What to be Aware of with Turnkey Properties

[Dave Payerchin]

What to be Aware of when Investing in a Turn Key Rental Property

If you are looking to invest in out of town real estate, it is vitally important to be aware that not all brokers or sellers are trustworthy, honest, or straightforward in their dealings. In fact, many commission-driven promoters are eager to find unseasoned investors who are willing to take their income projections at face value. Many new investors are blinded – by their own greed and lack of experience – to the less-than-enticing realities of the hidden costs of turnkey properties, and may be conned into making unprofitable investments based on inaccurate numbers and an incomplete Pro Forma.

Most players new to turnkey real estate investing only look at the projected income they could acquire from a rental property, and fail to take into account total costs of doing business. They may consider normal monthly expenses, but don't include major repairs and the very real possibility of extended vacancies in their calculations of ROI.

It is critical for investors to have all of the facts in turnkey real estate investing, to maximize their return on investment and minimize financial risk. To find and correctly “read” the true projected costs and income inherent in investing in a rental property – especially multi-family properties -- it is vital to have an in-depth understanding of the market segment in which you are investing, and what it can cost to operate the kind of property you are considering. The first step can be to examine the broker’s Pro Forma, but accurate Pro Forma are unfortunately not the norm in cash flow investing.

Ideally a Pro Forma should be transparent and complete, including purchase price, monthly rent, real estate taxes, and property insurance costs, as well as projected major repair and maintenance reserves, vacancy reserves, and property management fees, at the very least. In actuality, the provider often leaves closing costs, fees to finding tenants, maintenance, capital improvement costs, and vacancy reserves out of the calculations, because without them, the numbers look far better to inexperienced investors. Being unaware of these hidden costs can mean a significant risk of losses, unrealistic expectations, and disappointment with actual results for investors.

[Jon Holdman]

Pro-forma = Pre-tend. A seller's made up numbers of what might happen with the property.

Things I'd look for with any turnkey deal, based on having looked at and evaluated a number of these:

Value: Turnkey sellers often overstate the value of the property. Verify the value independently. Watch out for "comps" that are from better areas nearby enough to pass casual inspection or comps that are nicer houses.

Rent: Turnkey sellers often overstate the rent. They sometimes offer one year rent guarantees. Then you discover the rent is lower than you expected. Once the seller stops subsidizing the rent the tenant moves on and you're stuck with less rent than you're expecting.

Understated expenses: Apply the 50% rule. Its the best case for a well managed property, not the worst case if things go badly. Turnkey implies hands off so you will be paying for a PM. And you will be paying for someone to deal with the least little problems.

Shoddy rehab: Its not too hard to slap some lipstick on a junky house and make it look good. Then you're stuck with a never ending series of "maintenance" requests from the PM.

So, instead of the pre-tend numbers the seller gives you up front you end up with a property that's producing less rent, is hard to rent, has ongoing costs to deal with problems, and has expenses that were neglected in the proforma. Then you try to sell only to discover you've been underwater (or at a loss if you put in a significant down payment) from the moment you purchased.

The number one thing I would say you have to do is get on a plane or in a car and go have a look in person at the property and the area. These appear to often be targeted to new investors who are looking for something hands off. Someone who won't look too closely at whats really going on. I'm not saying that all turnkey deals are bad. Some are OK. You're always giving up some of your potential profit in exchange for less effort on your part. Some are really crummy deals. Some border on outright fraud with the buyer being fed a line of bull about every aspect of the property. Be very, very careful about going down this road.