Not All Turnkey Rental Investments are Created Equal

Credit: freedigitalphotos.net

Credit: freedigitalphotos.net


I hesitate to use the word “turnkey” because there is no clear definition of what it means. Sometimes I refer to my real estate investment as a turnkey investment, but that isn’t exactly accurate. Generally, a turnkey property is defined as a house that has been fully renovated and is ready to be rented out. The company that sells this turnkey property usually also manages the property for the investor. The goal is for the management company to handle the day-to-day operations of the property, it takes a fee, and you, the investor gets to sit back and have the remainder of the rent sent to you. This is mostly true for my investment except the first part.

The Hybrid Turnkey Approach

The company I worked with first acted as my realtor in bidding on the foreclosure. Then it acted as a project manager in hiring and managing the contractors in making renovations to the property. The property I purchased ultimately appraised for about $10,000 above the purchase price plus the renovation costs. If you were to buy a pure turnkey investment property, the company would have purchased the property at a foreclosure or short sale, made the renovations, and then marketed the property to potential investors. The key difference is that I purchased the property at the distressed price, whereas an investor of a turnkey property will purchase at fair market value. The turnkey company is a business and needs to make a profit so that is understandable. And I am not saying that buying a rental property at fair market value is unwise, I would just prefer to have some more equity from the start.

I was talking to another newbie long distance rental property investor, just like I am, and he purchased a property for about $55,000, which rents for $850 a month. Sounds like a good deal, right? However, he mentioned that the property he eventually purchased did not appraise for the agreed upon purchase price. Apparently, this is not uncommon in some turnkey investment properties. Appraising a house is not an exact science. It can be pretty subjective. An appraiser will compare the property you are looking to get a loan for and compare it with similar houses that were sold near that property. Generally, a property’s condition is not taken into account so it can be unfair to compare a newly renovated turnkey investment property to a property which has not been renovated.

He said that he was able to negotiate the price lower which made it a “steal” of a deal in his eyes. (Sometimes the seller won’t budge and the investor will have to put a higher down payment to get the deal done) His opinion is that the bottom line is what the cash-on-cash returns are and what his net monthly cash flow each month will be. Granted, those are incredibly important factors but I think it is short-sighted to only look at the numbers and nothing else. And it is definitely what I looked at when I decided to make my investment. But one thing that is also important when making an investment is to have an exit strategy. What if you want to sell the property? Will there be demand by other investors or by those seeking to purchase it as their primary residence? Will you have to take a loss when you sell it? I don’t want to be overly critical of his investment because he might just be a steal of a deal. I just don’t want to take that risk.

Cash flow is #1 but appreciation potential also matters

When investing in rental real estate, cash flow is important. Living in NYC, I hear many people talk about investing in properties here, even though there will be negative cash flow each month. They assume that because of the high demand in NYC, there will be great appreciation and they can then sell it for a much higher price. I’m not going to lie, the appreciation that I’ve seen in some neighborhoods in NYC are pretty impressive. I’m not taking that risk though. What if there is another downturn in the housing market? Will you be able to sustain paying the mortgage, property tax, insurance and for the upkeep. Also, NYC is pretty tenant friendly, so what will happen if your tenant doesn’t pay rent and it takes a long time to evict them?

While I invest for cash flow because appreciation can sometimes be hard to predict, the appreciation potential of the property and the market is still important. The newbie investor I spoke to bought a property that doesn’t appear to be in the greatest of neighborhoods. The numbers will look great because the property is very cheap compared to the what it will rent for, but numbers aren’t everything. You might end up with a property that is hard to sell or that you’re forced to sell at a loss. You might be dealing with more headaches involving the tenants.

Generally, when investing, money is made on the purchase so I would prefer to buy a property at distressed sale prices and fix it up to “force” appreciation. Once again, I’m not saying not to pay market price for a turnkey property or that I wouldn’t do it. I just prefer this route if possible. If I feel a market has a lot of appreciation potential, I would be more likely to pay fair market value.

What do you look for when you’re investing in real estate?

24 thoughts on “Not All Turnkey Rental Investments are Created Equal

  1. Erik @ The Mastermind Within

    I was very lucky to buy my house and not have to do many repairs or upgrades. There were some minor things and it is an older house, but it was pretty much Turnkey.

    I look for houses which have repairs for under $10k. If it’s over $10k, it might not be worth my time or money at this point in my investing career.

    Thanks for sharing your experience. Have a good one :)
    Erik @ The Mastermind Within recently posted…The Mastermind Within Goals Check-in – February 2017My Profile

    Reply
    1. livingrichcheaply@gmail.com Post author

      Yea, I prefer not have to make a lot of repairs because there’s just a little more risk especially since I’m delegating the project management to someone out-of-state. However, with properties that need significant repairs, you can often pay for even lower prices so I guess there’s a trade off. Maybe when I gain more experience…

      Reply
  2. Amanda @ centsiblyrich

    Great post, Andrew! In addition to decent cash flow, we look at location, location, location! We typically only consider properties that need some renovations so we can have the equity and cash flow right from the start. That said, we only consider properties in locations that are growing/appreciating. Though it’s never guaranteed, I want to be able to have the option to sell without a loss, if needed.

    Reply
    1. livingrichcheaply@gmail.com Post author

      Yes, that is the first and most important rule of real estate…location, location, location! I’m with you in wanting to have equity from the start as well as areas that are growing and appreciating.

      Reply
  3. Michael

    Hi Andrew,

    The best opportunity to make money is when you purchase the property.

