Reference for Turnkey companies: Elite Invest, Memphis Invest
Investor · Ottawa, Ontario · Member since 2015 · 63 posts · 4 votes
Reference for Turnkey companies: Elite Invest, Memphis Invest
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Real Estate Investor · Chicago, IL · Member since 2014 · 33 posts · 58 votes
11yHere’s an analogy that may be helpful in illustrating the fundamental problem of a turnkey rental strategy. Take a 2012 Honda Accord ES in pristine condition, low mileage, loaded with every available option: premium wheels, top of the line infotainment/GPS system, sunroof, etc. Its worth 14k. Another ES in fair condition, with high mileage and no options, is worth 11k. While the cars are very different, the differential in price is only 27%. The value of a car is primarily determined by the year, make and model. Condition and equipment are relatively minor factors. The same is true for real estate. Upgrading the mechanicals, finishing a basement, installing granite countertops, there are dozens of ways to spend thousands of dollars improving a house. While it may have a measurable impact, the primary determinant of a house's value is location. Turnkey operators are buying cheap houses and over improving them. A $5000 set of mag wheels on a $10,000 car doesn’t make the car worth $15,000. Neither does putting 30k in improvements in a 40k house make it worth 70k.
An investor using a competent turnkey operator, should not have a horror story in the immediate future. That would only occur if the operator seriously miscalculated rental demand or did shoddy construction. Good operators buy (cheap but) decent houses, fix them up in tip top shape, with the bling to attract tenants who will pay a premium for that new house smell. Any aging components should have be replaced so the investor shouldn't have major cap ex for the first 5-7 years. In the short run things look good, but shortcomings in the underlaying fundamentals can’t be avoided. The investor is likely to experience disappointment in the long term. The first surprise may occur in a couple of years, when the first tenant moves out and the investor needs to spend 2k to get the property back into ready to rent condition (the cost of painting, re-carpeting, fixing dinged up kitchen cabinet doors, etc. adds up). The property may take a bit longer to rent out this time, since its not as fresh as it was. As the years go on, the investor is unable to raise the rent because the rental market is so competitive, rent levels are flat. Unfortunately, the same can’t be said with expenses. A couple of cap ex events occur in year 10 that eat up the equivalent of several years’ worth of profit. But the biggest disappointment comes 15 years down the road, when the investor sells and realize at closing that the proceeds are just enough to cover their loan balance.
Under the best case scenario, the pro forma ROI that turnkey providers quote may be hit the first year or two. I'd love to hear from anyone who's achieved their expected 10 year IRR. The only way to win big with turnkey rentals is with significant appreciation. I don't know about other areas, but that is not likely to happen in Chicago in the neighborhoods where the turnkey operators work. Here's an article that provides one explanation of why. Without getting into the sociology, I'll summarize: people don't always behave in an economically efficient manner.
http://danielkayhertz.com/2014/12/05/chicagos-growing-income-donut/
Turnkey operators price their properties based on the income approach (which is typically used on commercial and 5+ unit multifamily properties). But the prevailing model for valuing 1-4 units is based on the comp approach. The problem arises when there is a large discrepancy between the two models. If I own a 6 flat and increase the rents by 50/mo per unit, I’ve increased the value of my building; if I appeal my tax bill and win a reduction, I’ve increased the value of my building. If I do the same actions with my rental house, the value is unchanged. The value of my house is roughly the same as the surrounding houses. My house is not inherently more valuable because its rented out and my neighbor’s house is not worth less because he lives in it. While the ludicrousness of this is obvious on houses, the flawed logic is a little less apparent with 2-4 flats. This is probably why Chicago turnkey operators are focusing on them. I don’t know how they are getting the banks to make loans at these inflated valuations, but I’m guessing they couldn’t get them to play this game with SFHs.
I’ll preface this by saying I’m just a landlord. Unless you’re looking to rent a 2 BR in the South Deering neighborhood, I’ve got nothing to sell anyone. I don’t personally know any turnkey operators in Chicago and have no vendetta against them. I’m just sharing my opinion.
