4 Most Common Mistakes When Buying Turnkey Real Estate

I have been working with turnkey buyers for the past 6 years and I have come to find that there are some common mistakes that many investors make when they start looking at turnkey properties. Some of the mistakes cost investors money. Some of the mistakes cost investors time. All of the mistakes carry little lessons with them that can easily help an investor avoid making the same mistakes twice! Now, if we would all only listen…

History Repeating Itself

Looking back over the last few years, there is one thing we all can agree on. This has been one heck of a ride for the real estate market. What I find really interesting though is that even with such a wild ride, there are still lists out there of things you need to avoid. Oddly enough, there are still many investors who are choosing to not learn from history. They are still making some poor decisions and many are finding it easier to fool themselves than to exercise a little more patience. Although any list is going to be subjective and without a doubt, incomplete, this list at least gives a starting point for investors looking at turnkey investments.

Money Burning A Hole In Your Pocket?

I guess I am at a point where I should not be surprised anymore by how quickly some investors want to get moving. It is the exact opposite of a phrase that has been around for a number of years describing investors who love research – Paralysis by Analysis! I wish I were more witty and could come up with a quick alliteration to describe the opposite problem.

Too many investors continue to jump into the real estate market with no understanding of why they are investing in the first place and to make matters worse, they have no clear plan for how to manage their future investing. Not manage their portfolio, but to manage themselves and their plan for investing going forward. I speak to investors on a weekly basis who are in need of assistance with a “problem” house they have bought. Usually, they bought the house because the marketing looked slick, the picture of the house was great and the person on the other end of the line promised to handle everything. Eight hours later they were under contract and after a couple of short weeks they were in the game! Of course, they soon find out that the property is not rehabbed to a high standard, the property has a hard time keeping tenants and that company who told you there would handle everything is having a hard time finding their phone to answer or call you back.

The warning signs about bogus companies have been out there for years, but it is still up to the investor to do their own due diligence. Proper due diligence has more to do with effort and time than it does with where you look or what you find. A real estate investor purchasing a turnkey investment property today needs to understand that the market is changing in many cities around the country, but that does not mean you have to invest Today to get a good deal. Beginning your research and gathering the needed information to feel comfortable is an essential step, but that step leads to the next step and to the next step and eventually to purchasing a property. If someone tries to tell you that all the good deals will be gone before you get around to buying, you need to keep looking. In order for an investor to have a good and healthy turnkey investing experience, they need to have a solid understanding of who they are doing business with.

How long have they been in business?
What makes them a strong choice as a company?
What are the factors that make them stand out among so many choices for investors?

These are all very important questions for an investor to ask and feel comfortable with the answers long before every buying a property.

Purchasing For Yield

Whatever happened to good, old-fashioned, solid returns of 7-9%? When did it become such a negative to have a consistent performing property in your portfolio that you could rely on year over year to produce a positive return?

Investors today have so few options when it comes to consistent rates of return and to hear someone talk about consistency in real estate may seem a bit crazy. But consistent returns are out there and while they may not always be double-digit returns, what is wrong with a 7-9% return? With interest rates being forced down, investors are finding it harder and harder to locate good solid rates of return that they can count on. Many investors are turning to turnkey real estate opportunities to find higher yields without having to join the landlord game. Unfortunately, the reach for higher yields carries a counter balance…much higher risk.

Those risks include turnkey companies selling older properties – some built 60-80 years ago. Under renovated properties is another huge risk for investors buying some of the higher yield properties as holding down renovation costs is a way to lower the entry-level for investors. The lower the entry-level, in theory, the higher the yield can be. Under staffing can also be a major risk for an investor as an understaffed company means a lot of work being preformed and managed by a small group of people and can lead to mistakes and sometimes costly choices where the company is forced to overlook essentials.

Investors who are buying turnkey rentals really need to fall into one or two categories of investor. One category is an investor who is not interested so much in real estate, but likes the idea of a solid, appreciating asset that works as a good hedge against rising inflation. Your acquisition cost remains neutral, yet as inflation rises, the opportunity for your rents to rise as well exists. That allows you to acquire an asset at today’s prices and reap the benefit of higher rents. Of course, everything else in your life will go up in price as well, so this is simply a hedge play.

