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.

[O'brian R.]

So here are my returns using my numbers:

50% rule as a reference shown below:

If you've gotten this far, bless you!

I'd love to hear what you all think. With fully rehabbed turnkeys, are we still looking at expenses close to 50% or is it fair to make the assumptions the turnkey made or is it something in between?

[Dave Olverson]

Hey O'brian, I am new to this as well and looking at turnkeys, so I don't have much advice to offer yet, but I am absolutely interested in what other BP members have to say about this. Best of luck!

[Matt R.]

Hi O'brian, here is my newbie two cents. Those numbers suck. Not sure if that's an official investment term:) Investment wise, you would be better off in Reit at 6%.

Thanks,

Matt

[Dean Letfus]

You're paying 88 grand in 38118 to get $895 rent??

Run Forrest run, you are being ripped off BIG TIME!!

[Robert G.]

The best-case scenario, which is the first set of numbers you provided, paints the picture of a marginal investment with a slightly sub-par cap rate.

More likely it will come out somewhere closer to your assumptions. With a cash flow somewhere around $50 a month and a cap rate of 6%.

You know the answer here, you just want to hear it from others. The purchase price is too high (and you should probably see if you can put less down so you can leverage more of the deal and get better COC returns).

[Dave Olverson]

This makes sense to me - I figured it was looking like a not great deal. However, as an exercise, would someone be willing to play with the numbers a bit to a level that they WOULD recommend it? For instance:

"I would purchase at $XX,000 at current rent" or "I would need the rent to be at least $X, etc"?

Just trying to get a better sense of these deals. Thanks!

[Curt Davis]

Throw the 50% rule out the window. Simply put, if you can buy a home for say $79,900 that rents for $895, that would be a decent investment and at good price. Everyone calculated their figures differently but we have not had a problem selling homes with that rent to price ratio.

[Liam Goble]

Just like @Dean Letfus says, leave the deal and find another one. For a short period of time, I looked at the Memphis area but only found deals like the one you provided. One of the biggest red flags from some TK providers is the 'need' to put +10-30% over the appraised value to purchase the property. Someone's making a killing, and it won't be you.

Check out some other areas. @Mike D'Arrigo can probably chime in as well, but he usually operates out of KC and Indy. Mike's pricing and numbers seem much more in line with my expectations.

[Curt Davis]

Though its all personal preference but KC and Indy are not as good as Memphis. You just need to find the right deal with the right numbers. There are plenty of people here in Memphis selling that you should be able to find someone who has what you want.

[Dean Letfus]

@Dave Olverson the issue is more about value. Making the numbers work doesn't help if you are simply paying too much as your only exit strategy is to find a bigger fool

For example the last home we sold in 38118 (Medora) were for 65K rented for $975 and we currently have one at 62K, rehabbed which will rent around $900

@obrian rossi That's what that area is worth generally. DON"t PAY ABOVE RETAIL EVER!!

If the rent is $900 NEVER pay more than 70K.

[Dave Olverson]

Thanks @Dean Letfus - I think it would be great if there were a chart like this that basically said, if rent is x, NEVER pay more than y - perhaps I will be able to start one for my personal preferences as I learn more.

[O'brian R.]

This post was meant more as an exercise to check that I'm making good assumptions on the numbers for a fully rehabbed turnkey. So if my assumptions are correct, then I can apply similar guidelines for analyzing other turnkeys.

Obviously it's a bad deal based on my numbers, but if my assumptions are correct, then it boggles my mind as to how this company has so many repeat investors buying their turnkeys who continue to sing their praises. While one may say that these are uneducated investors, but I'm thinking what's factored into their decisions are the subtle benefits of turnkeys talked about in this article, "Do the Markups on Turnkey Properties Kill the Deal".

@Ali Boone Maybe you can also weigh in here.

[Kevin Perk]

Your vacancy rate is low. You will also have many more expenses as the property turns over. Did you calculate in reserves? In my opinion you can find a much better deal with a lot better cash flow.

Looking at the comps for 4/2's in 38118 you will be paying top, and I mean top of the market. Comps range from between $50 and $60K. Looking at the comps also demonstrated that everything was out of state owner. Hmmmmm...wonder why folks from Memphis are not picking these up?

[Robert G.]

