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Updated almost 11 years ago, 02/26/2014
1st Purchase - Turnkey Analysis
I've been looking into turnkeys in Memphis and came across the following 4/2 SFH in the 38118 zip code. Though it was built in 1963, it's had extensive rehab work done in the amount of $22,500. The major work done include: refinished hardwood floors, converted the living room into a fourth bedroom, painted, laid new tile and installed new light fixtures.On the exterior, they replaced any rotten wood, painted, installed new fence, pressure washed, and installed new light fixtures. Also put in a new A/C unit, furnace, water heater, and dish washer. The roof isn't new, but has been replaced in the last 10 years. The property management is handled by a company that the turnkey owns. 99% of the time, they do 2 year leases. PM fee is 9%, full months rent for new tenants, no lease renewal fees, no upcharge when any work or repairs are done, but just charge the cost of the repair. They also get very discounted pricing on major work such as replacing roofs when the time comes.
As for references, this turnkey has been recommended by many fellow investors (even here on BP) and I've had a very good experience with them so far. I'm nearly certain that I can put my trust in this turnkey, but my only beef is with the numbers. The projected returns are extremely dependent on the assumptions being made so I'd like to check with the BP to see who's right.
Using the turnkey's numbers, I may cash flow $160/mo with a 9.5% coc return. With my assumptions, I would only cash flow $63/mo with a 3.8% coc return.
My going in assumptions about the property and financing:
Here are the numbers the turnkey assumed:
I felt the 5% vacancy is okay since they do 2 year leases. Even 1 month out of 24 would result in a 4.2% vacancy so I'm okay here. I know the property is fully rehabbed, but 5% for maintenance just seems low especially when thinking long term (10 or 20 years) and because this property was built in the 60s. Given this fact, I'm assuming 10%. They assume a new tenant every 3 years which is an average between 1 lease period (2 years) and 2 lease periods (4 years). Worst case, I'll assume a new tenant is needed every leasing cycle (every 2 years).
Property taxes is an issue that I'm trying to understand. Based on data from the Shelby county assessor of property, the appraisal value in 2013 was $62700 resulting in city and county taxes that add up to $1220. So they're using the correct number and since the next appraisal is in 2017, their tax number is good till then. Though their last appraisal seems like a low anomaly. From 2009 - 2012, the appraisal was $80,900. From 2005-2008, the appraisal was $80,500. From 2001 - 2004, the appraisal is $75,300. These historical appraisal values would indicate that the 2013 appraisal is on the very low side and I'm thinking that future appraisals will likely be higher and so will my taxes. So for an 80,000 appraisal, my total property taxes would be $1564 as calculated by their county property assessor's calculator here.
As for insurance, I haven't gotten a quote yet but bumped it up just for good measure.
Post continued below.
Everyone gets their % and cash flow differently but for me a simple way to look at is is take your ending positive cash flow total for the year and divide it by the total out of pocket cost to purchase and repair the home along with closing costs and you should get your number. It was hard to follow your figures the way they showed up.
- Curt Davis
I figure mine the same way. On this particular deal the only out of pocket I had was closing costs and rehab costs. +/- $5400. and with technically "no skin in the game" my COC looks nice. Now if I would have purchased the house with cash my COC returns would have looked something like 4.2%. It would have went more positive for every 1000 that I leveraged! Not a bad deal for me!!
Now we have had luck charging a "refurbish fee" in replace of a security deposit. We were basically getting 13 payments off a 12 month lease. Most tenants here in Memphis damage up your house pretty good by the end of 2-3 years. They just dont take the "ownership mentality" thing too seriously! At the start of 2014 we did start charging security deposits of $500 and have been implementing the move-in/move-out checklists. I just want my property back in the same manner I rented it out!!
We did this in leiu of a post at SmarterLandlording.com
@Dewayne Gammel Cool!
I hope it works for you, works for us. Let me know if I can help more.
