If and when the sky "IS" falling, will it crash on Turnkeys too?

Question

Hey Guys,

I have some thoughts / Questions for you RE Rock Stars out there....

If the market is looking crash worthy, like my Northern California Market is looking, is this bad timing for turkey properties too?

Do homes in a Turnkey markets (Indianapolis, Memphis, etc.) differ from West Coast homes when it comes to a huge downturn or another crash?

I’m guessing (hoping) that the upside of turkey 50 – 100 k properties is, while they may not appreciate as much or any, they won’t depreciate that much either?

Mike D'Arrigo · Answer

Account Closed Every market is different but if you look at what happened in 2008, some markets like Phoenix, Las Vegas, Atlanta, parts of CA and most of FL were devastated. However, the Midwest tends to be more stable. You don't see the big spike and drops. For Indianapolis, Indianapolis dropped 7.7% from their high to low while other markets saw 40-50% declines. We sell turn keys in Indianapolis and personally, I find it one of the most stable markets in the country. In my opinion, I don't think we're headed for another crash, even in hot markets like CA for several years. The economic and financial fundamentals don't support it like they did in 2008. For instance, new construction is still way down, lending practices are much tighter and the money supply is not filtering in to the economy yet. Banks are still sitting on $1.6B in excess reserves. Until these reserves make their way in to the economy, we're not going to see the hyper inflation that led to the 2008 crash. I had an economist on my radio show recently that talked about business cycles and the next real estate downturn. He predicted the 2008 crash 11 years before it happened. You can hear a pod of the show on my website. Just look for the 8/18/2015 episode in the podcast section.

Shawn Holsapple · Answer

All good points above.

Like Memphis, Indianapolis has historically been a lateral market and doesn't move much either way.

With that said, even if your turnkey rental goes down in "value" the rent, more than likely, will not drop.  So, it doesn't matter how far "down" the value drops as long as you can keep it rented and don't try to sell it as a potential loss.

If it cash flows today @ $100k ARV and $1100 rent, it will cash flow tomorrow @ $75k ARV and $1100 rent...

Douglas Skipworth · Answer

Hi, Doyle.

I can really only speak about Memphis, but I believe the value of homes in our market will not fall very far if there is a market correction because they have not increased significantly.  Memphis is usually a pretty steady market.

That said, investors who buy turnkey deals often pay full price for the property, which leaves them less of a margin of safety (i.e., less equity in the deal).   However, investors who buy from turnkey providers are usually buy-and-hold types as opposed to flippers so they aren't forced to sell when the market dips a bit.  In fact, when the market goes down that's when the true investors back up the truck and buy even more deals!

That's my $0.02.

Hope it helps.

Eric Fernwood · Answer

Hello Account Closed,

You asked a very good question and on the surface it seems like a simple question to answer but it isn't. I will start by stating that the purchase vehicle (turnkey or direct purchase) makes no difference when it comes to how a property is likely to perform in times of economic instability. In my opinion, the only difference might be that since you will pay more for a turnkey property you will likely see a lower return but that is not a factor of economic stability.

Rental stability is totally dependent on the jobs your tenants have. If the tenant's jobs go away, they cannot pay the rent. So, when you are considering a property, consider the major employers where your tenant pool is likely to work. How did these employers and their market segment fare in the last crash? A more likely future risk is how the location is trending. Are property prices increasing or decreasing? Are the quantity and quality (earning power) of jobs increasing or decreasing? You need to consider these factors because ROI and similar metrics are only a snapshot of the market as it is today. ROI tells you nothing about how the property is likely to perform in the future and typical hold times for investment real estate is 10+ years. Also, in times of economic instability there are no "safe" regions or safe metro areas. "Average properties" in "regions" don't exist. You buy a specific property in a specific location and whether your property stays rented (performs) depends on whether the tenant pool stays employed. There is another layer to be considered.

There are a range of rental prices available for any given area. You might have properties renting from $300/Mo. to $10,000/Mo. The occupations of the people who live in a $300/Mo. property are likely very different than people who live in a $10,000/Mo. rental. Because they have different types of jobs they likely have different employment sectors and thus have different vulnerabilities. For example, assume that the primary pool of tenants for $10,000/Mo. rentals are doctors. If the federal government decides that all doctors incomes are capped at $100,000/Year, the tenant pool for $10,000/Mo. is going to vanish. Would a cap on doctor incomes significantly impact properties renting for $300/Mo.? Probably not at all. How does my (silly) example play out in the real world?

