When I was working in Newport Beach, times were good! Actually, back in the middle of 2011, it was prime time to be investing in stocks and real estate. Panic was in the air, and little did most people know then that such a crazy bull run would ensue so shortly after.
Back in the Day
Everyone was concerned with Europe. Remember the whole Eurocrisis that was on the news just about everyday? I heard about it, but it didn’t really affect me because I wasn’t an investor in 2011. Yup, back in those days, I put all my savings into company stock and my good ol’ low-interest savings account. 🙂
Even though I wasn’t investing, I oftentimes overheard co-workers talking about refinancing their mortgages. I didn’t have a clue what they were talking about, but just kept hearing “interest rates are sooooo low right now”. Eventually, it stuck with me. So much that I knew I had to relocate back to the Bay Area and land a rental property. I didn’t want to miss this golden opportunity everyone was clamoring about.
All that talk amongst co-workers was just the kick in the pants I needed to get up and go do something about it! Beginning in May 2012, I was on the hunt for my first rental property. I lucked out, and was able to win something that cash flowed reasonably well in July. Feeling pretty good about winning, I continued saving my money like a maniac, and wanted another property. I rolled the dice on a short-sale property in November, and with lady luck on my side, I was able to close in February of 2013.
Up until early 2013, times were good to be an investor. Even in an expensive area like the Bay Area. Why? Properties still cash flowed! Even with vacancy and maintenance reserves factored in. Around mid-2013, the dynamic began to change… Drastically. Just like that, local prices were soaring upwards of 20%. By May, cash flowing properties were all but non-existent in the Bay Area.
I searched day and night trying to find something. Anything. Redfin. Zillow. Realtor. My agent. No luck at all. So, I then started looking outside the Bay. Naturally, I started to move inland, focusing on the Central Valley and Sacramento areas. Although cash flow still could be found in those areas, the numbers weren’t overwhelming.
Cash flow was only moderate, and the numbers were made much worse when I added in the 8-10% property management fee, which would be unavoidable since I wouldn’t be able to manage these properties from afar. Sure, everyone says they will drive up to Sacramento to fix a problem… but that’s a two hour drive in each direction. Do that enough times and you’ll be begging for a property manager.
“Too much risk, not enough reward” was my final answer. I needed a better cash flow market. So, I turned to Bigger Pockets forum and researched my way out of this problem. In the process, I learned about turnkey investing.
Maybe your story is similar? Maybe you also can’t find good deals in your local, expensive area? Maybe you should consider turnkey investing…
What is a Turnkey Property?
The term turnkey is starting to get thrown around like crazy in the real estate community. I guess 10 years ago, not many people or companies were doing this. These days, it seems like everyone is jumping into turnkey properties.
Without over-complicating, quite simply, a turnkey property is one that has been acquired, fully rehabbed, and rented out to a tenant prior to it being handed over (sold) to an investor. As a further selling point to the investor, the turnkey company typically also runs the property management (PM) that oversees the day-to-day operations of the property after you purchase it. The whole point of using a “turnkey” company is to make investing EASY for busy people.
The turnkey company is supposed to do all of the work for you. All you should have to worry about is collecting the cash flow each and every month. 🙂
A good turnkey company will guide you every step of the way. From the very beginning, they should present you with good information (sales flyers, proforma sheets, scope of work/pictures, etc.), testimonials, and be willing to answer all of your questions.
Once you decide to purchase, they will send you over a contract with all relevant fields filled out. There is no need for you to hire a real estate agent (although you might want to consider a real estate attorney). In most cases, if you are using financing, they will also set you up with their preferred local lender. So, you don’t need to find your own lender.
Or Do It Yourself
For instance, if you didn’t go the turnkey route, you would have to do the following yourself:
- Hire a real estate agent.
- Browse the MLS, or use other means to find a suitable property.
- Win the bid to purchase and close.
- Find a lender to work with (if financing).
- Rehab and repair.
- Advertise/list, perform background checks, tenant showings.
- Rent out.
- Manage the property yourself or hire a property manager.
What’s the Catch?
Turnkey companies provide a great (convenient) service to investors. So there must be a catch, right? Of course. With turnkeys, you should not expect to pay below market price. As a matter of fact, you should purchase one with the mindset that you are paying retail price for your property.