Originally posted by @O'brian R.:

Obviously it's a bad deal based on my numbers, but if my assumptions are correct, then it boggles my mind as to how this company has so many repeat investors buying their turnkeys who continue to sing their praises.

It boils down to the market, I think. That and many buyers make purchases with appreciation in mind even when the numbers don't look as attractive.

For example, in the immediate area I live in (Miami), there are tons of SFR in the $250,000 to $300,000 range. These bring in around $2000 a month in rent.

I don't care how you bend it, those numbers don't work. But they sell (and sell well). For a variety of reasons (the monthly rent income being very low on the list).

[O'brian R.]

Originally posted by @Curt Davis:

Throw the 50% rule out the window. Simply put, if you can buy a home for say $79,900 that rents for $895, that would be a decent investment and at good price. Everyone calculated their figures differently but we have not had a problem selling homes with that rent to price ratio.

Do you think that rule is too high or do you just not believe in simple metrics like this? It's interesting that my bottoms-up estimate resulted in 48% of rent lost to expenses and vacancy.

[O'brian R.]

@Liam Goble I believe the low 2013 appraisal value of 62,700 was before the turnkey picked it up and rehabbed it. Though I'm looking into other markets for sure.

@Dean Letfus Thanks for the comparable sales. That's helpful.

[Chris Clothier]

Originally posted by @O'brian R.:

This post was meant more as an exercise to check that I'm making good assumptions on the numbers for a fully rehabbed turnkey. So if my assumptions are correct, then I can apply similar guidelines for analyzing other turnkeys.
Obviously it's a bad deal based on my numbers, but if my assumptions are correct, then it boggles my mind as to how this company has so many repeat investors buying their turnkeys who continue to sing their praises. While one may say that these are uneducated investors, but I'm thinking what's factored into their decisions are the subtle benefits of turnkeys talked about in this article, "Do the Markups on Turnkey Properties Kill the Deal".

@Ali Boone Maybe you can also weigh in here.

Hi O'brian - I found my way to your post from my alerts and laughed to myself when I realized that I sent you a colleague request earlier after our 1:00 meeting and seeing that you found us on BP.

To your original question, the 50% rule is generic and there is nothing right or wrong with applying it to TK purchases. Your decision to use a TK companies' numbers should be based on how and why they reach their numbers and can they show you with data why their assumptions of 38% or 42% or 45% or whatever are accurate. I think each case, each property and each company will be different. It all depends on the comfort level you get from dealing with them as to whether or not you use their numbers or input your own assumptions (or use a mix) or use the 50% rule

I read @Ali Boone 's article a year ago and I thought it was a very good representation or why so many good investors make the decisions they make. I also liked her use of charts...I think she threatened to use more!

They are paying for a perceived value that sometimes others either don't see or they don't need so they put no value on it at all. Perceived value meaning that it is a value that cannot be quantified such as how much time, energy and headache/worry will be saved. It also comes down to comfort level and security. When a company can provide exactly what a client asks for and surprise them along the way with over the top service and performance that was better than anticipated...then they will have a tendency to do what you said - sing praises and buy more properties.

Others will dismiss them and say they were uneducated and could have done better. Of course that is said without knowing a single thing about that investor except that they bought a house from some other company or paid a price for a house that they would not have paid.

Not everyone has the same needs for investing in real estate or desired outcome and certainly not every investor has the same time/energy to put into real estate investing. Ali's article was all about determining if a turnkey property, and more importantly the company, match your personal needs and your needs as an investor. So yes, the subtle benefits of dealing with a TK company that meets your needs as an investor absolutely comes into to play for some investors when they are buying investments.

[O'brian R.]

Originally posted by @Kevin Perk:

Your vacancy rate is low. You will also have many more expenses as the property turns over. Did you calculate in reserves? In my opinion you can find a much better deal with a lot better cash flow.

Looking at the comps for 4/2's in 38118 you will be paying top, and I mean top of the market. Comps range from between $50 and $60K. Looking at the comps also demonstrated that everything was out of state owner. Hmmmmm...wonder why folks from Memphis are not picking these up?

That's really interesting about out of state owners in that area.

As for the reserves, I figured I'd budget the 10% for maintenance whether it is needed or not until I have $5k set aside to deal with any larger items. Also with turnover, the turnkey provider says that they'd keep the tenant security deposits to used toward making the property rent-ready again and any leftover is given back to me. They said keeping the security deposit is standard in TN, which is news to me because out here in CA I've always gotten my security deposit back as a renter.