Las Vegas was one of the hardest hit metro areas in the US during the last crash. Unemployment exceeded 10% during the 2008 to 2014 market crash. However, like in all crashes, not all income levels were equally affected. We did a study of how single family home rental rates for properties renting in the $1,000/Mo. to $1,300/mo. range in the area shown on the map below fared during this period.

As we all know and reflected in the chart below, the property $/SqFt prices fell sharply during this period.

With the high unemployment rate, falling property prices and large numbers of foreclosed homes coming onto the market you would expect that rental rates would also fall. They didn't. Below is a chart showing $/SqFt rental rates for conforming properties during this period. As the graph shows, rental rates were virtually unaffected by the market crash.

The reason there was virtually no change in rental rates is that the tenant pool for these properties continued to be employed and thus continued to pay the rent. However, if you owned properties and the tenant pool was largely connected to the construction industry the results were very different. Construction virtually stopped in Las Vegas at the beginning of this period and time to rent and rental rates for rental properties catering to this pool of tenants did not perform well at all.

In Summary

• The method you choose for purchasing the property (turnkey or direct purchase) is not a significant factor when it comes to how the property will perform during times of economic turmoil.

• "Average properties" in "regions" don't exist. You buy a specific property in a specific location and whether your property stays rented (performs) depends on whether the tenant pool for that specific stays employed.

• Within the same general location, different economic pools of tenants are subject to different job risks during times of economic turmoil.

Doyle, you asked a great question and I hope I answered it. If not, post another question.

Account Closed · Answer

Thanks All!

Great Points here...

David Hutson · Answer

I also agree with Douglas.  As a buy and hold person though, I kinda wish they would go down in value so that the taxes go down with it.  My taxes on all of my properties are all creeping up.

Memphis is a pretty steady market.  If you look at any of the home values over time Memphis has stayed fairly flat.  So while you may pay full price for a turnkey home it shouldn't go down much, but probably won't go up a lot either.

Stephen Akindona · Answer

I agree with Doug, it's all about how you buy and your exit strategies. Buy and hold guys can be affected by market swings but usually only on paper. We hold our investments through the downturn and then sell only in up markets. Flippers on the other hand can be severely impacted by market swings and lose big! If you buy right and don't over leverage you should be able to weather the storm.

Ali Boone · Answer

Without diving into major details or specifics one way or another-- the general rule is that the markets that appreciate the most also crash the hardest. Markets that don't appreciate a ton, also don't typically crash very hard either.

But where your question gets a little quirky is with the turnkey-specific part of this. The turnkeys have nothing to do with it. As far as 'turnkey markets', those markets vary between them. Indy, for example, is a stable market so usually doesn't go too far up or down. Atlanta was a bigger appreciator so it crashed much harder when the bottom fell out a few years ago, which allowed it to be a great market for turnkeys and appreciation because if you bought at the beginning of the up-cycle, you were golden.

The only thing about this question that does have to do with turnkeys is that markets like those of NorCal or SoCal or any of the big appreciators still won't have turnkeys because of the general prices of the properties. They could, certainly, with a big enough crash, but it's doubtful. Turnkeys typically pop up more in the middle of the road markets....but within those some may grow and crash much harder than others.

Alexander A. · Answer

This is why also it is imperative that there is enough cash flow in any deal you get.   Obviously when its a down market or crash, you don't want to have to sell or you will get bit hard.   You will need to hold it and at worse, lower rents a bit.

If there is enough cash flow in the deal to lower the rents and you still are profiting then I would say that is a winner.   Ride it out!

James Wachob · Answer

Many of my clients bought their first investment homes, in Memphis, from a turnkey/flip company. The markup on these properties was tremendous. Therefore, they are married to those properties until the market shifts.

On the other hand, properties these same investors bought through me. (A RE Broker NOT a flipper) They bought at a fair price and are realizing fantastic returns... no reason to ever sell. Our property management team takes care of everything and sends back the returns quarterly.

Jw

If and when the sky "IS" falling, will it crash on Turnkeys too?

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