1st Purchase - Turnkey Analysis

[O'brian R.]

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.

[Curt Davis]

All these zip codes are hit or miss. All have good and bad areas. Certain areas in that zip are trending away from being a place to own. I personally have homes there and they do very well. If your in the right area it can be good. This is why it's critical to have a good mgmt company or a turnkey company that doesn't sell in the hood.

[Matt R.]

For sure Curt, it looks like there are good pockets in that zip. There are more rentals than occupied now and trending I guess that way. The residential streets on surface look B ish. No abandoned homes and not many looking bad at all. It amazes me that such quality can be such a hit or miss. These homes would cost so much more to build new and the proximity to good jobs etc...In a lot of cities these would have been rediscovered as desirable locations. Still amazed how quality goes so far south. I wonder what that exact area will look like in 30 years.
Thanks,
Matt

[Alex Craig]

Matt -- the blog I wrote hits on the point of buying into areas that are sustainable. If an area is going South, it will probably continue upon that route until finds that spot where the area will become stable. I manage a couple of homes for Curt in that Zip Code that do well; the area is always easy to rent too. But the crime is there, no doubt. The returns in 38118 should be higher then other areas of my great city as the risk is also higher too.

I want to address property pricing on O'brian's property. While that is high for 38118, he does have a new AC, Furnace, H2O tank and dishwasher which represents about $4,700 (not including Property Management mark up's) in capital expenses that do not have to be addressed for 15 years +++. At that price point, I would like to see a brand new roof. I believe you were paying around $87,000, which is $22,000 more then Dean's property. You have to evaluate the condition of the house, age of system, quality of rehab which would be verified by a good property inspector. Then you would have to evaluate the service of the $87,000 provider versus Dean and the area. One pocket of 38118 may be stronger then the other pocket. The value of a turnkey provider to stand by their product is priceless. At $87,000 I would expect you to have virtually $0 in maintenance in year 1 and not much in year 2 and 3. Then you need to evaluate the sustainability of the rent. The $87,000 house should be the nicest house in the area and look retail ready. The $895 is sustainable if you commit to keeping the house in the condition when you first bought it---most investor don't. I think anything over $895 in 38118 is asking for disappointment down the road, but even at Dean's price of $65,000, even a rent of $850 is good. Dean, I am not picking on you, just using your property as comparison and point to think about. As far as I know, Dean's property could have gold plated cabinets, granite, marble, etc.

I sort of rambled here, but the point is, it is hard say one deal is better then the other without looking deep into the condition of the house and age of the large capital expense items and the value of the team you have decided to align yourself.

All that being said, I still think $87,000 is high, you should have virtually no maintenance cost at that and incredible service. Your risk is no doubt higher as the chance of theft is going to be higher in a high crime area. I suggest pulling your AC unit when the house goes vacant and you may want to consider the furnace too. I have seen many AC cages stolen over the years. There are other areas that I like in that price point, but that is a totally subjective opinion. The more crime in the area, the higher the ROI on your Pro Forma should be....higher risk, higher returns. Personally, I would prefer a boring 11 to 13% return on a house in a better area such as Bartlett where rents are $1,250 and selling for $124,900. That is subjective too..........

Just my 2 cents.............

Good Luck

[Dean Letfus]

@alex no offence taken. I agree with you completely but I think that close to 90K in that area is too much even if the whole place was gold plated. It is simply impossible to justify that value in that area. You can NEVER sell that property in this lifetime as it will never be worth the purchase price and that's the problem. Maybe it's my kiwi mindset but in my world you never buy an investment when the only exit strategy is to sell at a loss.
For 80plusK I can buy in East Memphis, Bartlett, Cordova proper where there are multiple exit strategies to home owners, other investors and hedge funds.

[Curt Davis]

You can buy $80k in Bartlett and Cordova but that is surely before rehab.

[Dean Letfus]

Plenty of them need no rehab if. We have bought plenty that only needed 2 to 5K spent on them.
But my point is you wouldn't spend the sort of money Obrian is looking at in a marginal area. it's craaaazy!!

