Two Ways to Force Appreciation with Turnkey Rental Properties
How many times have you heard that forcing appreciation is the key to being profitable with real estate investing? And how many times have you heard there's no way to force appreciation with turnkey rental properties?
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Surprise! There are two ways to force appreciation with turnkey rental properties.
But first, let me make sure we are all still on the same page with terminology here. I don’t want to leave out anyone who is newer to the real estate game and may not know what I’m talking about.
- Forcing appreciation. This, for example, is what flipping a property does. You buy a cheap distressed property, you rehab it, and suddenly the value of the property is higher than the cost of the property and the rehab combined. It's like magic money! So maybe you buy a property for $50,000 and then you put $50,000 into rehabbing it, and all of a sudden it's worth $130,000 instead of just the $100,000 you put into it. So you are forcing appreciation by going in and doing that rehab. This is also the premise behind the BRRRR (buy-rehab-rent-refinance-repeat) method you might have read a lot about. You are going into a property and increasing its value by rehabbing it and renting it out. You are forcing it to be worth more.
- Turnkey rental properties. Technically this means that a property is in rent-ready condition when you buy it, and in more in-depth levels of turnkey, it may mean there are already paying tenants living in the property. The idea is that all you have to do is “turn the key” [in the door]and boom, that’s it. It may be spelled “turn-key” on occasion. So while the term turnkey really actually only applies to the condition and status of a property, meaning it could be any property, quite often if you hear people talking about buying turnkey properties, they are talking about buying the property from an actual turnkey provider. A turnkey provider, in this context, is a company who produces turnkey properties in bulk and sells them to investors. Buying from a turnkey provider would be a different experience than just finding an individual property on your own that could be appropriately labeled. Neither is better than the other necessarily, they are just different and I only specify the two so you have a clear picture of turnkey options. Usually, if I refer to turnkey properties, I am referring to properties sold by turnkey providers, but it really doesn’t matter which I’m talking about as ideas expressed in this article are the same for either.
Now that we have our terminology defined, let’s get back to this claim that you can’t force appreciation with turnkeys.
Oh, one more clarification about the turnkeys and why people make this claim. Most often, turnkeys are sold close to market value. It makes sense, of course, because the property isn’t distressed in any way so there wouldn’t really be a reason to discount the property. If they are sold at market value, you’d be hard-pressed to suddenly value the property any higher when the market won’t support it (i.e. you can’t just charge someone any amount you want for a property, you have to base it off the market value). Even if you could somehow get away with valuing the property at a higher value, what would you do to create that higher value? A turnkey property is already freshly rehabbed or renovated and tenanted.
So it makes sense that people want to claim you can’t force appreciation on a turnkey rental property because, how could you?
Fortunately, the reality about turnkeys is that they aren’t completely hopeless for forcing appreciation. You don’t do it in exactly the same way you would with a distressed property, and one of the methods isn’t always an option, but there are options.
Hang onto your seat, you’re about to take a ride on the appreciation train!
2 Ways to Force Appreciation on Turnkey Rental Properties
There are two ways which you can try for appreciation with your turnkey. While they are two totally different options, one thing they have in common is that you must decide before you buy a property that you are going to do one or both of these things. You may be able to do both of the options together, you may only be able to do one of the options, or you may be able to do neither of them.
I’ll explain each method as well as the criteria for when you can do each one.
Option 1: BRRRR your turnkey
Wait, what? Oh yes, you heard me. BRRRR your turnkey.
A couple years ago I wrote an article that explained two different kinds of turnkey rental properties. You can check out the article at What Are The Different Kinds of Turnkey Properties? BRRRR-ing your turnkey is what I call in the article “option 2”. At the time I wrote the article, I admit I was a bit more pessimistic about this approach to buying turnkeys due to the risk involved, but after working successfully over the last year or so with a turnkey provider who offers this approach, I have gained some confidence with the idea.
I’m going to trust that you’ll read that article to get a full handle on the in’s and out’s of this model, mostly so I don’t have to write it all out again. But in short, you are following the BRRRR exactly as you would if you were doing it all yourself, but the turnkey provider is doing all of the work for you.
Normally if you are buying a turnkey, the turnkey provider uses his own funds to buy the distressed property, rehab the property, place the tenants, and get it ready to sell to you. Once you verify everything is in place and functioning as advertised, you buy the property and start collecting your cash flow. The nicest part about this model—the normal turnkey model—is there is significantly less risk to you in it because you aren’t putting any money down until you have verified everything. That’s huge! That means all the risk is on the turnkey provider because he is using his own funds to buy the property, rehab it, and tenant it. All of those things are arguably some of the riskiest parts about an investment property. The property could prove to be total bunk for any one of a million reasons, the rehab could end up significantly more costly than budgeted for, and maybe they can’t get tenants in at the rental amount they intended so no investor will want to buy it.
The problem with this model is that once you buy it, the money you put into it is just in there. There’s no sudden forced appreciation, you can’t really pull any of that money back out, and now it’s just a waiting game for cash flow. That’s not a bad thing, but it can pose challenges to people who are wanting to increase their portfolio size with more properties but they only have so many “20% downs” to keep putting down on properties.
