Turnkey Investing: Questions to Ask the Seller

by FI Fighter on March 12, 2014

in Real Estate Thoughts

turnkey

Out-of-state real estate investing is starting to catch fever. Due to a surging housing recovery, many investors are finding it difficult to locate good deals in their own local markets. This is especially true for anyone living in a high priced coastal region where cash flow has become quite literally impossible to find (using conventional 20% or 25% downpayment). If there is cash flow to be had, chances are the returns leave a lot to be desired.

It’s All About the Cash Flow

Let’s be real about this — If the cash-on-cash returns for an investment property are under 4%, is there really a point in buying a rental property? You can basically get a similar type of return in the stock market (and without all the headaches associated with landlording).

What about appreciation? In my mind, that’s a game of speculation, and one that can get you in trouble real fast. Without sufficient cash flow to cover you each month, all it takes is another market correction (or crash) to bring down your house of cards. This is how many people got burned in 2008. The downfall is always swift and brutal… and no one can accurately predict when the next one will be…

So, always plan for the worst. If a market crash were to happen, assume that your investment property will lose half of its value instantaneously. This means selling is completely out of the picture. Let’s say you also lose your job… In a doomsday scenario, the likelihood of your property losing half its value and you losing your day job simultaneously are much higher than you might guess.

If all this were to play out, could your investment property still support itself? If you are sufficiently cash flow positive (you buy right), the short answer would be “yes”. However, if you are cash flow negative, it would be impossible. Bottom line — If you can’t sell the house and you can’t rent it out for enough to cover all the monthly expenses (PITI), you are going to be in for a world of hurt.

When the Local Market Doesn’t Work

I started investing in out-of-state turnkey properties in July 2013 for cash flow. The local numbers didn’t make sense anymore so I needed to look elsewhere. I’ve since acquired three out-of-state rentals, and will look to expand more over the next two years. My immediate goal is to purchase one additional property for 2014.

Since I now have the experience, and relationships in place with certain vendors in specific markets (Indianapolis and Chicago), it makes the whole buying process a lot more straightforward. That is, I’ve already done my research, so I know who I can trust. If I want to purchase another property in those markets, I know how to do it. For this year, I’m looking to expand into Houston/Dallas. These markets are new for me, so again, I will have to repeat all the work (due diligence) that I performed when researching the other regions.

I’ve done the work before, so have a good idea of what to do. However, I do vividly remember when I was first starting out… I had a lot of questions, and had to learn many things on the fly. I realize that when you are first starting out, you may not know who you can trust out there. There are a lot of scam artists, so you must be extra cautious. It is EXTREMELY IMPORTANT to perform you due diligence and make sure you are working with the right people.

I’ve always scheduled a phone consultation with any prospective vendor, prior to me flying out there to perform even more due diligence. Here are a list of questions that you might want to consider asking a turnkey provider:

General Questions:

  • Please give me an overview of your company and operations. How long have you been in the business for? How long have you been a turnkey operation?
  • How many markets do you operate in? Does the company plan on expanding into other markets? (Allowing you as an investor to potentially diversify your portfolio with the same company, although this would mean trusting their due diligence in the new market.)
  • Is your company vertically integrated? Do you own the construction teams? How about the property management company?
  • How many properties do you acquire/rehab in a given month? How much business do you do annually?
  • What type of properties do you acquire? Single family homes, townhouses, condos, duplexes, triplexes, quads, etc.
  • What is the typical age of the home? Older? Newer construction?
  • How many investors (clients) do you have? How many are from out-of-state, or out-of-country? How many properties has your “typical” investor purchased from you?
  • Can you put me in touch with some of them? (Red flag if they aren’t willing to do this… A good turnkey company will have lots of happy clients who will gladly put in a good word for them.)
  • Where do you see this company in 5-10 years? Will you still be acquiring/rehabbing properties? Is there enough inventory out there, and do the numbers make financial sense for your company to keep doing this?
  • What happens if you stop acquiring/rehabbing properties? What are the ramifications for investors in such a scenario? Will the PM be able to support itself on its own? Will you sell the PM or disband it? Will you outsource your investor portfolio to a new company/PM?
  • Can I make a tour out there and visit the team? Can you take me on a property tour? (If they say “no”, or discourage you at all from doing this, that’s a clear sign you should NOT work with this company!)

