3 Important Due Diligence Items When Buying Turnkey Rentals

Having been around turnkeys for quite a few years now — and being a buyer/owner of them myself — I believe I have established in my head a list of the problems I tend to see on repeat coming out of turnkey ownership. Remember that owning a turnkey rental property is no different than owning any other rental property, but the turnkey model does tend to tempt people to slack in some areas of due diligence — areas that become detrimental to the success of the investment.

Knowing the problem areas has allowed me to update my mental list of turnkey due diligence items. From this mental update, I have deemed what I believe to be the absolute most critical due diligence items when going through the turnkey buying process.

There are 3 things.

In no way whatsoever can I guarantee that if you do these three things that you will never experience a headache or unexpected expense with your turnkey rental property, but I will say that 97.5 percent of the problems I have seen people run into with their turnkeys once they have purchased them can directly be traced to a failure in doing thorough due diligence on one or more of these three things before they closed on the property.

Property Inspection

This is your best chance of confirming that you are buying what was actually advertised to you and more specifically, confirming that you aren’t going to have any major repair expenses that you weren’t expecting in the near future. Go wild with this inspection. Ask the inspector anything you want. Even have him give you his impression of the neighborhood! Ask him about the overall quality of the rehab. Hire a second inspector if you want, just so you cover all your bases in case the first one misses something. Make sure the inspector inspects all appliances, even the ones not currently being used due to weather.

I had a property inspected in the summer one time and just a year or so ago I had to spend quite a bit to replace the entire heating unit which apparently was in complete shambles. The inspector hadn’t checked it though because it was hot outside. Had he even looked at it, I would have been able to get the turnkey seller to replace it with a new one, and I never would have had a problem. Have the inspector confirm as much as he can about any potential foundation issues. Are there any notably old parts in the house? Is there anything, anything at all, the inspector foresees you having to replace in the next five years?

Remember, any repairs that are needed before you close on the house will be covered by the turnkey seller. Any repairs that are needed after you close on the house will have to be covered by you! Use that as your motivation to go crazy with this inspection.

And just as another reminder, when you get the inspection report back, there will be a decently long list of items on it needing repair. That’s normal. Just present the list to the seller and let him do his thing (on his dime). You aren’t required to close on the property until it is in the advertised condition. So don’t panic when you see a lot of things on the inspection report. All is good and normal. The only thing that matters is that everything is fixed before you close.

Property Manager Interview

Here is a big one — though very few people do this when buying turnkeys. This is one of the areas where I think turnkeys give people too much confidence, and they end up foregoing the same level of due diligence that they would do when buying a regular (non-turnkey) property. In no way whatsoever are you required to use the property management (PM) company that comes with the turnkey.

You can do whatever you want with your turnkey property once you own it. You can live in it, you can sell it, you can house grandma in it, and you can use any property manager on it you want. With that said, interview several property managers or companies just as you would if you were buying non-turnkey. Don’t assume the one that comes with the property through the turnkey seller is going to be worth a darn! Chances are, they aren’t!

I am confident that the area of business that turnkey sellers are typically the worst with is with property managers. The good turnkey guys are extremely good at everything about the turnkey business — finding distressed properties, neighborhood analyses, rehabbing, negotiating, etc. The one thing they typically fail miserably on, however, is anything related to communication. Well, guess what property management is all about? You guessed it.

I’ve even known turnkey sellers to try to establish communication systems for their PM side to help with this problem, and they can’t even get communication systems set up right! The number one issue I see with the turnkey PMs is a lack of communication with the property owners (you). So when a problem arises, good luck if you as the owner hear about it. Then the problem gets worse when you become aware of the problem and then try to communicate with them about a remedy, and they don’t respond. Suddenly fear sets in, money loss is happening, and you are freaking out thinking you bought a bad investment.

For more information on this issue with turnkeys and their PMs, check out “The Downside to Turnkey Rental Properties No One Tells You.”

The good news — or bad news — is that this problem is not specific to turnkey PMs, but rather it is a rampant problem across the board with PMs in general. This is good news because it shouldn’t deter you from buying a turnkey. It’s bad news because dealing with PMs period can be pretty annoying.

The best thing you can do to both lessen the risk of having PM issues and to avoid feeling had by the turnkey process is to interview a handful of property managers and go with the one you feel most comfortable with. I realize this can be difficult when the turnkey sellers offer incentives like rent guarantees, maintenance guarantees, or scope-of-work guarantees (which aren’t valid if you are using another PM company), but still do it and consider other PMs if you don’t feel good about the turnkey one. I’ll make a suggestion for how to work this at the end of the article.

Tenant Review (OR Eviction Insurance)

Or both! Another thing that tends to slide by buyers’ views without being confirmed is the quality of the tenant who is being placed in the property. This tenant gets placed before the buyer closes on the property (part of the incentive of buying turnkey — having a paying tenant on day one), so it’s very easy for all of that to happen without any input from the buyer.

My hunch is that this is more on the seller end because the seller really doesn’t reach out to the buyer to say, “Hey, what do you think about this tenant we are about to place?” They just place the tenant. You as the buyer should confirm how legit the tenant seems. Ask to see their information. Just as you would approve a tenant for a non-turnkey property, assume you should check this tenant out too!

Before you immediately rule anyone out, ask the PM about whatever concerns you may have, but for the most part, you should feel OK about buying the property with this particular tenant in it. Maybe if you can be in touch with the seller/PM about it soon enough, you can ask to be the one to give final approval before any tenant is placed. Since it can be hard to really rule the roost on tenant placement before you own the property, though, the other consideration is getting eviction insurance. Oh yes, it exists. This could literally save your butt (also known as your wallet).

I recommend eviction insurance no matter what, quite frankly. But to try to avoid major hassle later with tenants, at a minimum you should fully vet and approve of the tenant yourself and/or have eviction insurance in place. When it comes to tenants, this is also when having a good PM in place is critical. PMs will make or break your investment, and tenants are in my experience the absolute most costly thing to a rental property. Since PMs are the ones who will let tenants cost you a fortune or not… see where I’m going with this? The more I think about it — get the eviction insurance regardless. At least until you get used to property ownership and feel good about how things are going.

There you have it — the three most crucial due diligence points when buying a turnkey rental property.

There is a fourth item that has caused problems in the past, so if you really want to get wild, you can also verify all of the advertised numbers — rent, taxes, and insurance. Most importantly, you want to verify how realistic the rental amount expected to be collected is. If the turnkey seller lands tenants paying higher than realistic market value, then when you get new tenants, you may have to take an unexpected hit on your monthly cash flow. I didn’t include this due diligence item in the main list because I haven’t seen much of an issue with it over the past few years. When I started buying in 2011, this was a huge issue and popular occurrence with turnkey companies, but I haven’t seen it in a while. If it has happened, it hasn’t made nearly as high of an impact as the other three issues have. Plus, if you get a good PM company, they aren’t likely to try to warp the numbers.

Any turnkey buyers out there — are there any other things you would consider to be imperative due diligence items?

Let me know with a comment!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.