Using 50% rule on TK properties_barely cash flow

[Tim Greenfield]

I am a newbie but I have 1 rental property in Albuquerque which only breaks even. I currently live in Arizona and I travel a lot overseas for work so I am looking at TK providers. My primary residence is paid for in full. I just obtained a $92,000 HELOC on it and I have $60,000 cash to invest. I was going to use the HELOC initially to test the waters and keep the cash in reserves. I am still putting everything I save into my cash reserves to keep building it up. Due to my travel I was going to use a turnkey provider and I have been in contact with a few of them. Listening to podcasts I know that a quick rule of thumb to determine whether a deal is good or not is the 50% rule. But whenever a put the numbers that are provided by various TK providers, they never cash flow or are marginal? Further, the examples provided by the TK do provide for taxes but NOT insurance, vacancy, maintenance, PM fee.

Example- Memphis property in zip 38118 C or B neighborhood. 3/2- Complete rehab by a TK with a good reputation from what I understand. Price 87,000. Finance 69,600 finance, 910 rent and estimated 1321 a year taxes.

Monthly Rent: 910 so makes the 1% rule

-50% for expenses (taxes, insurance, vacancy, maintenance, PM fee)

_________________________

NOI: 455

Debt Service expense: 368.12 without taxes/insurance

Cash flow: 86.88

*****************************************************************************

Example 2 different TK provider- Texas Property A or B neighborhood property in zip 75063. 3/3

$154,100 Purchase price

$30,820 down

$123,280 finance

$1495 Rent so less than 1% but close

-50% expense(taxes, insurance, vacancy, maintenance, PM fee,HOA fee)

__________________

$747.50 NOI

$644.58 debt service without taxes/insurance

102.92 cash flow

This TK provider provided a little more information with exception of vacancy and maintenance. If I add in 10% for each I come up with even less cash flow of $33.58.

Am I figuring this correctly? My plan was to buy some properties that are strictly cash flow and the other with less cash flow but a better upside potential for appreciation. These two actually cash flow, some of the others that I looked at dont' even do that.

Any thoughts/advice would be appreciated

Thanks,

Tim

[Chris Clothier]

I guess like @Ben Leybovich, this forum gives me a chance to rant again (sorry, it will be a little long)...

So many are using the word Turnkey like it's a noun - a Turnkey house - with actual meaning.  It is not.  It is a marketing term applied to buying houses many years ago and one that exploded back in the late 2000s.  I think the industry really improved over the years, but is really sliding backwards right now with a lot of opportunists who are intelligent marketers.  Unfortunately, the word Turnkey has no real meaning and is way over-used today to attract eyeballs. Especially the eye balls of new investors without a ton of experience or knowledge.  At the same time, to believe that the only investor buying Turnkey properties are brand new investors is not only wrong, but extremely insulting.

Unfortunately Ben, when you go on your rants, you fail to recognize that companies and opportunities only exist because there is demand for them.  That demand is not always built on the back of stupidity or the naivety of new real estate investors.  I love our online back and forth that we have had over the years and look forward to those conversation in person in the future.  They are always respectful.  That same respect needs to be extended to investors who are interested in buying properties from Turnkey companies.  Passive investors far outnumber active investors and this is a legitimate and viable option for many investors here on the site. 

My concern is a lack of clarity in understanding that the marketplace is shifting and investors need to shift with it.  With that shift needs to come an understanding in how the conversation is shaped here on BP.  A majority of the conversation in the BP threads from TK companies is meant to win market share.  Most is directed toward investors with the intent of selling properties. Often overtly, but sometimes direct selling like offering to help or let me review something for you or even listing actual properties.  Brand new, first-time investors with no knowledge of real estate are the most impressionable investors out there.  Many over-whelmingly approach this type of purchase with the idea of cash-flow so that is what is marketed heavily to them.  Long-term security, investing in high-risk (that is a relative term because history may say it is not) investments like negative cash-flow appreciating properties and just basic, bland investing like buying the best assets possible and letting a resident reduce principle over time are rarely if ever mentioned as a reason to buy a passive, turnkey property.  Yet, I would argue that security is the most important thing an investor should consider today when buying a passive investment - Not cash flow.  

