People think that when turnkeys are advertised as “hands-off,” it means they have to do nothing. Then, inevitably, when something goes wrong, the investor is irritated because things are getting handled.
Well, I hate to break your cookie jar and spill cookies everywhere, but turnkeys aren’t fully hands-off!
Turnkeys do, however, take care of a lot of the work for you. You don’t have to spend time focusing on more advanced skill sets such as rehabbing, negotiating, or direct landlording. You also are likely working with experts so you are able to get a lot of built-in expertise with your property as well, which can be especially advantageous for newer investors.
But then some questions arise—how do you know if the turnkey folks you are working with are legit? How do you know if they really are experts? Can you buy a bad turnkey? Are you getting scammed? Is the property getting taken care of as it should?
This is where your job as a turnkey investor starts—with knowing how to answer these questions and then knowing what to do with the answers.
I believe there are three stages of a turnkey investment purchase, and each of these stages requires a certain level of effort on your part to ensure they are leading you towards a successful investment.
The three stages are:
- Choosing your turnkey provider.
- Conducting due diligence.
- Owning the property.
For each stage, I’m going to list out what I believe are the things you need to educate yourself on to be a successful turnkey investor. Some of the things are just education-based, but other things may require you to actually do certain things.
Choosing Your Turnkey Provider
Before you ever select a property or sign a contract, there are some things you need to know. Prerequisites, if you will.
These two things are:
While most turnkey providers sell properties with cash flow, since cash flow is the primary focus of turnkeys, you still need to be familiar with what you are looking at in terms of the numbers as you start shopping. You’ll want to be able to identify the accuracy of the numbers any turnkey provider is offering. For example, I think it’s a red flag if anyone doesn’t include maintenance and vacancy estimates in their projections because both of those things are unavoidable if you own any kind of rental property. Another red flag, to me, is when a turnkey provider offers appreciation projections. While this can give a decent idea as to potential income along the way and help paint a picture of the income benefits of a rental property, I think these numbers can be distracting from the numbers that really matter. Anyone can throw in some fancy appreciation (i.e. speculation) and make an otherwise bad cash flow look promising.
You need to understand numbers so you can know what you are looking for, what you want to see, and what you should and shouldn’t consider in terms of the numbers.
Most often, turnkey providers will show you the net cash flow on a property (without financing) and the calculated Cap Rate based on that. If you are financing, then you would want to calculate the cash-on-cash return with that financing taken into account.
Understanding the market in which you are buying is critical to sustain the numbers you so diligently calculated. It doesn’t matter how fancy of equations you use in calculating the cash flow or how great the numbers look—if the market you buy in can’t support those numbers, you’ll never actually see those returns.
With markets, as with most things, it’s all about risk. You can buy an insanely profitable property in a tanked market, but your chances of doing well continue to decrease the worse the market gets. On the flip side, you can end up with horrible tenants that cost you a fortune in a fantastic market, but the better the market, the better your chances of not experiencing the bad tenant conundrum or other issues that can demolish your numbers. So nothing is guaranteed on other side, but your chances of sustaining your numbers get better the better the market is you are investing in.
The reality is, in my experience with turnkeys, not all providers are in what I would consider to be solid growth markets. I’ve known turnkey providers to sell hundreds of properties in what I consider to be declining markets. It’s not to say they are trying to deceive you or that they don’t run a good business, but it is up to you to understand the market in which you are choosing to buy and the market fundamentals that are associated with that market so that you understand any pertinent risks.
Once you understand the basics of running numbers on rental properties, then you can go ahead and move forward on interviewing or researching different turnkey providers and then ultimately select which one you want to go with. If you don’t learn numbers and market fundamentals, though, you won’t have much of a basis to differentiate between all of the turnkey providers who advertise their products to you.
One of the keys of being a real estate investor is to have enough knowledge so that you can decipher between everything being offered to you—hence, this “prerequisite” knowledge that I believe every turnkey investor needs before diving into any properties.