Something to consider when calculating vacancy expenses, most property managers charge you a months rent for placing a new tenant. So if you have one month of actual vacancy while a unit is being repaired and a new tenant is being found, you actually lose 2 months of rent.
@Chris Clothier Thanks for you input. I think many investors who purchase TK are doing exactly as you're saying, buying a perceived value that is suitable to their unique situation.
@Ali Boone Thanks for checking my work.
@Matt R. PM me and we can talk more.
@Kevin Perk You're right, tenants wouldn't have any incentive to keep the property in good condition if they know that they're not going to receive their deposit back, but I think what the PM meant is that from their experience (kind of like @Dean Letfus), they generally need to use the deposit to repair some damage that the tenants cause. Your point about one day selling in an area where mostly investors have purchased and will be prospective buyers is a great point. That and over time, my cash flow will likely get worse due to repairs is exactly what I'd be worried about with such a property.
@Dewayne Gammel 15 properties and still considered a newbie? I don't even know what that makes me then. Thanks for sharing your numbers. Always appreciate actuals. Great returns you're getting by the way. I noticed you're budgeting 22% (10 + 12) for repairs/maintenance and replacements. How old is your property by the way and what condition was it when you purchased? I didn't see it, but does your PM not charge a leasing fee for when new tenants are placed?
@Brant Richardson This PM also charges a month's rent for new tenants. I captured this fee in the row "tenant turnover (every 2 years)". Since it's a 2 year lease, I figure worst case I'd have to pay a full months rent every 2 years. So every year, I would budget for half a month's rent spread across 12 months.
If there's anyone not too shy to share their actuals with a turnkey, I'm sure myself and others would be interested.
it looks like you've done a very thorough analysis of the numbers which is great. Is it a good investment? It depends on what numbers you believe reflect reality. Under your assumptions, it's clearly not a good investment. The problem is you can slice and dice numbers every which way until the cows come home and get them to support whatever you want them to. One of your biggest variables is taxes. I'm not sure what you're basing the increase on partly because I'm not familiar with the Memphis market and how property taxes are assessed there. You need to find that out. You need to understand how Shelby County establishes assessed values. Every taxing jurisdiction has a formula and process they use. Find out how it's done in that county since that's one of your big variables. I'm not sure what basis you're using to forecast some future tax rate. From what others have said, it looks like you might be buying at the top of the price range. If that's the case, then it might already be overvalued and if so, you might not have any tax increases for quite some time. Unless Memphis is seeing exceptional appreciation that I'm not aware of, then I don't see what would trigger the 28% increase in taxes you've assumed. If you think you're numbers are right then there's no discussion. It's not a good investment. If you think the turn key companies numbers are right, then you need to decide for yourself if a 9.5% CAC return is attractive to you. Coming from CA, 9.5% looks pretty good, especially if it's a B class neighborhood which I don't know if it is or not. Can you get a better ROI in other markets? Yes. But there must be a reason you chose Memphis to begin with. Do those reasons outweigh any potential increase you might get in another market? You'll have to answer that question for yourself. There could be some great reasons you'd take a somewhat lower yield. I'd take a lower yield in many markets over what people show on paper in Detroit. The biggest issue I see with the numbers is the cash flow. Even under the best of scenarios, $165/mth isn't terribly exciting. I like to see $200 and above. Lastly, look at your debt coverage ratio and ask yourself if you're comfortable with it. The debt coverage ratio is only about 1.4% because the cash flow is on the lower side. Do you have enough reserves to cover your debt service if the unexpected happens? Sorry for the lengthy post. These are just my thoughts.