The BRRRR version of turnkeys is another story because, if it works right, you can oftentimes pull most of your money back out of the property fairly quickly! The downside is that it's your money at risk while the property is being made up to turnkey status, not the provider's. Meaning, if any of the aforementioned things happen, it's your money on the line and not theirs. Because of this, it's a much riskier model than a standard turnkey. But in return (ha, pun), you may be able to get most of your money back out and use that money to do it all again, all still while maintaining the cash-flowing property that now has forced equity in it. This is a much easier way to snowball your purchases and increase your portfolio much faster.
So what would happen is—you connect with the turnkey provider who is going to do this for you. He shows you the available inventory and tells you what the total cost is going to be. This will include the distressed property cost and the rehab cost. You fork over that amount to buy the property and fund the rehab. The rehab typically takes 4-6 months or so and the turnkey provider is the one doing all of the work. You are hands-off. When the rehab is completed, they place a tenant in the property who begins to pay rent. Once that is all in place, you go to your lender and tell them you would like to do a cash-out refinance on your property. When they assess the property, they will include the fresh rehab and the income-paying tenant. That will maximize the value of the property, and they will base the loan amount off of this value.
Assuming all of this works as planned, you now have a high-cash flowing property, with 20-25% equity in it, and most of your cash back in your hand. Now, rinse and repeat and do it again. In addition to building your cash flow and equity that way, you are also now increasing your tax benefits with each property you buy.
I know it may sound confusing if you aren’t familiar with this concept, but feel free to reach out or write any questions you have in the comments section and I’ll answer them as best I can.
A major disclaimer on using the BRRRR+turnkey method to force appreciation—as I said, it’s your money at risk doing this! In no way do I advocate working with just any company offering to do this for you. There’s a lot to lose if done wrong, and it will be your money lost. The turnkey provider I work with on this style of turnkey, in attempt to mitigate the levels of risk, offers multiple guarantees—appraisal guarantee, fixed cost guarantee, and a rental guarantee. Those eliminate the risk of any of those major items taking out all of your money. So be extremely cautious of who you are working with and only work with the providers that have a proven track record with this style of turnkey.
Option 2: Buy in an appreciating market
This is the one that isn’t always going to be an option. How much a market may be able to experience appreciation is very dependent on the general real estate economy at the time.
For example, right now we are midway through 2017 and prices everywhere are extremely high. There are no markets right now that are expected to see major appreciation. Whereas in 2011, when I started buying turnkeys, there were a handful of markets expecting massive appreciation. At the time, the real estate economy was just coming out of a major crash so there was a lot of room for prices to increase. Atlanta, at the time, was one of the markets that was expecting higher appreciation than just about anywhere. Or, at least anywhere that was also cash-flowing. I bought my turnkey properties right then, knowing it was about to boom, and every one of them ended up more than doubling in value.
Dallas was another big city that this happened to. The time to buy in Dallas was much shorter than in Atlanta…only about a year, two years max…but sure enough, the market boomed all of a sudden and everyone who had bought experienced significant appreciation fairly quickly. Even the turnkeys! I remember just a couple years after buying ~$100k turnkeys there around this time, those properties experienced about $40,000 in appreciation within a couple of years.
So, people can say what they want about not being able to force appreciation on turnkeys, but I can speak from personal experience of having all of my turnkeys double in value that the market can play a big role in accomplishing some fantastic appreciation!
I will say, however, $40,000 in appreciation or doubling a property’s value is not the norm. There is a lot of strategy in that in terms of when and where you buy. I do know that if you are one of those people who waits until a market is ‘proven’, it’s too late. If you are trying to buy in Atlanta now, any appreciation potential is very minimal because we are post-boom. So, sorry, you’re too late. Same for Dallas. Same for Phoenix from way back in the day—anyone remember when there were turnkeys in Phoenix?? I bet most of you don’t. On the flip side, you also have to be careful about assuming a market will boom. For instance, Detroit and Cleveland have been projected to boom now for a lot of years and it still hasn’t happened. There are variables you need to understand about market fundamentals to know how to hit the markets right, but if you are on top of those, the market can absolutely help you with appreciation on your turnkey.
Again though, right now for instance there aren’t really options for doing this because of where we are in the current real estate economy. There are a couple options, but nothing to the levels Atlanta or Dallas hit. So don’t hold onto unrealistic expectations.
Be smart on when and where you buy, and take it from someone whose turnkey properties all doubled in value—the market can help you with appreciation!
Keep in mind, the point in investing in turnkeys is not appreciation. Turnkey’s focus is always cash flow, and cash flow should be the only main variable that you rely on. Appreciation should always be considered a bonus and never part of the final assessment that makes you decide whether to pursue a turnkey property or not. Investing for appreciation is speculation, and that’s not a strategy I’m a huge fan of for real estate investing. Personal preference!
There are risks involved anytime you are banking on appreciation, so in both of these cases—BRRRRing your turnkey and buying at certain times in particular markets—be sure that you are as educated as possible and understand exactly why you are making the decisions you are making!
Anyone else have good turnkey appreciation stories? Any other turnkey investors in Atlanta or Dallas during 2011–2013 who experienced insane appreciation like I did?