Do the Markups on Turnkey Properties Kill the Deal?
Absolutely not! Are you crazy?
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Ok, wait, that was a little rash. It's kind of hard to yell about something without at least offering a justification for the statement. So I'm going to offer you an analysis on turnkey prices so you can understand what is really behind the prices of these properties.
The two biggest objections I hear to buying turnkey rental properties are:
- The margin between the listed price and what the seller actually bought it for is way too much!
- I could buy a similar property for much cheaper!
Before I counter both of these, you need to understand that I don’t believe turnkeys are for everyone. If you are extremely handy, or have a phenomenal team of folks who can handle properties for you, or if you just want to be more involved in the process than totally hands-off, turnkeys are not for you. It makes much more sense that you go get cheaper houses and do the work yourself. I may even be envious of you that you are in a position to do that, so congratulations and go have fun with it. For those of you without those resources (or desires) though, hopefully I can make you feel better about paying more but not feel like you are getting ripped off.
Yes, turnkey properties are more expensive. And yes, people involved in the process are making money off of your purchase. Hello, it’s business. Without business, none of us would eat or have a place to live. The guys selling the turnkeys, that is their business. But other than making money, what else does a business do? They provide a service. So before you worry about how much everyone is making, you need to understand what service you are getting for your money. Only then can you make an educated decision about whether a turnkey is for you. Lucky for you, I can break it all down.
Dissecting a Turnkey Rental Property
If a property is labeled “turnkey”, it means (or it should mean) that the property has been fully rehabbed, tenants are already in and paying rent, and property management is in place to handle the property. Sounds easy, right? Anyone can do that, right? Yes, technically anyone can do that. Let’s compare how you can do this yourself versus what the turnkey guys can do.
- Task: Find a property.
If you don’t find a property at a good deal, you’re wasting your time. Making money is the point, right? Preferably you find an excellent deal, not even a good deal.
What you do: Common methods for finding a good deal on a property are: buying foreclosures, buying short sales, shopping at auction, or finding motivated buyers willing to sell at a discount for whatever reason. You might resort to the MLS to look for properties.
What the turnkey guys do: Most often, turnkey providers buy properties in bulk. Meaning they don’t buy one house, they buy 500. Anything bought in bulk tends to be priced lower per unit, so you can get a house for much cheaper when you buy 499 more of them instead of just that one. Turnkey providers also shop at the auctions as do the individuals. Lastly, when buying discounted properties is your full-time job, you tend to have a lot of connections in that field. Turnkey guys know people who know people who know people, and therefore they can snag good deals no one else ever knew about.
- Task: Rehab the property.
The extent of the rehab necessary to make the property functional and/or nice will vary. It could vary from only needing cosmetic work to a property having to be completely gutted and redone. Anything over just cosmetic work is going to require professionals.
What you do: If the work is only cosmetic, you probably do it yourself. No biggie there. For bigger jobs, you will most likely need a general contractor so multiple jobs can get done.
What the turnkey guys do: The turnkey providers have crews who work only on the properties bought by that provider. Essentially all of the work is done in-house.
- Task: Find tenants and property managers.
This task is broken down a little differently because you have two choices of doing this yourself: 1. Be the landlord yourself or 2. Hire your own property manager to do all of this for you. Versus the turnkey provider who does the finding of a property manager for you. But to keep going with our flow of differentiating, I'll compare you doing all the work yourself (not hiring a property manager) versus the turnkey guys having management do it.
What you do: You advertise for tenants, screen them which may include credit checks, reference checks, background and criminal checks, and income verification. You provide all of the legal documents for the tenants to sign and must make sure you are in compliance with all state rules. Then you collect rent each month, respond to repair calls as necessary, handle the turnover of a move-out, and if an eviction has to occur at any point, you have to handle the legal process for that.
What the turnkey guys do: The property managers do all of the above for you. The cost is usually 10% of the monthly rent. So for a house collecting $1000/month in rent, you’re looking at $1200/year. There is no extra fee for using the turnkey provider’s manager over your own.
Have a preference yet? You may be able to judge just from that breakdown whether you prefer to buy a turnkey property or do everything yourself. Maybe you are still unsure, so let me really drive this one home and then address the costs.
The Bang You Are Getting For Your Buck
What I didn’t point out in the above comparisons are the good and the bad of each. A quick summary of each of the same tasks mentioned above:
- Task: Find a property.