Market Related Questions:

  • Tell me about your local market. Why should an investor invest in your city?
  • Is your city tenant friendly or landlord friendly? How difficult is it to evict a tenant? How long does it typically take?
  • What are typical rents and property prices your company targets?
  • How does your company come up with rent estimates?
  • Population and job growth? Is it happening, or is the city declining? Why?
  • If the population/jobs are increasing, what’s driving it?
  • What percentage of the population rents/owns?
  • What type of neighborhoods are you buying into? A, B, C, D, etc.
  • Tell me more about crime and crime rates. Do I need to be concerned?
  • Can you provide me a heat map of where you buy your properties? What are the things you look for?
  • What areas do you avoid? Why?
  • Tell me about the jobs and major industries in this city. Anything big on the horizon? (New football stadium, high-tech company moving in, etc.)

Tenant Related Questions:

  • What is the typical credit/background profile of your tenants?
  • What type of jobs do your typical tenants work? What is a typical salary?
  • How long does your typical tenant stay for?
  • Do you rent to Section 8, or low-income? Why or why not?
  • How much damage does a tenant typically do? When they move out, how much should it cost to get the place move-in-ready for the next tenant?
  • If a tenant destroys my property, do you press charges? Has this ever happened before?
  • What if a tenant sues me? How do you protect your owners? Have you ever been sued? How do you discourage this from happening? If it does happen, what are the next steps you take?
  • How many evictions have you had this past year? How often does it happen?

Property Management Questions:

  • How many properties are currently under management by your PM?
  • How staffed is your PM? Who will be my primary contact? How do I best reach/communicate with them?
  • What is your current occupancy/vacancy rate?
  • What is your historical occupancy/vacancy rate?
  • What is the PM fee each month? Will I get charged this fee if my property is vacant?
  • When is rent due? Is there a late fee you charge a tenant? How long is the grace period?
  • How do you screen/source tenants? In house, or do you outsource the work?
  • How long does it typically take to find a qualified tenant?
  • Is there a lease-up fee for sourcing a new tenant?
  • Is there a lease-renewal fee for retaining a tenant?
  • How long is the typical lease? Do you allow tenants to lease month-to-month once the initial lease is up?
  • How often do you raise rents typically?
  • Does your tenant give you a security deposit, or move in fee? Is it refundable?
  • If a tenant is delinquent, how long before you contact them? How do you enforce rent collection?
  • If a tenant is delinquent, how long before you start an eviction?

Rehab Questions:

  • How much do you acquire your properties for? (Sellers are having more difficulty hiding this information these days. A simple search on Google will oftentimes reveal all information about a particular property to the perspective buyer. Asking is just a way to double check seller’s integrity, or “word”. What they tell you shouldn’t be far off from reality…)
  • How much do you budget into the rehab?
  • Can I see a scope of work report and costs breakdown for a recent rehab? (Ask for several reports. Even ask about any properties you are considering purchasing.)
  • Do properties come furnished with appliances? (stove, fridge, washer/dryer, etc.) Is the owner responsible for maintenance?

Financing Questions:

  • Do you work with a preferred lender? If so, are they investor friendly? How many loans can I get?
  • What’s the typical downpayment I need?
  • Can I use my own local lender?
  • Have you run into appraisal problems before in the past? What happened? How do you get around it?
  • If we do run into an appraisal problem, what are the next steps?

