An entire vast market in turnkey rental properties has sprung up, basically ventures that specialize in taking a broken house, fixing it up, getting a tenant in it, and then putting it up for sale the moment they’ve got a few months’ income in a row so they can advertise it as a proven moneymaker.
On the one hand, it can be a pretty decent decision to invest in a turnkey rental property because you get to skip to the good bit: the profit. On the other hand, there are several good reasons why you might want to DIY and start at the beginning and work your way to the profit-making stage on your own.
The Argument for Turn-Key Rental Properties
First, let’s define “turnkey rentals.” There are some companies who advertise “turnkey rental” properties as houses that have been fixed up and are ready to rent. That’s not good enough. A turnkey rental property is one that has been fixed up and is being rented. It may or may not have property management already attached to it, but it is at the minimum being overseen by the current owners and hasn’t had any meaningful problems in the last few months.
The argument in favor of buying these properties comes in four parts:
When some other company goes to the work of deciding which of the thousands of relevant properties is going to be able to be profitable—arranging and overseeing its rehabilitation, marketing for and signing a tenant, and (usually) hiring a property manager—it’s not hard to take over from there. In the ideal situation, you sign some papers, tour the property, shake hands with the PM, and start collecting rent. Piece of cake!
All that work isn’t just work, it’s long work. It’s not uncommon for a DIY investor to spend two months researching, one month purchasing, three months renovating, a month advertising, and finally you get to collect your first month’s rent. Eight months later. That’s a huge amount of time to wait to become cash-flow positive!
You may go the DIY route and put in all time and effort in developing a property, only to find in the end that you made one or more critical errors: picked the wrong location, picked the wrong property, overspent on the purchase price, overspent on the renovating, overestimated the rental market in price and/or demand. Any of these errors may lead to you losing money instead of making money.
A Matter of Diversifying
When you’re comfortable picking and buying turn-key properties, you can insulate yourself from localized shocks to real estate markets by purchasing properties in a number of widely-varying locations.
The Argument for Going DIY & Doing It the Hard Way
There’s a good reason for the phrase, “Nothing worthwhile ever came easy.” So let’s dial back our perspective a little bit and talk about why you’re investing in real estate at all. The reasons to choose real estate over stocks (for example) are fairly well-established:
The ability take out a loan (mortgage) and thus invest someone else’s money to turn your own profit. So long as you make a greater return than your mortgage’s interest rate, you’re winning this game—and you can do that by purchasing properties below their market value and then cranking up the value with a bit of rehab.
Real estate isn’t as volatile as the stock market—if there’s a big shift coming, it’s not that difficult to get ahead of it, and even if you can’t, it’s a lot less difficult to ride it out and sell once things are on the rise again.
When you buy a property, you are in control of that property. You can have it renovated to your specifications. You can set your level of rent. You can choose the property manager you feel most comfortable with. Heck, you can even choose the neighborhood and building that you think has the best chance of turning a profit.
Now ponder what happens to those great reasons for choosing real estate when you invest in a turnkey rental property. Leverage isn’t going to happen, because you know full well that the turnkey company has already purchased well below market price and is selling it to you at very close to full value—so they’re milking that cow before you get your hands on it. Control? You don’t have it! Once you buy it, sure, you could decide the current PM is awful and the home needs new work, but at that point, you’ve lost all of the advantages of a turnkey in the first place.
There are other potential pitfalls with turnkey rentals that boil down to you not doing the proper research and buying on hype. Here are some of the issues we’ve encountered when taking over management of properties for owners that purchased them from turnkey rental sellers:
Just because someone is advertising that a property is in a great location doesn’t make it true. We’ve seen many investors buy properties in terrible areas based solely on hype. Don’t rely on the company or person you’re buying the property from! Even if they are ethical, they are naturally biased. Hire an independent third party to evaluate the location and neighborhood.
Unfortunately, there have been several occasions where we’ve discovered that a turnkey rental was poorly renovated. Often major maintenance issues were deliberately hidden. The owners were of course very unhappy about our news, and several tried to pursue the turnkey selling company for reimbursement, with zero luck. Hire an independent third party to professionally inspect a property before buying it. And don’t take a referral from the seller, as they may be in cahoots with the seller.
Lastly, we’ve found that the quality of tenants in the turnkey rentals we’ve taken over management of is well below average. Many we ended up evicting for nonpayment shortly after taking over management. So, just because a property is advertised with a “paying tenant” doesn’t make it so. Rent ledgers and receipts can be easily faked. Ask for copies of rent payment checks and money orders, and if they’re not available, ask for bank deposit records accompanied by deposit descriptions (if deposits have co-mingled rent payments).
So in short, while turnkey property investment has some distinct advantages—and you shouldn’t ever discard the idea of buying a turnkey property out-of-hand—you should make sure that you understand why a turnkey is what you want and thoroughly investigate. Turnkeys might feel like a “genuine” real estate investment, but in many ways, the “turnkey-ness” itself could be robbing you of the biggest reasons to get into real estate in the first place!
If you’re already saddled with a turnkey that isn’t living up to its potential, remember the central truth about residential property investment: It’s better to have good management of a bad property than vice versa. Switching to a serious PM is the first step toward saving many a bad turnkey investment.
Would you rather invest in turnkey real estate or do the work yourself? Why?
Let me know with a comment!