The foreclosure and short sale process can be very uncertain and take forever. Auctions are extremely competitive and if you don’t know what you are doing, are at all inexperienced, and/or don’t have a significant amount of cash in your back pocket, the big boys (oftentimes the turnkey providers) are going to trample you. Finding motivated sellers can be done in multiple ways, but it can be very time-consuming. All of these options just scream a lot of work and time. Most often, the properties sold by turnkey providers have a lower initial baseline price than anything you can find on your own and you didn’t have to do any work.
- Task: Rehab the property.
Anything done in mass will be cheaper. Not just with finding good deals on properties, but with rehabs as well. The turnkey providers use standard paint, carpet, flooring, trim, you name it. Since they have so many houses that need these materials, they are able to buy materials in mass and therefore at discount wholesale prices. Guess what, you as an individual can’t get those prices on materials (unless you have a brother-in-law who works in the Home Depot warehouse). So the material costs required to rehab and maintain a property are cheaper for the turnkey guys than they ever will be for you by yourself.
Another way mass comes in handy is the turnkey guys live to fix these houses up. It’s all they do. Therefore, since they do so many, the crews are able to get the rehabs done significantly faster than most general contractors. That saves on major labor costs. One of my favorite turnkey providers in Atlanta has a rehab team that averages only five days for a complete rehab. Tell me what individual you know can do it that fast. And yes, they are high-quality rehabs.
- Task: Find tenants and property managers.
There is a reason the term “slumlording” exists. Dealing with tenants can be horrible. I would never want to do it myself.
Back to the Buck
Now you understand all of these things, how does that tie back in to cost? Because I love PowerPoint and drawing, I’m going to give you an illustration I made myself of the cost differences between a do-it-yourself (DIY) property and a turnkey property. The subject property is a cheaper-end house that needed a decent amount of rehab.
The totals come out to be $55,900 on for the do-it-yourself (DIY) property and $60,500 for the turnkey. In this example, the price didn’t turn out to be too dramatically different whereas some cases it could be tens of thousands in difference, usually because of a difference in level of rehab. When all the rehab costs are on you, you probably tend to skimp out a little on the quality or what you have done just because it’s a rental and it doesn’t need the nice stuff. The point is not to debate actual allocations but more to show you what those different allocations are. For this example, you have:
- Initial Purchase. The price the property was acquired for.
- Rehab Costs. Cost of the rehab.
- Seller Profit. I told you this. Of course the turnkey provider makes a profit, it’s his business. And he really took a lot of work off your shoulders, so he deserves the profit.
- Access Costs. If you buy a house on your own, you will pay a real estate agent fee to whoever found the property for you (I kept this cost extremely minimal for this example). If you buy a turnkey, because most of these are private channels, someone had to get you in, and whoever that is makes a referral fee of some sort. Oftentimes however, there were multiple chains of who knew who and more than one source has to split that one referral fee. So yes, your purchase does include their fee, but remember- if it weren't for them, you wouldn't have this property at all (there's no way because most turnkey providers won't work with random individuals)! And they may not have made as much as you think they did because don't forget, they had their own underlying costs to do the business in the first place.
- Guarantees. Some turnkey providers offer a rental guarantee for some length of time (often a year) meaning if the property is vacant for any reason, you still get paid the same monthly rent. While paying this extra ~$2,000 or so is kind of lame if you don’t have any vacancies in that time, it is also extremely handy if you do! You could easily be out way more than $2,000 in a year due to vacancies. Consider this fee like insurance of sorts.
One more monetary factor with doing the property yourself and going the turnkey route is the difference in resulting cap rate. I'm going to put that graph side-by-side with a graph I created for stress. Yes, stress. While a monetary number may not be readily known for stress factor, I guarantee you it's worth something! Think of the cost difference between the two methods above, and then top it off with cap rate and stress differences.
A turnkey gives you little to no stress. Doing everything on your own will inevitably give you some stress, or if you’re like me and a perfectionist, a lot of stress. Time is the other factor. With a turnkey you are spending no time on the investment other than that required to do the paperwork. Doing everything on your own could take up to weeks of your time when you look at combined hours. How much is your time worth?
So bringing this all together. I’m obviously an advocate for turnkeys, but again, I don’t think they are for everyone. A lot of people I know enjoy the process of finding properties on their own, managing the rehabs, and dealing with tenants. If that’s the case, have a blast with it and do your thing. If you are more like me, I hope you are less hesitant now about whether or not you are getting “ripped off”. As long as it is a reputable turnkey provider, you aren’t getting ripped off. You are paying for services, not spending money that goes into someone’s pocket with no purpose.
I can draw more graphs if you would like.