Closing Questions:

  • Will I have tenants in place prior to closing? Will the property be cash flow ready from Day 1? If no, why not?
  • If my property needs additional repairs (outcome of independent inspection report), will you have them completed prior to closing? Will you provide me evidence (photos)?
  • Do you warranty your work? On which items? What happens if I run into maintenance problems over the first 6 months, 1 year?

More General/Technology Questions:

  • How does owner disbursement (payment) work? Do you send me a physical check, or do you ACH funds to my checking account? When are payments made out?
  • Do you have a web portal available for owners? How do I check my owner’s statement each month? How do I keep tabs on maintenance requests? Online?
  • Can I see a pro-forma statement? Sales flyer? Are there any hidden costs not accounted for? Are the property taxes accurate? Please verify and send me a link to county assessor’s website to confirm. What about HOA dues? Landscaping? Utilities (water, electric, gas)?
  • How passive will my investment be? What decisions do I have to make, if any?

Starting Point

Use the questions above as a template, or starting point when you first speak to the seller during your phone consultation. Also, it’s never too late to ask a question! If you hadn’t thought of any of the above before, feel free to ping the seller and ask them to clarify. More information doesn’t hurt.

When considering purchasing an out-of-state property, any good seller will realize that this is a HUGE financial decision you are making. You are taking a leap of faith and trusting someone else to manage your investment from many miles away. They need to understand and accommodate for this. You should never feel pressured, or pushed to have to sign ANYTHING, or buy IMMEDIATELY! Further, if the seller does not do an adequate job of answering ANY of your questions, walk away.

There are reputable sellers out there… Don’t waste your time on anyone who isn’t willing to give you the best service. When buying turnkey, you are paying a premium, after all. The seller makes their cut off the “flip” when they sell the property to you. If the seller buys strategically and has a good construction team in place, there is a good chance that you will be able to purchase at market value (the property will appraise to the purchase price so you don’t overpay). If the property doesn’t appraise, you also have the choice to walk away. It is a good idea to keep an appraisal contingency in place on any contract you sign.

Paying a premium might not seem very appealing to you… At this point, you might be asking, “why not just do it myself?” But remember, your time is also money. You could try and tackle an out-of-state rehab yourself, but would it be worth your while? Personally, I don’t see any appeal in trying to manage construction teams/contractors from afar. If you were to attempt this yourself, you probably don’t have the luxury of economies of scales. You would be paying full price to hire outside help . You would also be paying retail price for all materials… Also, don’t forget that you would have to eat the costs on any screw ups or major mistakes that happened along the way. On the surface, doing it yourself always appears cheaper… But like most things, the devil is in the details.

With that said, paying fair market value for a property is still NOT for everyone. Many investors won’t buy unless they feel like they are getting a deep discount. If you are resorting to turnkeys, it’s probably either because your own local market does not cash flow, or you want the convenience of owning a more passive investment.

However, paying a premium isn’t necessarily a bad thing… If you are getting a higher return on your money than you would locally, you still win. If the seller can make money on the flip, they win as well. This type of relationship can benefit both parties. Further, if the seller wants to sell you more properties, or have you refer someone else over, they have an incentive to take care of your investment. Their PMs should be focused on maximizing the investor experience (ROI), not on making money. If vertically integrated, the turnkey company already makes their money on the flip, so they don’t need to nickel and dime you more on the PM side of things.

Still, turnkey investing isn’t for everyone. If you are considering going this route, spend the necessary time needed to do your due diligence and only proceed if you feel comfortable. Investing in rental property isn’t trivial. It’s an important decision, so don’t rush into anything!

Best of luck, and happy hunting!

{ 10 comments… read them below or add one }

1 Income SurferNo Gravatar March 12, 2014 at 3:43 am

Great list of questions FI! If you want help putting together an ebook or seminar on this turnkey stuff, let me know. You have the experience and most of us don’t.