Chicago is segregated and my comments do not apply to the north side, South Loop, Hyde Park, Kenwood, or gentrified areas. The areas of Chicago that have high rents relative to home prices are on the southside, "west side", and southern suburbs. That’s where the turnkey operators work, that’s also where my properties are. For the purposes of this discussion, these areas I'm referring to when I say Chicago.
Chicago turnkey properties are overpriced by a lot, like 90-100k too much. Every example I’ve seen on their websites is priced at least twice what the property is worth as a rental. I’m not talking about appraised value, as a buy and hold investor, that’s not necessarily relevant. Value for me is measured by lost opportunity cost (ie. what else can I get for my money).
There is no financial justification for paying 70k+ per unit for 2-4 flats in the neighborhoods where these turnkey properties are located. I won't refer to a specific example because it wouldn’t be fair to pick on one operator when they’re all doing the same thing, but if someone wants to post the specifics about their particular deal, I’ll be happy to respond with specific comparisons.
So let’s say an operator is selling a duplex for 170k that is rented out for 2200/mo, located in a marginal (with regard to the type of tenant it will attract) neighborhood.
Alternative 1: That same amount of money could be used to buy and fix up a couple of brick bungalows in Chatham or Pill Hill, two of the most desirable neighborhoods in Chicago. They'll rent for a combined 2700, to a higher quality tenant (resulting in less turnover, less management, higher ROI). While the properties may still not experience future appreciation (refer to the article in link above) there is appreciation baked in, achieved by buying it undervalued. In this example, a cost basis of ~65% of current market value. Overall, this strategy is less work, less risk, and earns a higher return than the stereotypical turnkey duplex.
Alternative 2: For those willing to assume more work and risk, in exchange for a higher ROI. The 170k could be used to buy 4 houses in neighborhoods similar to where the turnkey property is located. This would bring in 5000/mo rent. Many of the issues would be the same, but compared to equivalent multifamilies, detached houses are able to attract the best of the applicant pool and command higher rents.
Alternative 3: If asset appreciation is more important than interim cash flow, there are areas where gentrification is most likely to occur. These areas are obvious, and that anticipation is reflected in the prices. In the short run, the property bought for 170k might look and operate a lot like the turnkey duplex. But over the course of ownership, the IRR may be vastly superior because of exit strategies like a condo conversion 10 years down the road.
No matter what the investment goal is, turnkey properties aren't a good way to get there. I’m throwing down the gauntlet to any turnkey advocate. Please challenge me on any of this as it pertains to Chicago. I’d love to hear your case. If you provide the details of a deal we can analyze it here for all to see.
28 Replies
- Real Estate Broker · Chicago, IL · Member since 2013 · 6k+ posts · 5k+ votes11y
I do not have direct experience with them on the buy side. I have met both owners personally and have nothing but good things to say. That doesn't specifically help you but make sure you do your due diligence and ask the right questions to compare apples to apples
Second City Real Estate4.821 Reviews - 11yDouglas SkipworthBusiness MemberRental Property Investor · Memphis, TN · Member since 2014 · 1k+ posts · 1k+ votes
I'm not a fan of turnkey investing, but Memphis Invest (and their property management company Premier Property Management) has a stellar reputation. We are friendly competitors with them in Memphis and I have nothing but good things to say about their service and their products.
Good luck to you!
Investor's Guide to Memphis Real Estate - Investor · Ottawa, Ontario · Member since 2015 · 63 posts · 4 votes11y
Thank you Brie for your feedback. That is good to know.
@Douglas Skipworth Thanks Douglas for that information. Just curious as to why you are not a fan of Turnkey investing? for example, what pitfalls and disadvantages to you see?
- Specialist · Memphis, TN · Member since 2012 · 1k+ posts · 1k+ votes11y
For a safe pair of hands with massive muscle to back them up you cannot compare Memphis invest with any other player. They are the best in that space by a country mile.