Mike
@Mike D'Arrigo Maybe someone here can explain how the property taxes work in Memphis better than I can. I only learned this stuff a couple days ago. Though from what I've researched, properties are appraised every 4 years. Based on the appraised value, 25% of the appraisal is considered the assessed value which is subject to both county and city taxes. The current county tax for a non-Memphis resident is 4.42% and the Memphis city tax is 3.42% of the assessed value (i.e. 25% of appraisal). I didn't forecast what the future tax rate would be, but rather estimated what the appraised value might be and applied today's tax rates. I used an 80,000 appraisal just because in the past 4 appraisals since 2001, the appraisal came out to about 63k (2013), 81k (2009), 81k (2005), and 75k (2001). I don't quite know why the 2013 number is so much lower than the other years. You're right, property taxes definitely seem like they can vary over the years so my thinking was to just take the high estimate and if never gets appraised that high, only better.
I'm not fixed on the Memphis market. Being in Southern CA where there's so little cash flow if at all, I'm open to looking into any out of state market where there's both cash flow and growth. I'm still new...like 2 months new, so I've only gotten so far as researching Dallas Fort Worth and now Memphis. Perhaps from this thread, I'm learning that I should start considering other markets as well.
you're doing a great job for only 2 months. You're analysis is very detailed and thorough. Keep it up and you'll do very well. My only advice is not to overanalyze to the point that you never take action. That's a big danger starting out. Do your due diligence thoroughly, review it again and make the best decision from there.
maybe I am missing something but I can never understand why it is sometimes OK or justified to pay above retail for a property because the supplier promises you something special? Am i missing something.
Real Estate 101, you make your money when you BUY.
There is never, ever, ever a reason to pay more than the property is worth. It is financial suicide.
In some markets, like my native New Zealand where we have 10% capital growth average year after year it can be sort of justified as you know values will catch up but here in the USA it is just nuts to pay retail as an investor for a property.
It may take decades for a property in Memphis to appreciate to where it is worth what you paid if you are paying 20 to 30% ABOVE retail.
Tell me how this can ever be a good investment strategy?
Dean Letfus I believe that buying over retail is only a good and proven strategy when you are the seller of said property! However I completely agree with you that you make your money when you buy.
O'brian Rossi property was built in 1956, it was in good condition, just outdated. Previous owners had just installed new kitchen cabinets and countertops. We had to refinish hardwood floors and paint, and some other minor work. Nothing major, was rented within 2 weeks of buying. Let me remind you this particular deal was my very first buy and hold!!
I pay myself my own property Mgmt fee. That is why I budget 10%. You can easily get 6-10% around here. And you do not always get what you pay for!!
As far as my budgets for r&m and replacements...
r&m would be used for any repairs such as a item in my rental breaking or being abused.
Replacements would be for any improvement needed to keep a tenant there longer.
As Kevin Perk eluded earlier in the post your BIGGEST EXPENSE is tenant turnover. So I personally include a higher vacancy rate(10%) as well as the higher r&m (12%) and add replacements (10%) (which are technically capital improvements).
As most people have stated in this post, if the numbers are not satisfactory then move on...if not and you can accept those numbers do the deal! Don't sit on the sidelines, but be aware that all kinds of problems can arise from rentals as well as from being an out of state owner.
Hence making sure your numbers work in a worst case scenario.
and as for me being a newbie after 15 deals...most of the guys on this site that are from Memphis have well over 50 units. So yes I am still learning from those guys as well as others!
Hope this helps...
Yes, yes, and yes, what Dean said. I can't say it any better.
I don't know why anyone would pay retail for anything in Memphis. The properties I work with are nicely renovated and in good areas and still sell for 10-20% below fmv.
Best of success to you O'brian
@Matt R. It's not just this turnkey provider whose management keeps the security deposit. Every property manager I've dealt with keeps the security deposit rather than giving it to me. They give it to me if there is anything leftover at the end, but not before.