Conducting Due Diligence
You also need to have enough knowledge so that you can verify things about the property being sold to you. I often argue that it doesn’t even matter which turnkey provider you work with, as long as everything about the property checks out. Now, typically a bad turnkey provider will offer you a bad property, but technically nothing about the provider themselves matters if the property checks out.
With that said, how do you check out a property?
This is where due diligence comes in. Due diligence on your prospective property isn’t the first time you’ll performed done due diligence—remember that numbers and market analysis talk? Learning all of those things and comparing that knowledge to what is being offered is a really a version of doing due diligence as well.
But now it’s time to do due diligence on your property, rather than the theories or bases for decisions.
The three most important things to do during your due diligence period before you close on the property are:
- Get a property inspection. The actual condition of the property is critical. If you buy a property with some lingering large ticket maintenance item, your cash flow could tank in a heartbeat come time to fix that thing. A turnkey should be fully rehabbed or redeveloped, so you want to confirm that is really the case so you don’t end up with any unexpected large out-of-pocket costs. Keep in mind, the inspection will come back with a fairly significant laundry list of things that need to still be fixed on it, but that’s OK because that’s what you use as the punch list to demand that the turnkey provider fix before you close.
- Interview the property managers. People often assume that the property managers who come with a turnkey should be completely up to par. That’s a great thought in theory, but the reality is property management is rarely a turnkey provider’s strong suit. As the person who is going to own this property, you have the right to use any property manager you want on it, so interview managers accordingly. If you decide to use the one that comes with the property, that’s great, but do it because you feel comfortable with them rather than just because you assume they should be good.
- Verify the numbers. Do a little verifying here. Do you know for sure the advertised rental income number is accurate? Either confirm the tenant lease and how much they are paying and confirm that amount seems realistic for that neighborhood, or if tenants aren’t in yet, contact a third party who can run comps for you and give you an estimate of what you can expect for that property. You’re basically just trying to ensure that the rental income being advertised is realistic and can be sustained. For sustaining it, what is the neighborhood like? What quality of tenants will be attracted to this property? Again, don’t take the turnkey provider’s word for it—know these answers for yourself.
Owning the Property
Over the years of watching people buy turnkeys, this one has baffled me the most. What tends to happen is that a turnkey is advertised as being a hands-off method of investing in real estate, so people take that to mean they can not only be hands-off, but they can also turn their brains off and solely rely on whoever is managing the property.
In theory, that’s what should happen. But we also live on Earth, and we are also talking about the real estate investing industry here. If only life and our expectations always held true.
While someone else is managing the property for you, so you don’t have to worry about the day-to-day stuff, you do still need to be willing to jump in if anything starts going astray. I don’t mean jump in necessarily like suddenly start fixing toilets or collecting rent checks, but you need to be willing to manage the manager if need be. If the property manager isn’t performing up to par, be able to put your foot down about it. Or you may need to fire that manager and hire a new one. Identifying when a property manager goes bad isn’t always easy, but as soon as you realize it, it’s up to you to do something about it. I’ve seen it time and time again when a property manager isn’t performing, the owner/investor just sits back like “Well, I don’t know what is happening. What do I do?” Do something! This is when you should truly not be hands-off with your property.
Another tips is that if a big-ticket maintenance item comes up, before you just pull the cash out of your pocket to pay for it, call your insurance company! My rule of thumb is that if a repair is going to cost more than my deductible, I’m going to first try and see if insurance can help. Maybe they can’t, but at least I can say I tried (it’s free to try). If it’s early on in the ownership of your property, first contacting the turnkey provider about the issue is the best move because maybe the issue is covered by a scope-of-work warranty or maybe even just out of their good graces they offer to cover it because it should’ve been included with the rehab (depending on what it is, of course). The point is—try other avenues before you just fork over the cash!
So a summary of what I believe turnkey investors need to know and be involved with, when applicable:
- Know how to run rental property numbers.
- Understand market fundamentals and how to sustain projected numbers.
- Run due diligence on a property.
- Know how to “manage the manager” while owning a property and being willing to jump in and be the boss if necessary.
Some of these may sound painfully obvious, but according to my history of watching and helping people buy turnkeys, apparently these aren’t always as obvious as one would think.