- 11yDouglas SkipworthBusiness MemberRental Property Investor · Memphis, TN · Member since 2014 · 1k+ posts · 1k+ votes
Great question, William!
It is our experience that most turnkey providers extract all of the profit from a deal for themselves and then leave the investor with a high-priced asset that is almost always impossible to sell at or above the original purchase price.
Said another way, we find that most turnkey providers are selling houses at or above retail prices, which leaves the investor with no downside protection. We think that is a major pitfall or disadvantage with the turnkey market.
Personally, we believe in partnering with like-minded investors who want to pay a normal real estate commission to a licensed agent for helping them find discounted properties. It might be old fashion, but we think it is more of a win-win since it fosters a long-term relationship for investors who want to buy, hold, and grow.
Hope that helps.
Investor's Guide to Memphis Real Estate - Investor · Ottawa, Ontario · Member since 2015 · 63 posts · 4 votes11y
@Douglas SkipworthThanks Douglas.
You said that most Turnkey providers would leave the investor hanging. Since you had nice things to say about Memphis Invest, I am assuming that this company would be the exception to that general rule?
If not, I would be curious as to how they make money from dealing with a foreign investor like myself.
Thanks!
- Specialist · Memphis, TN · Member since 2012 · 1k+ posts · 1k+ votes11y
William there is much debate over even what Turnkey means so it's hard to answer. Generally what is being discussed is a company like Memphisinvest that basically does everything. They buy, they rehab, they manage, they provide finance and they get you to treat your investment, quite rightly, like any other investment. Look at teh over all return and be happy with it or not.
On the other side are investment house providers who do not provide all the bells and whistles like MI but they can supply you a good investment property for a lot less than MI can because they don't need all their infrastructure and don't provide the same level of comfort and "set and forget" as a turnkey does.
So some people don't like Turnkey because you will pay 10 to 30K more for the same house. This doesn't make it a bad investment providing everything pans out long term but we think paying above retail at the time of purchase can be a dangerous way to invest.
- Investor · Chicago, IL · Member since 2014 · 84 posts · 20 votes11y
Question for the group: do investors prefer turnkey individual properties (fees paid upfront as discussed, but with control of individual properties by the investor thereafter) or a pooled fund model (fees paid primarily based on actual return results, but requiring trust in the sponsor to select, purchase, rehab, manage and exit properties)?
- 11yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
@Ian Fisher I think the major difference here is the accredited investor rules.. If you look at some of MI post by the owner he delineated how many homes was owned by how many investors.. and the vast majority only own one or two, ergo probably not accredited ...
@William Wong the owner of MI makes no bones about it, you will pay top of market for his product and they think they have earned that right and give quality for the price.
As for Elite you should just go and check it out personally have them walk you through there current projects the are very detailed in their rehabs I can say that much.
- Accountant · Sunnyside, NY · Member since 2015 · 14 posts · 4 votes11y
I would agree with @Douglas Skipworth's comment about extracting the profit, although I would modify that statement to say they take the equity out of the house. Some houses have a bit of equity appreciation potential if you buy at a low price and rehab yourself. I believe that these companies do the purchase and the rehab for you, so you're left with the final product at a higher price point with less room (if any for appreciation)
With that said, if you're an out-of-state (or out-of-country) investor, then this may be your only option. If you don't know anyone locally that could do everything for you, then I would definitely suggest the Turn Key model.
As part of my own due diligence, I had visited Memphis Invest and was extremely impressed by what they offered. I took a tour of the entire facility and everyone was extremely professional. If you do invest with them, I know you'll have a great product and a great team to provide that support.
- Investor · Chicago, IL · Member since 2014 · 84 posts · 20 votes11y
@Jay Hinrichs, fair enough, makes sense - to me it is a strange world where the SEC doesn't care about people exposing themselves to the level of risk that comes with direct ownership of 1-2 homes but does care about people exposing themselves to the level of risk that comes with interests in a fund that owns 500 homes, but I do understand this is the case.