[Daniel Guillermo]

Originally posted by @Curt Davis:

Though its all personal preference but KC and Indy are not as good as Memphis. You just need to find the right deal with the right numbers. There are plenty of people here in Memphis selling that you should be able to find someone who has what you want.

Out of curiosity, what makes Memphis a better market? I don't own property in either of these markets but have analyzed properties in both Memphis and Indy and find that usually Indy has better cash flow. I'm curious, what am I missing.

[Kevin Perk]

@O'brian R.

"...keeping the security deposit is standard in TN" is news to me as well. I think the Tennessee Landlord Tenant Act, which applies in Shelby County, would beg to differ.

Plus, going into a rental agreement knowing that the security deposit is going to be kept regardless of the move out condition is really starting off on the wrong foot. What would your feelings be towards the landlord in such a situation? How would you return the property when you move out? What incentive do you have to return the property in decent condition?

Now, if our tenants have caused damage, yes we are going to use their security deposit to repair it upon move out. However, we regularly give over 90% of our security deposits back. So no, keeping security deposits is not, nor should it be, standard.

Think about this as well. One day you will likely want to sell your investment. In an area dominated by other investors who will you be selling to? Will they pay retail prices or will they be looking for a deal? When you are ready to sell, how much will you have to spend to rehab the property? After a few years of being a rental, it will need updating and rehab. How much will that updating/rehab eat up the cashflow you have made over the years?

I'm not saying not to invest in real estate here or anywhere else. But in real estate you make your money when you buy. So you have to be sure to buy it right.

[Ali Boone]

Heyo! Here I am :)

I think you are running numbers well. You mentioned in one post you know it's not a great deal but were wondering more about the numbers. If that's the case, I think you are looking at them fine. As far as the deal goes, I wouldn't call it a bad deal but I would say that you can get the same numbers (returns) in much more booming markets and with houses much newer and in better locations. I personally am not a fan of Memphis, but if you do buy there I hope it's through MemphisInvest (maybe this one is?). @Chris Clothier is amazing and the only one I would buy through in Memphis. If this one is through them, it would make sense to me why people keep buying from them. From my experience talking to Chris, they have an extremely sound business model and keep everything at good quality which will always trigger repeat buyers. Once you find someone who you have a good experience with, it's natural to continue buying from them regardless of the returns. Sometimes lower "returns" actually end up being higher than other projected returns simply due to higher quality.

Not sure I helped much? If you have any specific questions, fire away!

[Matt R.]

O brian, something does not feel kosher with this part "turnkey provider says that they'd keep the tenant security deposits to used toward making the property rent-ready again and any leftover is given back to me. They said keeping the security deposit is standard in TN" ...

In theory makes sense but in reality ummmm...not.

Tell them it's your standard policy that you keep 100% control of 100% of your security deposits.

Which TK company is this?

From a small business perspective it's just another way to get shorted at the end of the day. In business, you keep all the money all the time. I don't want to get nickled and dimed especially via accessing my security deposits without prior notice and pics of exact damage with multiple estimates. Those are totally seperate accounts in CA as you know. Maybe I am off on this...hopefully the TK pros can clarify.

Thanks,

Matt

[Dewayne Gammel]

I personally consider myself a newbie, even though I am 15 deals in, because I am still learning. However I have completed multiple deals in 38118 as well as own 1 property in that same zip code.

My deal looked like this:

Purchase	42000	owner financed $0 down
Closing Costs	1200
Rehab	4200
Rent	875	10500	100%
Vaccancy	87.5	1050	10%
Taxes	76	912	8.68%
R&M	105	1260	12%
MGMT	87.5	1050	10%
Replacements	87.5	1050	10%
FD Insurance	31	372	3.54%
GL Insurance	33	396	3.77%
Mortgage	200.51	2406.12	22.92%
Total Expense	708.01	8496.12	80.91%
CashFlow	166.99	2003.88	19.0900%
Cash on Cash	37%

[Dean Letfus]

I would say we have less than 1 in 100 when the tenant gets their deposit back. It's partly a Memphis thing. The tenants stop paying early as they are leaving and even in B areas there is often a lot of work to do on the turnover.

[Dewayne Gammel]

Sorry for the long message... I cannot figure out how to add a document or a picture. Or maybe the file is too big?? Not sure.