In today's market environment, unlike back at the turn of the economy, everything cost more.  The properties cost more, materials and labor cost more and services cost more.  All of that goes into the way investors should approach a passive investment today, in my opinion.  Here is my advice to Tim and really to anyone looking to make passive investments in the very near future.

@Tim Greenfield - First, to answer your question, the 50% rule is a good rule of thumb to use to run your numbers.  Like was said before, do not double deduct certain expenses.  Use the 50% rule on expenses and go from there.  As you will read through the rest of my answer, based on the risk profile of the company and property, you may need to run those numbers off a higher percentage, yet only rarely would you be able to run it off of lower and even then I would say 44% to 45%.  That is all going to be based on the company and the product and service they put out.

More specifically, the advice I would give to you is to reflect on your investment goals and your reasoning for purchasing property.  If you are in need of cash flow, then there are certainly other ways to invest your money.  If you are simply looking to deploy capital and build a portfolio that puts your money to work and provides a return, then here is my advice.  Both as an investor and a business owner providing these types of passive investments, my advice is your #1 goal when buying needs to be RETURN OF CAPITAL.  The higher the risk profile of both the property and the company, the lower the likelihood of a return of capital.

RETURN ON CAPITAL is secondary in this market and every passive investor should start their investment decisions by reviewing the risk profile.  IMO, every passive investor should always have a return of their capital as their biggest concern and then look to maximize their return once they know they have reduced the chances of losing their money to the lowest level possible.  Especially in the current market conditions.  This market will change and the housing market will crash again in many cities and price points around the country.  At that time, there will be lots and lots of opportunities that will both feel and actually be less risky and they will provide higher returns.  That is not the environment we are in right now.

Passive investors need to focus right now on acquiring the absolute best assets they can and make sure their money is secure in that investment.  If they can earn an average to above average, modest return on that investment, then they are way, way, way ahead in the game.

Lastly, there is a ton of risk right now if you are investing in "Turnkey" properties.  The word itself has already raised the risk for investors.  I have said for years that the city, the company, the processes and management team you do business with is more important than the widget itself you are buying. Everyone is using the word Turnkey even though there is little continuity in what it means and it is easier than ever for investors to make huge assumptions.  Anything can cash flow on paper and any investment can be made to look really good or really bad with a few black and white statements.  I think I have my finger pretty well on the pulse of this particular niche and the reality is, this statement from Ben is not true:

It is NEVER a good idea to buy above market (what the **** is market, anyhow?) It's never a good idea to buy without equity. It's never a good idea to buy without cash flow. You need all of the above to survive in this game!

The premise is good and on the face it is correct. I am not going to argue with the advice and while I may disagree with it, for all investors, the most important things you must have to survive in this game is a reliably steady income, earmarked money that they can risk in an investment (cash, SDIRA, HELOC - whatever you use as your capital) and a high level assurance that you will get a return of your capital before you buy.

I am a seasoned investor who has lost money on stupid investing.  Today, I buy plenty of properties where I don't give a damn what someone else says is market value.  As Ben says, what the **** is market value anyway?  I don't care if it has equity and I don't care about the cashflow.  But I have a solid income.  I have money set aside that I have earmarked particularly to invest with and I am comfortable if I lose it and have learned enough about real estate investing that I am making well-informed investment decisions.   I know with the highest certainty that I will get 100% return of my capital.  When all is said and done I will make a pretty damn good return too for the low amount of risk I am taking.  This is what investors need to understand about buying passive investments today and the word Turnkey.  Success depends entirely on who you are dealing with and their ability to reduce your risk as an investor.