- 11yDouglas SkipworthBusiness MemberRental Property Investor · Memphis, TN · Member since 2014 · 1k+ posts · 1k+ votes
William,
Dean Letfus and George Chang above did a nice job answering your question about how turnkey providers make money.
Just to be clear, I would not say that most turnkey providers leave investors hanging. My point is that turnkey providers usually make significant amounts of money by selling houses that they own, which leaves the investors with less equity in the property (i.e., more risk).
There are alternatives to turnkey for foreign investors, but they oftentimes require more involvement on the part of the investor.
Hope that helps.
Investor's Guide to Memphis Real Estate - 11yDouglas SkipworthBusiness MemberRental Property Investor · Memphis, TN · Member since 2014 · 1k+ posts · 1k+ votes
William,
I just saw this blog post here on BP.
http://www.biggerpockets.com/renewsblog/2015/08/25...
It's an alternative to turnkey investing that works well for investors who are willing to be a little more hands on. (Whether they admit it or not, we have found that most BP members are hands on investors!)
All the best,
Investor's Guide to Memphis Real Estate - 11yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
@Douglas Skipworth I see your new to BP welcome. Nice to have the brokerage community chim in as well.
I think on BP you have 3 distinct camps.. 1 a huge body of folks that have never done anything in RE and are wanting to do so, so they are trying to get educated on line here.
Then you have the local investor, who 90% of the time probably does not buy from turn key but I know instances in all markets were locals will buy turn key.. But as you state generally they are more hands on and are more experienced in the market place. IE they already know the Zip codes to stay out of the school districts etc etc. and they will buy the homes on their own retain their own GC or do it themselves. No denying this investor gets the best deals at the end of the day if they have any clue as to what they are doing.
Then you have the Out of area investor.. which includes the MIllions of CA. investors who are market makers. ( IE take the CA investor out of any cash flow market and you would lose a big % of your sales).. this investor is what created turn key in the first place. They were followed by other out of area investors then the Off shore investors started getting marketed to and you have seen a big influx of AU GB CA CH SING those folks invest turn key. All with a varying degree of success.
So your impression maybe that most people on BP are hands on but that's just not the case in my 18 months of following the boards here.
And Turn key is really just local fix and flippers instead of selling retail they sell to investors and have put together in many cases property management. ( as you know that is critical in your market and most turn key markets at the price point these folks are buying at)
If you represent a fix and flipper that does retail deals to owner occ.. you expect them to make a profit correct ? and usually a fairly big one for all the risk and cost of capital and time etc.. So turn key is no different but in fact in many turn key operations they do volume and the profit margins are much smaller than what a retail fix and flipper would expect.
- 11yDouglas SkipworthBusiness MemberRental Property Investor · Memphis, TN · Member since 2014 · 1k+ posts · 1k+ votes
Thanks, Jay.
I'm excited to now be actively involved in the BiggerPockets forum community (I've been a passive BP participant for several years...mostly just reading the blog posts each day).
As an investor, Realtor, and property manager, I have strong opinions about owning rental properties. I intend for my comments to be thoughtful and courteous, although they will admittedly be biased towards what I believe and have found to be true.
I appreciate others like you rounding out the dialogue with insights and observations that I don't have. That's why I think BP is a great place for newbies and veterans alike!
Best regards,
Investor's Guide to Memphis Real Estate - 11yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
@Douglas Skipworth you don't have to soft sell it on BP.
If you think buying in neighborhoods in Memphis at the 30k price point Is basically suicide for an out of state investor its best to state your thoughts and opinions.. I think it is LOL.
Many out of state investors really don't understand the dynamics of the mid west markets IE the huge % of the population that rents SFR's..
