Passive Income-to-Equity Ratio

[Cole Melcher]

After re-reading Rich Dad's Cashflow Quadrant, I have a renewed focus of increasing our passive income from our investments. Up to this point, my main focus has been on increasing our net worth. 

Right now we are generating a cashflow of 3.4% on the equity we have in our rentals. That is after subtracting a 10% vacancy rate and a generous estimate of maintenance expenses. 3.4% seems very low to me, however, I have searched the internet and cannot find any discussions on passive income returns on equity. What are other people seeing on their rentals?

[Clayton Mobley]

Hi @Adam Juodis, thanks for the question! You are definitely not the only one who wonders how TK works or if it is too good to be true, and I'm always happy to have the opportunity to get some good information out there.

So the way TK (turnkey shorthand ;) works is that we, the provider, purchase properties that we think we can rehab and rent as profitable rentals. Then we execute a high-quality rehab to ensure the property rents for as much as possible. This is where there can be a HUGE difference betweent TK providers. The less scrupulous will "put lipstick on a pig" and focus on just making a property look as good as possible for as cheap as possible. At Spartan, we do a thorough top-to-bottom rehab that typically includes a new tin roof, new 15-year vinyl flooring, new HVAC system, new paint, fixtures, landscaping etc. This not only makes our properties highly desirable rentals, but it keeps the long-term maintenance costs down. This is why asking a potential provider about their rehab process and maintenance costs is so vital.

Once the property is rehabbed (or at least mostly done), the TK company markets the property to find tenants and investors. When an investor comes along that likes the property and the numbers, they purchase the property (either cash or financed, just like a primary residence). However, instead of being a landlord, the investors basically has to do nothing else. The Tk company manages the property, vets and selects the tenant, handles issues, move-outs, maintenance reqs -  everything. The investor simply collects the net cash flow every month. This is why TK is such a popular RE niche for people who are either too busy or just not inclined to do all the heavy lifting themselves.

Now, it bears noting that, though we at Spartan do manage everything in-house (meaning we execute the rehab, find the tenants, manage the property) not all Tk outfits are full-service. Some have agreements with third-party property management companies or contractors - meaning each party needs a slice of the pie. Asking about what services are in house and which are contracted is another good question to ask a potential provider.

When it comes to costs, again they vary depending on what services the TK company actually provides. At Spartan, we charge a flat property management fee equal to 9% of the annual rental income (lower than many leading TK companies), as well as a leasing fee equal to one month of rent for each new tenant. However, because our turnover is so low (average tenancy is 34 months, minimum is two years) that fee is only incurred about once every three years or so.

In short, yes you do pay for the convenience of having someone else do all the work. However, if you work with a good team, it can absolutely be a win-win situation that results in a great cash flow investment. It's a little like going to a mechanic. You might be able to watch some YouTube videos and fix it yourself, or you can pay for the convenience of professional help and the knowledge that it will be done right the first time. 

I hope that answers your question, if you need any other info feel free to PM me any time.

All the best,

Clayton