People seem to be talking a lot now days about “turn-key” real estate investments. In concept this sounds really good – easy. You buy a house that has already been fixed-up, has a tenant already in it, and in most cases ongoing management can be part of the deal. So, all you do is sit there and collect cash flow. I am not dumb, but I am confused…
What about Control?
First of all, if I chose to place my bets on real estate in lieu of handing my money over to a stock broker with apparent talents on loan from God, it is in large part precisely because I trust myself to manage my investments better. Real estate as an investment vehicle allows me to retain control by not outsourcing the management; this is one of the key characteristics of real estate investments. Even if I don’t choose to personally be the manager on site, I am free to hand-pick, train, and manage the manager. I get to see the books whenever I need to, and I am able to respond to management issues and market fluctuations quickly! Control is the greatest advantage inherent to real estate – isn’t this the point?
But the issue goes deeper, since by purchasing turn-key investments you are effectively resigning yourself to the status of a Retail Investor – an investor whose strategy is to be satisfied with investment returns present on day one, without the aim of substantially improving upon those returns through strategic management. The way I see it, the ability to improve returns which is inherent to the real estate market more so than any other market is why sophisticated investors get involved in real estate in the first place.
Efficient Market Hypothesis
The Efficient Market Hypothesis is a theory that the price of a security at any given time reflects all of the available pertinent information. That is to say that at the moment you purchase the asset, the price that you pay reflects the true value of that asset – price setting is efficient. This theory has been around since around the 1960s, and while there may be appropriate application for this theory relative to paper assets, it is completely inapplicable to real estate – and that’s a very good thing.
Real estate is an inefficient market, which carries two advantages. First of all, price-setting in real estate is solely a function of the “meeting of the minds” between the seller and the buyer; the two people, or entities, who make decisions based entirely on their respective circumstances, and having very little to do with the market at large. This makes value in real estate very much a moving target. It also means that a skilled negotiator may be able to negotiate a price which is considerably below the intrinsic value of the asset, which is impossible to do with most other asset classes.
More importantly, the inefficiency of the real estate market allows the investor to apply principals of strategic management and expandability to increase intrinsic value. At times the value is represented with equity, while other times the increase is respectful of income. Regardless, wherever you place the emphasis in a particular transaction, the inefficiency can result in an increase of investment return, which is hugely advantageous.
By purchasing a turn-key investment, however, you’ve foregone the opportunity to fully capitalize on the inefficiencies of the real estate market. You’ve allowed someone else to negotiate the lowest possible price and to apply the principals of strategic management to increase their investment return, while you are paying a price which is much closer to retail. In my opinion, this is not the way to maximize returns in a real estate portfolio.
Sellers of turn-key real estate certainly do provide a service for those buyers who don’t have the time or expertise to find, negotiate, repair, and manage assets themselves. But if you, as a buyer, are lacking in one or more of the above categories, you owe it to yourself to consider whether real estate really is the most appropriate investment vehicle for you.
Are you a retailer of turn-key investments, or considering purchasing one of those? If so, you are likely slightly irritated, and possibly even offended by this article. Want to talk about it?