It's already known that turnkeys won't give you the same returns as doing everything on your own. But doing everything on your own isn't for everyone either, so turnkeys are a cool option. It's quite obvious they aren't for you and you aren't a fan, but most of them are legit and offer a cool opportunity for people who can't do otherwise. Go easy on us turnkey buyers :)
Originally posted by @Ali Boone:
It's already known that turnkeys won't give you the same returns as doing everything on your own. But doing everything on your own isn't for everyone either, so turnkeys are a cool option. It's quite obvious they aren't for you and you aren't a fan, but most of them are legit and offer a cool opportunity for people who can't do otherwise. Go easy on us turnkey buyers :)
For sure Ali. I understand the pm holds security. I think the owner needs to supervise security is my position. TKs are great. I am sure the successful TK operators are that way for good reason. They don't do it for free obviously and deserve to be rewarded accordingly. On the other hand some TK outfits seem to offer questionable properties systematically. I am positve the ones you associate with are rock solid:)
Thanks again,
Matt
@Dewayne Gammel Running numbers from a worst case scenario is definitely what I plan to do regardless of what reasons a tk may tell me. Sure it's rented out now and fully rehabbed, but what about in 10 or 20 years? Budgeting that extra expense now creates a good margin of safety and if it's still cash flowing with those conservative numbers, I'll pull the trigger.
@Dean Letfus Whole heatedly agree with you. Thanks to you and @Kevin Perk for sharing comps in the area to give me a perspective of where their price stood.
Thanks @Melodee Lucido, @Dave Olverson, @Robert G. for your comments and support.
You are welcome!
How does a person determine when buying a property in expenses 20yrs down the road? If you buy a home today and put in a new hot water tank, roof and HVAC, there is a good chance you will have to do that all again 20yrs from today. Everyone does their own way but looking 20yrs down the road is the first I have ever heard of that. How could any deal ever stack up price wise?
- Curt Davis
Thanks to you too, @O'brian Rossi - this has been a great discussion.
@Curt Davis The point I'm making is to just be conservative when running one's analysis. So even if a rental is fully rehabbed with a tenant in place at the time one is considering to buy that property, one should still treat it as if it will need regular maintenance and experience vacancy. In the case of a turnkey that has very little maintenance/repairs during the first year or two and no vacancy because it was just rehabbed and rented at the time of purchase seems to represent the best case scenario. Here a 5% maintenance and 5% vacancy may well be valid for the first year or two. Longer term however, I'd be more comfortable bumping those numbers to 10% maintenance (at least) and 8% vacancy. This way, I am building contingency into my investment so that I can better handle unexpected expenses in the future. I won't know what that expense may be (h20 heater, new roof, etc.) or when it will occur, but that's exactly why I'd want a margin of safety accounted for in my analysis.
I manage quiet a few in 38118--some have done really well and some have done really bad. That is single family investing. I pulled out of 38118 as I see gangs have taken that Parkway Village area over. My friend in the OCU (Organized Crime Unit) for MPD says that area is the most gang infested area of Memphis right now. As Daulton in Road House says, "It is going to get worse, before it get's better."
Plus a contractor in our industry was murdered over there in October--that was the straw that broke the camels back for me.
Much better, safer areas to invest. But for the right price--you can be successful over there. If you are buying at $80,000 + over there, you need to be realistic that you are stuck in that property for several years as owner occupants are few and far in between. I just posted a blog on Bigger Pockets about what is more important, The House or The Area. You should take a look!
Good Luck!!!!!!!!!!!!!!
- Alex Craig
- 901-848-9028
Wow..that's hairball. Is this zip really that dangerous? I found this anecdotal review from 2005, see below. The houses look decent. Is it just landlords keeping them up? Is it that bad?
Here is the wonderful story for this hood.
DO NOT MOVE HERE !!!!!!If you like to live then don't do it. I lived here and my husband worked here and we saw too much death and people being shot and stabbed. too much gang activity.My children couldn't even play at the play ground. My children were outside and a police officer was shot and killed here. THEY HEARD THE GUN SHOTS!!!! The schools are horrible also.I had to send my children out of state to live until we could get out !!!! I will never again be back in memphis!!!!