The other category is the investor who is either looking to diversify into another area of the country, another segment of the real estate investment market or simply does not have the time to manage the investment process. Many turnkey opportunities appeal to this type of investor because it lowers the barrier of entry for an investor and provides a chance to meet their investment goal.

However, both of these buyers are highly sought after and marketed to and one of the biggest marketing pulls is dangling 15 to 18% returns on turnkey properties. Again, I ask the question, regardless of your reason for wanting to buy turnkey properties, what is wrong with a consistent 7%, or 8%, 9% or even 10% return on an investment property? When did that return become one to turn your nose up at?

Using Promoters To Find Properties

I have several very good relationships with companies in the real estate industry whose main focus is to locate opportunities for other passive investors. Many times, the opportunities they are locating are with turnkey companies. There only focus it to point a client in the direction of an opportunity to buy. Because of the size of my company, we get pitched on almost a weekly basis from people who want to “promote” our company and sell our houses to their students or followers or clients. That puts us in a pretty unique position to see both the good and definitely the bad examples of these promoter companies.

First, if you are an investor and you are having to pay someone to get access to their “exclusive” list of properties, you might want to think twice about going forward. Are they all bad if they charge you money for their expertise? The answer is no. But there are definitely problems that are inherent with this model. It is no different from foreign property promoters charging clients thousands of dollars to “tour” American cities to buy investment property. Too often a grey line is created that blurs black and white and makes it harder for the buyer to know exactly what they are paying for…and here is why.

Often times promoters receive a fee from the companies whose properties they are peddling. They essentially get paid by both sides of the equation. There is nothing wrong with that and it does not mean that you cannot trust an investment property promoter – it just means as an investor you have to do even more due diligence before buying. Unfortunately, there are many things going on in a scenario like this and it is possible for the best interest of the final investor to be last thought calculated in the deal.

There are a few questions every investor should ask of a promoter before moving forward. Such as – are you getting paid by the vendor that you are referring me to? That is a simple straight forward answer and their full disclosure should be expected. Second, ask the promoter if they have a real estate license and how they accept funds. Third, ask the promoter how many properties they personally own with the company they are referring you to. You can start getting a clearer picture from this point and an understanding of whether they promote anyone and everyone that will pay them, or if they promote high quality companies that they have had a positive experience. Believe me, there is a difference.

As I said, I have met many, many promoters and been pitched by dozens. I have done business with one. I have a long-standing relationship with another company that is not a promoter but gladly tells their students about our company. Recently we agreed to do business with one other company. Three total companies that I feel put their clients first. After seeing company after company bounce around and simply look for anyone with a pulse to provide them with properties, we are sticking with a very short list of people we will enter into a referral relationship with. On your end as an investor, I would suggest you do the same and do your due diligence before paying someone else to share their secret stash of houses.

Shiny Object Syndrome

Being attracted to the shiny bell and the loud whistle that are hung around the neck of a pending disaster house, is a very, very common occurrence for buyers of turnkey properties. For me, this is the easiest one to address and I put it very plainly.

If the best thing you can say about a turnkey property is that it comes with a 12 month guarantee that you will not have any maintenance or vacancy, then you may not have done enough homework. I am not against any company offering guarantees on their homes. However, if they are used as a selling tool – a reason for an investor to buy the property – then the investor should really ask the question of “why do you need the guarantee”? How about asking what would happen if the guarantee were not in place. That should give you about all the answer you need.

Again, there is nothing wrong with a guarantee…as long as it is not used to attract an unsuspecting buyer who does not realize how poorly the property is going to perform when the guarantee is over.

Like I said, this was not going to be an exhaustive list. But I get the chance to hear from a lot of investors and there is still a healthy mix of investors who are attracted to these 4 mistakes. I have never seen a group of investors more excited to spend money than today’s brand new investor attracted to turnkey. Investors like chasing yield and LOVE to tell others about the great buy they just made – while it is still a paper return. Too many continue to outsource the front end work to promoters without understanding the whole relationship and doing their own due diligence and lastly the attraction and pull of a guarantee still holds a heavy sway over buyers and some turnkey companies are quick to use them as an attractive selling tool.

This small list was only meant to help investors identify a few hurdles and help them get pointed in the right direction. So before anyone starts piling on turnkey vendors, just remember that they serve a huge swath of the current investment market and they are in high demand. So, knowing what to avoid and how to find a great turnkey company just might come in handy…

Photo: dprevite

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.