[Matt R.]

Good points Alex and Dean. Makes sense. If the area has cages over the AC, as regular hood practice, that's a red flag for certain. If those ACs get stolen even with cages that's a whole level beyond normalcy. You look at those homes from afar you would not think either would be common.
Thanks,
Matt

[Alex Craig]

I am just trying to give a property the benefit of the doubt. I am thinking that O'brian has shopped the market and found that price to be acceptable for the house and service he is going to get.....so really I am giving him the benefit of the doubt. I pointed out that price is high for that area. A 1 to 1 ratio should be reserved for the Suburbs. Your right Dean, it is not hard to find a deal for $45,000 in 38118 that needs 15k in reno. I routinely get text from Wholesalers in Memphis advertising those. Most recently one on Castleman for $53,000, which could probably be bought for $47,000. Nice all brick house.....Curt probably saw that one.

Dean if you have any rent ready homes at 80k in Bartlett, Cordova or True East Memphis, I will buy each and every one of them. My bank will finance me at 75% LTV and those would all essentially be $0 down deals for me. I would have to push over @Curt Davis to get them though.

I went to the MLS and looked at the 2 predominant zip codes in Bartlett. I found one deal under $100,000 in 38135 and that one is at $92,000. The bank refused by offer of $82,000 on that one. I was in the house last week and it needed easily 15- 20k. There are 4 deals in 38134 under 100k. Average price on those is $83,000 and all of them are in distress.

But if you have them mate, send them to me.

Thanks!

[Dean Letfus]

All my stock goes to my clients man I can't find enough to supply you as well! You're a local you should be better at finding than me :-)

[Alex Craig]

If you are buying at the prices you say you are, then make me a client and I will help you with the ABP on Terry B...HAHAHA, could not resist.

[Curt Davis]

no one is supplying anyone with Bartlett or Cordova homes for say $85-90k and have enough room to make a profit. Now if your selling condos then yes it's possible.

[Dean Letfus]

To be fair Matt Memphis is maybe a bit different. You cage EVERY AC everywhere in this town :-)

[Matt R.]

wow Dean, I learn something new everyday on bp. So you are telling me there are that many criminals roaming the streets of Memphis. That's insane...even the A hoods are caging ACs?

Thanks,

Matt

[Curt Davis]

Matt,

Most investors will cage their AC's regardless of where they are at. Its better to spend $250 to cage it then risk another $1,500+ including freon, unit and installation if it walks away. Some investors will risk not putting a cage on it but me personally I do it on all of my units.

Putting an AC on in a nice area doesnt mean the area itself is bad, you are just making the home less of a target.

[Jake Kucheck]

I'm a little late to this party, but two things here:

1) O'Brian- I'm pretty sure we played little league together in Irvine. You have a pretty unique name.

2) What's up with wanting to go with a turnkey? Why not find the properties on your own, either rehabbed or pre-leased, and turn over to a trusted PM? It seems like you want far more control over all of the different "groceries" that go into a purchase than a typical turnkey will be able to give you.

[Matt R.]

Understood Curt. I have only seen caged ACs in industrial locations nearest D type hoods.

I think I would just razor wire it

up inside the cage. Put a sign on that says "Go for it"

Thanks,

Matt

[Curt Davis]

@Jake Kucheck

If your investing long distance and have never purchased in that market I would suggest anyone to go turnkey first. You will learn so much regarding the city, where to buy and best of all you have someone to call regarding anything about your property. Most turnkey's will also stand behind their product for a time as if you do this all on your own you will find out quickly you are on your own, even if you find your own contractors, PM's, etc....

Very few investors who are long distance can truly do this by themselves. The nominal amount of mark up by the turnkey is worth it to not have all the troubles if not using one.

[Curt Davis]

@Matt

I always wanted to figure out a way to set it up to have a massive electrical charge so when its touched between the hours of 10pm and 7am they will get electricuted!!!

[Jake Kucheck]

Curt,

Kinda have to disagree there. In what world is establishing your own broker/contractor teams, doing your own research, hand-picking your own PM, and having final cut on tenants (if you so choose) a worse scenario than putting blind faith into a company that profits from you continuing to buy (and thus will shape your opinion of good/bad deals to fit their inventory).

