self-help/real estate books and I think they provide a great framework for newbie investors to identify their goals, create a strategy, and devise and action plan to become a real estate investor. Real Estate books such as "ABCs of Real Estate Investing" Ken McElroy or "Millionaire Real Estate Investor" Gary Keller cover all the areas I have mentioned earlier such as finding a market, finding a team/networking, defining your criteria/goals, analyzing a property, and obtaining financing. It is really worth the $10-15 per book. Check out my “books” section of the blog for summaries and personal reviews of business/self-help books I have read over the years.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Advisor before making any investment decision. 

Good Luck!