For instance in my neck of the woods less than 10% of all SFR's are rentals... So your never going to go into neighborhoods that have burn outs board ups and barred windows and caged condenser units... and those things can extend into mid price in the mid west as well at least the caging the condenser units.. And houses don't go vacant one day and get stripped the next here as well. These are things that can catch a west coast investor completely by surprise and be shocking to them.
So its important that we tell both sides of the story here on BP.. So that folks understand that % returns are directly related to Risk .. and by risk I mean physical risk to the property and very very HIGH touch tenant base that are and will always be renters.
In our markets renters rent apartments. SFR's are owned by homeowners..
this is why you see all these post about how West coast properties don't cash flow.. its because they are owner occ generally..
You set me down I Georgetown TN which is generally owner occ and those houses won't cash flow any better than our west coast SFR's its because of the renter vs owner demographic.
The reality is the horse is out of the barn... these areas that provide cash flow rentals are and for ever more will be rental areas.. Locals in your market that want to own a home know this and you as a broker know it.
- 11yDouglas SkipworthBusiness MemberRental Property Investor · Memphis, TN · Member since 2014 · 1k+ posts · 1k+ votes
@ Jay Hinrichs, I appreciate your comments.
I won't hold back from now on!
Thanks,
Investor's Guide to Memphis Real Estate - Investor · New York City, NY · Member since 2015 · 808 posts · 417 votes11y
I have done business with Elite and have had a good experience. It is a certainly not for everyone so I would suggest you talk with them (if you did not already) and go out to see the properties.
Memphis Invest I know only be reputation and as you can tell they have a good one.
I would say one of the primary differences at least for me was that Elite was probably more likely to work with you on price points while Memphis Invest I view as more streamlined.
- Investor · Gainesville, VA · Member since 2014 · 118 posts · 76 votes11y
I have bought 2 homes with MI and in contract with a 3rd. They are a solid company and have so far produced good results.
I have not heard of Elite Invest, however a quick look on their website shows me a ton of multifamily opportunities which you will not find with Memphis Invest. So if you want to go the multifamily route Elite Invest could be a good choice.
- 11yAlex CraigBusiness MemberReal Estate Professional · Memphis, TN · Member since 2009 · 1k+ posts · 1k+ votes
@Allison Karrels Keep in mind, when you purchase through Turnkey, after your inspection report, most all issues(at least 95%) should be fixed by the seller and this includes not only the items related to the house but also items such as external buildings, fences and potential tree issues. A owner occupant selling to a investor may not be willing to do that. Also, Turnkey providers should be positioning your properties for success in the long run through upgrades in the renovation (ceramic tile, updated lighting fixtures, ceiling fans in the master bedroom and den, vinyl plank in high traffic areas instead of carpet, new counter tops, updates to the electrical service box, new supply lines at angle stop valves, etc) and replacing big ticket items that are old with new. If a owner occupant has all of that in the home they are selling, their price should be in line with a Turnkey providers. Everyone is right, there is a premium when buying Turnkey and with that premium should be a seller willing to hand over a property with all deferred maintenance issues addressed and positioned for success for at least a 7 to 10 year min hold. Something else, I feel Turnkey should come with a property warranty and no initial lease up fee. In other words, the money you come to the closing table with will be enough to start cash flowing immediately and those cash flows should be sustainable (meaning you do not have to reach back into your pocket to pay any debt commitments) b/c the house is virtually maintenance free and you do not incur a lease up fee for your first tenant. If you have that, then you are buying 100% Turnkey.
- Investor · Ottawa, Ontario · Member since 2015 · 63 posts · 4 votes11y
Thank you all for your responses on this. It is quite helpful.
My objective like all real estate investors is to have a positive cash flow situation of a few hundred dollars and some appreciation, say, at minimum 2% per year based on the initial purchase price. I am also willing to look at this long term.
I guess I will have to check to see whether this type of situation is feasible. As long as the turnkey company in question is providing fair value for money, then, I am okay.
