Views on Turnkey Properties in the current market

[Frank Mancuso]

I know Turnkey doesn’t get as much love as other investment property routes on these forums, but was curious what others thought considering the current market and from the POV of a total newbie looking for a buy/hold (non brrrr) property with positive cashflow?

My thoughts being that with housing prices inflated at least a (legitimate) turnkey would help cut through the barriers of building a team/finding a prop/renovating/placing tenant, obviously your margins are still being cut into by the nature of how a turnkey organization's business model works, but interested to hear what others think?

[Eric Fernwood]

Turnkey is a purchase method, nothing more. Buying turnkey does not reduce your due diligence effort. The most important decision you will make is the location. Buy where you can make money today and into the foreseeable future. That means selecting a location that meets all the following criteria.

• Appreciation - The number one location selection criteria is appreciation. Inflation constantly erodes buying power; each year, it costs more to buy the same set of goods. If you buy in a location where pre-COVID prices and rents increased faster than the current inflation rate, you will continue to have the funds you need. If not, the initial cash flow will be the highest you will ever receive, and you will have a continuously declining standard of living.
• Population Size - Greater than 1 million. Small towns may rely too much on a single business or market segment.
• Population Growth - If people are moving into a location, many things have to be right. I would not invest in any location where the population is stagnant or declining.
• Crime - People and companies will not move to locations perceived as dangerous. One source of cities to avoid is Neighborhood Scout's 100 most dangerous cities. Avoid any city on this list.
• Disaster Risk - Some parts of the country are more prone to natural disasters. The best indicator for natural disaster probability is homeowners insurance cost. I would avoid states with high insurance rates. Note, even if insurance pays for all the damage your property suffers, you still lose. When a significant disaster occurs, people and jobs move to locations where they can make money today. The location may take years to recover, or it may never recover. ValuePenguin is a good source for the relative cost of insurance by state.
• Operational Costs - Costs like property taxes, insurance cost, state income taxes, regulatory costs (ex: time and cost to evict), inspections, rent control, etc., have a tremendous impact on your return. Select a location with relatively low operational costs. Operational costs are a direct hit on profitability.

Once you've selected a location, you next need to decide which tenant pool to target. Length of tenant stay, maintenance, vacancy cost, and many other things vary greatly by tenant pool. For example, below is the vacancy cost estimate for the three primary tenant pools in Las Vegas. As you can see, there is a huge vacancy cost difference that can only be offset with a much higher cash flow.

• Tenant pool 1: $3,200/Yr
• Tenant pool 2: $400/Yr
• Tenant pool 3: $3,500/Yr

Once you select a tenant pool to target, you then know what type of properties to buy, and you are ready to evaluate which purchase method is best for you. Note, only if the turnkey supplies properties that match your target tenant pool does buying turnkey make sense.

Decision Process

As an engineer, I believe in processes, not feelings and guesses. So, I put together the following decision tree to help you decide which purchase method was best for acquiring a long-term profitable investment.

Other Considerations

Turnkey vs. Investment team

In general, turnkey properties will always be more expensive than a direct purchase, which results in a lower return. Turnkey providers must charge enough to cover renovation costs, carrying costs, marketing expenses, tenant acquisition, and profit. These costs are in addition to the actual property acquisition cost. Below is a diagram illustrating the cost difference between direct vs. turnkey. The difference between a direct purchase and buying turnkey is what I call the "convenience fee."

Note that even though you pay more with turnkey and have a lower return, you save some time. That is the main value of buying turnkey.

Property Condition

Most turnkey providers put all their money into cosmetics, not systems. Painting, carpet, and light fixtures are small cost items compared to termites, roof, plumbing, wood rot, electrical, HVAC, and foundation issues. For example, during the inspection of a flipped property, we learned that the plumbing system was shot and the flipper patched over leaks. Estimated cost to re-plumb the house, $10,000. In comparison, the cost for the paint and carpet and everything else was probably under $5,000.

I have also heard that some turnkeys do not provide an independent inspection report or allow the property to be inspected. Unless I know the actual condition of the property, how do I know the actual cost? Never buy a property without an independent property inspection, not the one recommend by the turnkey company.

Property Management

One of the selling points for turnkeys is that they manage the property after the sale. The flip side is that you cannot use a different property manager, even if you are dissatisfied with their property manager's performance. While Yelp (and similar) reviews are problematic, read the turnkey's property manager's reviews. Once large turnkey's property manager had a rating of 1.5 stars based on a large number of reviews. Such a poor-performing property manager will result in more frequent tenant turns, more frequent maintenance, which generates more income for the property manager.

Another claimed advantage is that there is already a tenant in place. In the past, we purchased properties with tenants in place. Most were later evicted for non-payment of rent. In Las Vegas, eviction is quick and low cost. However, in some other parts of the country, an eviction can take over one year and cost thousands.

When I am investigating properties, I always talk directly to the tenant(s). On a few occasions, the rent claimed by the listing agent did not match what the tenant stated they were paying. The claimed rent was above market rate but what was actually paid was or below market rate.

Time to rent is another important consideration. The property could have been vacant for months. Or if the turnkey may have paid the tenant an upfront premium to move in a tenant at the stated rate. I've seen owners doing this many times in order to sell the property. In this situation, the tenant will move out once the lease is over, and you may be waiting a long time to fill the property at a lower rent than expected.

Another claimed advantage of the property manager is that they have an internal maintenance staff. This is an inherent conflict of interest. Property managers make more money on repairs than they do on rent collections. I do not want my maintenance costs be to the property manager's profit center.

If You Decide on Turnkey

I recommend the following as a condition of purchase.

• The right to have an inspection by an independent licensed property inspector.
• A list of all repairs made by the turnkey. You need to know which items (from the inspection report) still need to be corrected. Get a quote for all these repairs so you know how much the property actually costs.
• Get independent rental and sales comps for the property. This will enable you to compare market rent and property value vs. what the turnkey is stating.
• Get copies of their management and leasing agreement and read them. For example, I've seen terms requiring you to sell the property through the turnkey at a very high commission rate.
• You must have the right to choose the property manager. You want a property manager that works for you, not the turnkey. From what I have heard, you do not have that option with most turnkeys.
• Results from any code inspections. Also, what inspections are required to rent or sell. In some locations, the house must meet current codes. Meeting such codes may cost more than the value of the property.
• All disclosures provided by the prior owner of the property. In some locations, the seller must provide detailed disclosures on the condition of the property.
• A written statement from the property manager with specifics on the time and cost to evict a non-paying tenant.

If you obtain all the above, buying turnkey or direct becomes a simple time vs. return decision.