    However, if you are getting a property in very good condition from a turnkey provider at FMV, and it has good positive cash flow, that is a decent deal as well.

    –Michael

    Reply
    1. livingrichcheaply@gmail.com Post author

      I wouldn’t rule out buying a property at FMV with good cash flow in an appreciating market.

      Reply
  4. Done by Forty

    We definitely were buying at FMV with our turnkey properties, with an eye towards cashflow. Rough numbers were $90k for a SFH renting for $1125, and $82k for a SFH renting for $1000. The cashflow is nice but the expenses for repairs can be very, very spiky. It’s not the smooth 10% for repairs we were thinking it would be every month.

    These things can eat money, or at least ours can. Caveat emptor.
    Done by Forty recently posted…How Millennials Are Changing The Way We Handle MoneyMy Profile

    Reply
    1. livingrichcheaply@gmail.com Post author

      Yes, I think many newbie investors don’t experience these issues in the beginning and don’t take into account these expenses. The 10% for repairs is definitely not what I’ve experienced so far…hopefully they subside since some of the issues were kind of fluky. What kind of neighborhood did you invest in? B,C,D?

      Reply
  5. Mustard Seed Money

    Recently we were looking at some real estate and used the 1% rule to narrow down some properties. Nothing has quite fallen into our lap and we’re still looking for the right place but we’re re-evaluating to see if we need to be so rigid on the rule moving forward since the supply isn’t quite there. We’ll have to see but it’s a fun exercise in the meantime :)
    Mustard Seed Money recently posted…Are People Who Retire Early Selfish?My Profile

    Reply
    1. livingrichcheaply@gmail.com Post author

      The 1% rule is a great rule but I’d be okay if it was slightly under that if it’s in an area with potential appreciation. You’re in the DC area right?

      Reply
  6. DC @ Young Adult Money

    When it comes to real estate I like to think long-term, like decades and decades long-term. We bought our first house about four and a half years ago and have enjoyed renting the basement apartment and slowly making upgrades. I always have our long-term goal in mind when I make decisions: to rent out the entire house. Appreciation is important as well, but more so because it’s nice to have the option of selling a place and converting to cash if you really need to. But for me I like the idea of buying and holding “forever.”
    DC @ Young Adult Money recently posted…25 Ways to Make Money Off of WeddingsMy Profile

    Reply
    1. livingrichcheaply@gmail.com Post author

      Yea, I’m in it for the long-term too but since I was buying out of state, I needed to make sure I had a decent exit strategy. My thinking would be different if I was buying near where I live or if I was renting out a portion of my primary residence.

      Reply
  7. Primal Prosperity

    When I’m buying property, I look for a minimum of 15% ROI, but I prefer more into the mid-20% range. You use the word ‘turnkey’, but what I like to emphasize to people is that it is not passive and it needs to be treated as a business and so it is not worth my time and the hassle factor for too low of an ROI, in my opinion. Now, I do want to clarify that it is residual income, and a large return on my time, but I just personally think ‘passive’ gives people the wrong idea and they may take on more than they can handle.
    Primal Prosperity recently posted…How to Make $1,000 per Hour and a Better WorldMy Profile

    Reply
    1. livingrichcheaply@gmail.com Post author

      Good points. Real estate investing will never be like stock investing. However, with a good property manager, it’s been much more manageable.

      Reply
    1. livingrichcheaply@gmail.com Post author

      Yea, I don’t think I’d take on the projects myself as I don’t have that skillset. I had someone manage the contractors who made the renovations.

      Reply
  8. Kelly

    Aside from location, I gotta consider my needs especially those of my family. This is real estate, and when it comes to this, it should be for long term. One requirement is that one should do his homework to prepare for the biggest decision whether it is right to invest in one property or not.
    Kelly recently posted…Stay relevant by keeping your skills up-to-dateMy Profile

    Reply
    1. livingrichcheaply@gmail.com Post author

      Yes, that’s definitely important if you’re purchasing a primary residence. Not as much for an investment.

      Reply
  9. Jonathan

    Owning any properties is an investment. It’s a wise decision to purchase a property. If you aren’t going to live in it, you can lease and sell it down the road. Thanks for some food for thought! 

    Reply
  10. EL @ moneywatch101

    Real estate can be tricky in how you view it. Positive Cash flow is good in the short term. The illiquidity of it and the process to close is disheartening to many rookie investors. Good luck and many should just stick to buying REITs.
    EL @ moneywatch101 recently posted…The 6 Steps to FreedomMy Profile

    Reply
    1. livingrichcheaply@gmail.com Post author

      REITs are definitely a lot easier to invest in but lack some of the benefits of real estate investing like the use of leverage and tax benefits.

      Reply
  11. Passive Income M.D.

    Great post! I try to diversify my real estate holdings and am not afraid to mix class, location, cash flow, and appreciation potential. I’ve never used a classic turnkey company (although I’ve talked to many), however when I did buy an out of state investment property, I did use a company just like the one you used. Maybe we used the same one ha. I guess I like the transparent pricing of buying it first on the market and putting my own work in. I’m also trying to make it while living in a high COL area, best of luck!
    Passive Income M.D. recently posted…The 10 Best Real Estate Investing Blogs for DoctorsMy Profile

    Reply
    1. livingrichcheaply@gmail.com Post author

      I feel the same way about the classic turnkey company. I think I would have used them but the hybrid approach sounded much better. Good luck to you too!

      Reply

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