- Investor · Ottawa, Ontario · Member since 2015 · 63 posts · 4 votes11y
Thank you all for your feedback on this.
@Charles Worth Thanks for your feedback. Just wanted to get some more clarification on why Elite Invest is not for everyone in your opinion? were they difficult to deal with in certain areas?
- Investor · New York City, NY · Member since 2015 · 808 posts · 417 votes11y
Its more urban which has its good and bad. Some of the good and why I like it is
a) 2,3 and 4 flats are the norm so the cash flow is typically better than places where SFRs are the norm and tenants are used to these multis where as in Memphis you can get an SFR for cheap so a duplex can be more difficult to manage.
b) Urban cities that have long histories in my view have greater appreciation potential. The urban revitalization has gone well in many cities and this is an opportunity.
The drawbacks are
a) Like any long standing city there are problems with pensions, fiscal responsibility etc. Almost all major cities have these hangovers.
b) Like many urban cities there has historically been crime and poverty in many areas. Key is to pick the right blocks but that is a matter of trust for an out of state investor. In a place like Chicago go two blocks over and you will hit a not very good area even if your block is good. As such, this requires diligence on your part or trust. Elite does have good system for managing it and I did a lot of diligence but if you are an investor who thinks white picket fences it will be a bit different from that expectation.
- Investor · Ottawa, Ontario · Member since 2015 · 63 posts · 4 votes11y
I will be also interested in hearing about any horror stories people have had with Turnkey companies.
- Real Estate Investor · Chicago, IL · Member since 2014 · 33 posts · 58 votes11y
Here’s an analogy that may be helpful in illustrating the fundamental problem of a turnkey rental strategy. Take a 2012 Honda Accord ES in pristine condition, low mileage, loaded with every available option: premium wheels, top of the line infotainment/GPS system, sunroof, etc. Its worth 14k. Another ES in fair condition, with high mileage and no options, is worth 11k. While the cars are very different, the differential in price is only 27%. The value of a car is primarily determined by the year, make and model. Condition and equipment are relatively minor factors. The same is true for real estate. Upgrading the mechanicals, finishing a basement, installing granite countertops, there are dozens of ways to spend thousands of dollars improving a house. While it may have a measurable impact, the primary determinant of a house's value is location. Turnkey operators are buying cheap houses and over improving them. A $5000 set of mag wheels on a $10,000 car doesn’t make the car worth $15,000. Neither does putting 30k in improvements in a 40k house make it worth 70k.
An investor using a competent turnkey operator, should not have a horror story in the immediate future. That would only occur if the operator seriously miscalculated rental demand or did shoddy construction. Good operators buy (cheap but) decent houses, fix them up in tip top shape, with the bling to attract tenants who will pay a premium for that new house smell. Any aging components should have be replaced so the investor shouldn't have major cap ex for the first 5-7 years. In the short run things look good, but shortcomings in the underlaying fundamentals can’t be avoided. The investor is likely to experience disappointment in the long term. The first surprise may occur in a couple of years, when the first tenant moves out and the investor needs to spend 2k to get the property back into ready to rent condition (the cost of painting, re-carpeting, fixing dinged up kitchen cabinet doors, etc. adds up). The property may take a bit longer to rent out this time, since its not as fresh as it was. As the years go on, the investor is unable to raise the rent because the rental market is so competitive, rent levels are flat. Unfortunately, the same can’t be said with expenses. A couple of cap ex events occur in year 10 that eat up the equivalent of several years’ worth of profit. But the biggest disappointment comes 15 years down the road, when the investor sells and realize at closing that the proceeds are just enough to cover their loan balance.