I feel the exact same way about cash flow vs appreciation you do. Although I’m not wild about Robert Kiyosaki, I definitely think he got that part right. It’s all about cash flow!
-Bryan

Reply

2 FI FighterNo Gravatar March 12, 2014 at 8:12 pm

Bryan,

Thanks! At some point, an ebook or even book on this whole journey might be worth considering. I appreciate the offer to help.

Yeah, I don’t agree with everything Kiyosaki says either, but he’s right on the money about buying assets as opposed to liabilities and focusing on the cash flow.

Take care!

Reply

3 Tom @ FinanceandFlipFlopsNo Gravatar March 12, 2014 at 8:01 am

Good questions FI, you know much more than I on this subject but two other questions came to mind:

1) Does the company plan on expanding into other markets? (allowing you as an investor to potentially diversify your portfolio with the same company, although this would mean trusting their due diligence in the new market)

2) Do they allow tenants to lease month-to-month once the initial lease is up?

Reply

4 BrandonNo Gravatar March 12, 2014 at 9:29 am

I really like that first question Tom, that would be an interesting one to receive responses to.

Reply

5 FI FighterNo Gravatar March 12, 2014 at 9:40 am

Thanks Tom! I’ve gone ahead and appended your good questions to the post.

Cheers!

Reply

6 BrandonNo Gravatar March 12, 2014 at 9:28 am

Fantastic information Jay! These are the sort of things I’ve been really wondering about lately.

Reply

7 FI FighterNo Gravatar March 12, 2014 at 8:12 pm

Brandon,

Thanks! Glad you found the post useful.

All the best!

Reply

8 No Nonsense LandlordNo Gravatar March 12, 2014 at 12:30 pm

Property management companies are a dime a dozen. Contractors are even easier to find. Real Estate agents are like flies at the dump. And I am a RE agent…

Ask the property management company what their eviction or turnover rate is. Out of 100 tenants, how many were evicted last year? Or how many new tenants did they have to get. Or how many tenants were non-renewed? What are their minimum tenant screening criteria in terms of income ratio, credit score and criminal history? Who does their tenant screening, if they do it themselves they are likely to skip important steps. They should use a company specializing in background checks.

Proper tenant screening, and knowing what to do with it, will make or break you. I don’t care what a cash flow on a building is; a bad tenant can take away the cash flow for several years. That is why many people swear off beig a landlord. If it was easy, everyone would be doing it.

If a property management company is good, evictions will be well less than 10%. Remember, a property manager makes the MOST, when you make the LEAST. They make money on every turn. If they could, they would turn a unit every month.

There are good deals in every market. Not necessarily in every neighborhood. And not every deal is a deal you can make money on. But there are deals for flipping within a few miles of you, guaranteed. There are deals for renting, if you are in a rental neighborhood. There are deals everywhere, if you know how to find them, and make them happen.

One of my first properties I made an offer on was listed at 385K. I told my realtor I could not find a number with a ‘3’ in front of it that would work. I made a 300K offer and lost to a $380K offer from a different investor. Do not be afraid of making offers, and do not be afraid of losing a deal.

On another, the property had an offer pending at $390K that could not close after several months. I came in with a $269K offer and closed in three and a half weeks. $121K less.

In a recent one, a homeowner was $80K underwater on a home built in 2005, near the peak of the housing market. A partner and I acquired the property and made $55K to split between us after only three months. The price was too high to rent, but a flip was the goal.

I will be writing in detail about these deals in my blog as time allows.

Reply

9 Done by FortyNo Gravatar March 12, 2014 at 4:35 pm

Pretty timely post, FI Fighter! We’re trying to copy your model quite a bit, so I appreciate you sharing the knowledge you’ve built up.

We’ll let you know how it goes!

Reply

10 FI FighterNo Gravatar March 12, 2014 at 8:14 pm

Done by Forty,

You bet! If this post can help you, or anyone else in any way, it will have been worth it.

Please keep me posted and best of luck!

Reply

Leave a Comment

 

{ 3 trackbacks }

Previous post:

Next post:

Copyright © 2012 FI Fighter