Due diligence for a turnkey investment

[Yaniv Sigler]

hi,

As I'm in the learning process about real estate investing, I want to study the angle of turnkey investments sold by companies.

My question is what exactly do I need to know about the property when I do the due diligence to find out if it's a good buy, where do I find this information or should I use a lawyer for that? 

What other numbers and aspects of the property should I look for and aim for to purchase wisely?

I'm considering a turnkey because I want to buy it out of state (out of CA) and figure it will be less complicated if I don't need to rehab a place from long distance.

Thank you

[Anton Ivanov]

@Yaniv Sigler

To answer your specific question about what to look for in a property, I would start at least with this:

• Price: Your available cash savings will determine the maximum purchase price of the home. A typical loan requires a down payment of 20% - 25%, so take your savings and multiply them by 4 or 5 to get your max purchase price. For example, if I have $20,000 in the bank, I will be able to buy a turnkey for about $80,000 - $100,000.
• Location: Even if you pick a great city and neighborhood, the precise location of the home matters as well. Most tenants prefer quite, residential blocks and streets. You may want to avoid purchasing homes at busy intersections or near loud highways, businesses or venues. Also consider the topology of the land. Homes at the bottom of a valley may have water drainage problems, while those on a steep slope may have foundation issues if the ground moves.
• Year Built: I avoid homes older than 50-60 years, so if it was built before 1950, I will likely skip over it. Older homes will almost always have more maintenance issues, regardless of how good the rehab was. Additionally, older properties may have used poor or unsafe construction materials (like asbestos), which you may have to replace.
• Beds/Baths: Different areas will have different prevailing bedroom and bathroom configurations. While there will probably be demand for a variety of houses, I prefer to buy rentals that are average for that particular neighborhood. This is because, for example, if an area tends to attract middle-class families, it may be more difficult to rent out a 1 bedroom condo.
• Square Footage: My view on the size of the property is similar to the one expressed above - I like "average" houses that are not too large and not too small to appeal to the largest possible group of prospective tenants.
• Layout: Get a floor plan from the turnkey company, if they have it, or look at the photos to get an idea for the layout of the house yourself. Focus especially on the kitchen and bathrooms, which should be functional and large enough to satisfy most tenants. Avoid properties with weird layouts, small or dysfunctional kitchens or other noticeable problems.
• Parking: In order of preference, tenants prefer garages, covered parking or at least assigned off-street parking. A house with only street parking will likely be harder to rent in most areas.
• Yard: Most houses will have at least some front or back yard. I don't have a particular preference on the size of the yard, but I do prefer if it is fenced in. I also avoid properties with any sorts of yard amenities or complex landscaping, including pools, fountains, fruit trees, etc.
• Construction Material: Most city blocks are built using similar construction materials, but there may be exceptions. Brick homes tend to last the longest, but may require very expensive structural repairs as they get older. Wooden homes are cheaper to repair, but can have pest infestations.
• Flood Plane: You can look up a property's potential flood information on FreeFlood.com. Their report will tell you if the property is in a flood plane and which level of flood plane it is. You may want to avoid buying properties in areas that are prone to flooding or at least think about purchasing additional flood insurance.
• Rehab Scope of Work: Ask the turnkey company to forward you the full scope of work (SOW) that was performed during the rehab. This will give you an idea about the condition of the property before the repairs were made and allow you to hold the turnkey company accountable for the work they did.
• Property Photos: Almost all turnkey companies will have at least some pictures of the property post-rehab. Avoid properties that do not come with pictures. If you're unable to see the property yourself, this will be one of your only sources of information.

Then once you are ok with the above and are ready to look at its cash flow, I would look at the following:

• Rent: You need an estimated monthly rent you can collect from the property. In my experience, the estimated rent provided by the turnkey companies is usually accurate. You can also verify it using the following sources:
  • Current Lease: If the property is already rented out, check the current lease for the monthly rent amount. Since somebody is already paying this much, this is a fairly accurate indicator.
  • Rentometer: This online tool will show you average rents based on the property address and size. If the rent estimate provided by the turnkey company is on the high-side, it may be a red flag.
  • Craigslist: The vast majority of tenants find places to live on Craigslist, so it's a good source of rent information. Search for comparable rental properties in the same area and look at what they are being rented for.
• Vacancy Rate: There will be times when your property will be vacant. Most commonly, this will happen between tenants, as you search for new ones and do any repairs or upgrades on your property. The vacancy rate is a percentage of time you expect your property to remain vacant each year. For example, if you expect your tenants to change once a year and for it to take about 3 weeks to find new ones, the average vacancy rate will be 3 weeks / 52 weeks = 5.8%. The vacancy rate will depend on the neighborhood and the property type. Vacancies tend to be lower in better areas and higher in worse areas. Single-family properties usually have lower vacancy rates than multi-family homes. One of the best ways to estimate average vacancy rates for an area is to talk to other local investors or property managers. As a rough estimate, you can use 5-10% for a single-family home and 10-15% for a multi-family property or a home located in a rougher neighborhood.
• Operating Expenses: As a landlord, you will be responsible for paying a variety of expenses for each of your properties, which will reduce your take-home profits. Here are the most common ones:
  • Property Taxes: Every county and city will have mandatory property taxes, which are usually calculated as a percentage of the appraised value of the property. You can look up exact property tax amounts for each property on its county's tax collector's website. Be aware, that when you complete a purchase of a property, the county may re-assess it and increase the property taxes, so don't rely on previous year's values. Instead, determine the local tax rate and use your purchase price to calculate the new property tax amount.
  • Home Insurance: If you're using financing, your lender will require you to carry a basic fire insurance and liability policy. Even if you're not using financing, you should always have property insurance. Typical yearly premium for a landlord policy will be somewhere between $600 - $800, which you can use as an estimate before you have an actual policy in place.
  • Property Management: If you will be relying on a professional property management company to manage the day-to-day operations (which I recommend), you will pay property management fees. The base fee is usually calculated as a percentage of collected gross rent, with 8-10% being the most common. Your property manager may also have tenant placement fees, leasing fees or other charges. Ask your potential property manager for a full breakdown of their fees.
  • Maintenance: Even though most turnkey properties undergo a full rehab before you buy them, you will have maintenance and repair expenses as your rent it out. Newer homes and those located in nicer areas will usually have less maintenance expenses than older homes or those located in lower-end neighborhoods. Maintenance is usually estimated as a percentage of the gross rent, with around 5-10% being common.
  • Capital Expenditures: These are larger expenses that will be necessary to replace aging components of your rental, such as a roof, HVAC, water heater, electrical panels or plumbing systems. While they may only occur every 5, 10 or even 20 years, it is common to factor in a capital expenditure "allowance" on a monthly basis, similar to maintenance. You can use a set dollar amount or about 5-10% of collected gross rent.
  • Landscaping: Depending on the type of the property, you may or may not be responsible for landscaping expenses, such as grass, bush and tree trimming and removal of leaves or snow.
  • Utilities: In most cases, single-family home tenants will be responsible for paying utilities, but in some occasions you will need to pay them. It is more common for the landlord to pay some of the utilities for multi-family properties.
• Mortgage Payment: If you are using financing, you will have a monthly mortgage payment. You can use a variety of online mortgage calculators (like this one from Bankrate) to calculate your monthly payment. All you need is your loan amount and interest rate, which you can get from your lender.

Hope this helps, feel free to PM me if you have any questions.