Turnkey companies make their money by “flipping” the property over to you, the investor. They start off by acquiring dirt cheap properties from the courthouse steps, or foreclosures. It’s typical for the turnkey company to also own the construction company that performs the rehab. Due to economy of scales, they are able to save on rehab costs, which further puts money into their pockets. They will only target properties that they can acquire for very cheap, and that will appraise for top dollar after rehab. In other words, the after repair value (ARV) of the property must have substantial upside. Otherwise, the margins wouldn’t work.
Even though these companies perform the rehab, don’t trust them completely. Always do your due diligence and make sure you hire an independent inspector to double check their work. Even if the turnkey seller has a great reputation and the pictures look magnificent, you still have too much to lose. An inspection typically only costs between $400 to $650… a very small price to pay to insure the rehab done is up to par. In my own experience, each inspection I’ve done has ALWAYS returned a minimum of 15 items that needed to be repaired/replaced.
Turnkey companies don’t operate in every market. You will typically only find these companies operating in markets where cash flow makes sense. This means that the rent to purchase price ratio is very high.
For example, a $95,000 home in Indianapolis that rents for $1075/month meets the 1% rule. Cash flow is good, and investors will be interested. A $600,000 home in Newport Beach that rents for $2200/month fails not only the 1% rule, but the 0.5% rule. This property would be cash flow negative and a terrible investment for a real estate investor. A turnkey market wouldn’t exist in such a market.
Turnkey companies can be found throughout the country. Here are some general markets I’ve seen:
- St. Louis
You used to see a few in Phoenix and Las Vegas. Those markets have started to dry up as property prices have continued to rise.
Why I Buy Turnkey
Here are the main reasons why I’m buying turnkey properties these days:
- Cash flow numbers for local deals no longer make sense. Returns are too low. The returns further out of my immediate radius (1 to 2 hour drive) still aren’t high enough to motivate me to purchase. The returns from out-of-state, through turnkeys, are much higher (15%+ cash-on-cash return).
- I work a full-time job and blog. I also enjoy my free time. I don’t want to add more workload and take on big projects out-of-state. Further, I don’t want to do the research to have to find the right: agent, contractor, repair man, property manager, etc. I seriously just want to leave all the work to the pros… I just want to collect paychecks. Speaking of pros, the turnkey sellers are the local experts. They know where the good neighborhoods are and how to buy right (you probably don’t have this expertise if you aren’t local… or don’t have the funds to buy all cash). Even though they are marking up the property and selling it to you at retail value, you also have to remember that most turnkeys are vertically integrated companies. They also own the construction teams… So, odds are great that if you tried to do it yourself (and don’t have the luxury of economies of scale or access to cheap labor), you wouldn’t be able to fix up the same property up to the same standards for much savings… even after factoring in the turnkey mark up. Would it be worth your while? If you are planning on scaling up to 10+ properties, perhaps. For one or two, no, I don’t think it’s worth the time and effort. Also remember, mistakes do happen, and they can be very EXPENSIVE!
- I’m a long-term buy and hold investor. Paying retail price in 2013, 2014 is no big deal to me. Especially if I’m able to get 15% return on my money. In 10, 15, 20, 30 years, the appreciation should make today’s price inconsequential. Further, the principal paydown will be significant. Lastly, the downpayment will have been returned many times over from the accumulation of cash flow.
- Diversification. I don’t want to own in just one real estate market. I want to diversify throughout the country.
- Quality property management. If I buy through a turnkey company, odds are much greater that they will provide me (and their other investors) a high quality PM than if I were to go looking for a PM myself. Turnkey companies have an incentive to do so! How else are they going to get repeat business? Or referrals? And I’m sure they don’t want to alienate all of their investors either. Turnkeys make the bulk of their money through the rehab. Their PM doesn’t exist to necessarily maximize revenue. They need a quality PM to keep clients happy. In fact, the quality turnkey companies won’t even accept outside properties into their PM. On the other hand, if you bought/rehabbed a property yourself, and then hired an independent PM, their agenda is different. The independent PM ONLY makes money when your property has issues. So, don’t be surprised if the independent PM nickel and dimes you…
Here’s how you would buy a turnkey property, step-by-step:
- Introduce yourself, or get introduced to the turnkey seller.