I'm not saying turnkeys are bad, but I am saying they sit on the opposite side of the table from their customers. No two ways about that. I do think it is a disservice to tell a new investor that they should go the turnkey route from the start- how are they supposed to learn how to do things right when they will be learning from a company that is doing it wrong?

[Curt Davis]

@Jake Kucheck

You are correct. I can only speak from over 1,000 transactions. A true " New " investor who does buy and hold doesnt know how to or will most likely not have the confidence to do this. I see it all the time at my local REIA club.

If you are an investor who is say for example, new to Memphis but have purchased other properties in other markets, then yes they can do what you suggested.

The turnkey model is the path of least resistance.

Here is an example: You do this all on your own and you find a good property manager. To them you are just another investor. There is no special treatment. You buy a home and 1 month later the hot water tank goes out, its on you. Most turnkey companies, if the exact thing happens they will most always get you a new hot water tank at no cost to you, why?, bc they want you to have a positive experience and hopefully do business and buy from them again.

There is no right or wrong here, just depends on peoples risk tolerance.

[Dean Letfus]

@Matt R.

Curt you do impress me, from Chef to 100 odd sales 2 years ago now over a thousand. You must have sold like 800 houses last year? Man that's so awesome. Why haven't you retired?

[Curt Davis]

@Dean,

Since 2007 I have solld myself around 500 but from the different companies since then I have been a part of about 1,000 transactions.

Trust me, I wish I could retire.

[Dean Letfus]

To add to Curts comments I think most people underestimate Memphis. I have never seen people treat houses so badly nor have I seen so many cowboys in the RE space. Doing it yourself is only for the brave and the foolhardy and the locals. even if not "turnkey" get some good local help.

Even with our own staff and great partners we get ripped off and taken advantage of pretty regularly.

Run Forrest Run!!

[Chris Clothier]

Originally posted by @Jake Kucheck:

I'm a little late to this party, but two things here:

1) O'Brian- I'm pretty sure we played little league together in Irvine. You have a pretty unique name.

2) What's up with wanting to go with a turnkey? Why not find the properties on your own, either rehabbed or pre-leased, and turn over to a trusted PM? It seems like you want far more control over all of the different "groceries" that go into a purchase than a typical turnkey will be able to give you.

Jake -

I think you are right on. Not sure on the little league! But as for O'Brian, I got a chance to meet him last Saturday in OC and he is a nice and bright guy, but even as he says, new to real estate. He has a lot of questions, but does not necessarily want to be hands on. However, he is open to being a little more involved in the process while he has the time. Hopefully, I didn't share more than he would have wanted, but it is important to know what was motivating him as he was looking for opportunities, but struggling with how much time and effort he wanted or even could put in. Really good guy though and smart enough to keep his options open and get input before closing on a deal.

[Chris Clothier]

I think the conversation here got really far away from the original question...not that the conversation and back and forth was not good. He was asking about his numbers and is he calculating correctly. He wanted to know if he should take things at face value or if he should change his numbers to be more cautious and specifically should he use the 50% rule. I think we all would agree that each investor is going to run their numbers differently and you should always use caution and verify data when buying away from home and/or turnkey. Just makes common sense to verify and check and use whatever numbers you need to be comfortable before buying.

I both agree and disagree with some of the other Memphis guys and their comments - not that that fact really means anything! But when I research over there, there are from 12-14 sales in the last 6 months that are 3/2's or 4/2's with purchase prices at or above and all appear to be arms length transactions including financed and MLS sales. Does that mean it is a good deal? Nope! Just means that saying an investor is WAY OVERPAYING may not be accurate. It may not be something that one person or another would buy and anyone can say that they think it is a bad deal. But it may be a perfect fit for a particular investor - especially in light of the points that @Alex Craig made about the repairs and state that a property is in when purchased combined with the service given to the buyer. If it meets their expectations, then it absolutely could be a good deal for that particular buyer.