Under the best case scenario, the pro forma ROI that turnkey providers quote may be hit the first year or two. I'd love to hear from anyone who's achieved their expected 10 year IRR. The only way to win big with turnkey rentals is with significant appreciation. I don't know about other areas, but that is not likely to happen in Chicago in the neighborhoods where the turnkey operators work. Here's an article that provides one explanation of why. Without getting into the sociology, I'll summarize: people don't always behave in an economically efficient manner.
http://danielkayhertz.com/2014/12/05/chicagos-growing-income-donut/
Turnkey operators price their properties based on the income approach (which is typically used on commercial and 5+ unit multifamily properties). But the prevailing model for valuing 1-4 units is based on the comp approach. The problem arises when there is a large discrepancy between the two models. If I own a 6 flat and increase the rents by 50/mo per unit, I’ve increased the value of my building; if I appeal my tax bill and win a reduction, I’ve increased the value of my building. If I do the same actions with my rental house, the value is unchanged. The value of my house is roughly the same as the surrounding houses. My house is not inherently more valuable because its rented out and my neighbor’s house is not worth less because he lives in it. While the ludicrousness of this is obvious on houses, the flawed logic is a little less apparent with 2-4 flats. This is probably why Chicago turnkey operators are focusing on them. I don’t know how they are getting the banks to make loans at these inflated valuations, but I’m guessing they couldn’t get them to play this game with SFHs.
I’ll preface this by saying I’m just a landlord. Unless you’re looking to rent a 2 BR in the South Deering neighborhood, I’ve got nothing to sell anyone. I don’t personally know any turnkey operators in Chicago and have no vendetta against them. I’m just sharing my opinion.
Chicago is segregated and my comments do not apply to the north side, South Loop, Hyde Park, Kenwood, or gentrified areas. The areas of Chicago that have high rents relative to home prices are on the southside, "west side", and southern suburbs. That’s where the turnkey operators work, that’s also where my properties are. For the purposes of this discussion, these areas I'm referring to when I say Chicago.
Chicago turnkey properties are overpriced by a lot, like 90-100k too much. Every example I’ve seen on their websites is priced at least twice what the property is worth as a rental. I’m not talking about appraised value, as a buy and hold investor, that’s not necessarily relevant. Value for me is measured by lost opportunity cost (ie. what else can I get for my money).
There is no financial justification for paying 70k+ per unit for 2-4 flats in the neighborhoods where these turnkey properties are located. I won't refer to a specific example because it wouldn’t be fair to pick on one operator when they’re all doing the same thing, but if someone wants to post the specifics about their particular deal, I’ll be happy to respond with specific comparisons.
So let’s say an operator is selling a duplex for 170k that is rented out for 2200/mo, located in a marginal (with regard to the type of tenant it will attract) neighborhood.
Alternative 1: That same amount of money could be used to buy and fix up a couple of brick bungalows in Chatham or Pill Hill, two of the most desirable neighborhoods in Chicago. They'll rent for a combined 2700, to a higher quality tenant (resulting in less turnover, less management, higher ROI). While the properties may still not experience future appreciation (refer to the article in link above) there is appreciation baked in, achieved by buying it undervalued. In this example, a cost basis of ~65% of current market value. Overall, this strategy is less work, less risk, and earns a higher return than the stereotypical turnkey duplex.
Alternative 2: For those willing to assume more work and risk, in exchange for a higher ROI. The 170k could be used to buy 4 houses in neighborhoods similar to where the turnkey property is located. This would bring in 5000/mo rent. Many of the issues would be the same, but compared to equivalent multifamilies, detached houses are able to attract the best of the applicant pool and command higher rents.
Alternative 3: If asset appreciation is more important than interim cash flow, there are areas where gentrification is most likely to occur. These areas are obvious, and that anticipation is reflected in the prices. In the short run, the property bought for 170k might look and operate a lot like the turnkey duplex. But over the course of ownership, the IRR may be vastly superior because of exit strategies like a condo conversion 10 years down the road.
No matter what the investment goal is, turnkey properties aren't a good way to get there. I’m throwing down the gauntlet to any turnkey advocate. Please challenge me on any of this as it pertains to Chicago. I’d love to hear your case. If you provide the details of a deal we can analyze it here for all to see.
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