- Study up on the introduction information (packets, proforma spreadsheets, sales flyers, business background, etc.). Ask for testimonials and contact people who have worked with this seller in the past. Only if you get a good vibe should you proceed further. If this is your first purchase and you have no experience working with this turnkey seller, I would highly advise you make a trip out there to meet them in person, and to go on a property tour. Any reputable turnkey seller will provide this common courtesy. If they are too busy and don’t have the time to meet with you, cross them off the list and find someone else. Go out there and do your due diligence. Get a feel for the community, neighborhoods, turnkey team. Ask a lot of questions. Ask to see a lot of different properties that are in various stages of rehab (new acquisitions, half-way completed projects, finished products, etc.). If you have your eye on a particular property you are considering purchase, spend the most time at this address.
- When you are ready to take the plunge and buy, you will enter into contract with the seller. No need to find your own real estate agent. The contract will be provided to you, completely filled out, so all you have to do is sign the pages. If you aren’t completely comfortable with the laws of the state your are buying into, or the wording used in the contract, now is the time to hire a real estate attorney to double check everything for you. Do not wait to hire a real estate attorney too close to the closing deadline. If it’s too late in the game, they won’t be able to help you as much. Near the end, all parties (lender, seller) will be rushing to close the loan.
- Once you are in contract, it’s time to find a lender and inspector. This process can go in parallel. If you aren’t buying all cash, the easiest way to get lending is to use the turnkey’s preferred lenders. These lenders are familiar with the turnkey company and have closed many transactions with them. Closing should go relatively smoothly. It typically takes 30-45 days to close the loan from origination to final underwriter approval. The “rush” to close happens because lenders typically start a rate-lock at the time of application. Most rate-locks expire in 40-45 days. This isn’t a problem if interest rates are going down, but can be problematic if rates are going up (like in today’s market). Once the rate-lock expires, you need to pay extra costs (daily interest) to preserve your original, quoted interest rate. One strategy to get around this? Don’t start the rate-lock immediately. Wait another week or two after you’ve started the loan process.
- Inspection should be completed before the appraisal gets back to the lender. If so, you will be in good position to work with the seller to ensure all repair items get taken care of before closing. In fact, you should make closing contingent on inspection repairs being completed with the seller providing post-repair pictures as proof.
- Once inspection and inspection repairs are complete, the appraisal should be back from the lender. Appraisals shouldn’t be a problem, because the lender/seller should have all the processes in place and learned from past experiences. The right comps should be in place for the appraiser to use to justify the purchase price you are paying… If the purchase price appraises, you have cleared most of the major hurdles to closing. If the property doesn’t appraise, you will need to renegotiate with the seller and come up with a fair compromise. The final remaining hurdle is to clear underwriting, so make sure all your financial statements and cash reserves statements are up to date. You can use 401k and IRA retirement funds to count towards reserves… Once the file passes final underwriting, you should be clear to close. If the title company operates in your own location, you can stop in the branch to sign for yourself. Otherwise, you will need to use a mobile notary. The lender should help order a mobile notary, if that’s needed.
- Prior to signing the closing docs, the turnkey seller should have tenants in place, and the property should be ready to start generating immediate cash flow. You will need to ask the seller and make sure. However, some turnkey sellers do move more product than others, so this won’t always be possible. At the very minimum, the PM should be actively looking for tenants for you. If you aren’t comfortable with closing without having tenants in place, don’t sign.
- Once signing is complete, wire the money over (follow instructions provided by the title company) and you are all set! Congratulations, you have just purchased a turnkey property! Sit back, relax, celebrate, and get ready for some cash flow to come in! 🙂
Turnkey Seller and Turnkey Marketer
Know the difference! This is important. You want to make sure you are dealing with the direct turnkey seller. There are others out there who masquerade as turnkey sellers, but they really aren’t. These folks are turnkey marketers that don’t actually sell you anything. These marketing companies are just well connected to different turnkey sellers across the country. They claim to serve multiple regions, but all they are really doing is connecting you to different turnkey sellers.
Turnkey marketers are the middlemen… They match the investor up with the seller and earn a commission. Just make sure you know the difference… If you go through a marketer, know that you will have less leeway to negotiate a better deal for yourself since the seller will have less profit margin; they will have to pay the marketer a fair share for the referral…
What are your thoughts on turnkey companies? Love them, hate them? Would you rather do everything yourself?