Turnkey investments and note buying?

Question

What is a turnkey investment? What is a turnkey project? Are these two the same? Or are they different? And I know its an alternative to buy and holding properties but could someone explain to me also how "buying notes" work in real estate?

Jon Holdman · Answer

Bill Gulley is correct.  I'd recommend staying away from turnkey rentals.

Before buying ANY rental, you need to verify a number of factors:

1) What's the value of the property?  Ideally, you would like to buy properties at a value below "retail".  Retail means what you would get if you sold the house on the MLS.  But you absolutely do not want to pay more than retail.

2) What's the rent?  What can you truly rent the house for?   Follow craigslist ads for the area.  Look on rentometer.com.  Drive the area and call for-rent signs.

3) What's the demand?  This is somewhat tied to the rent question.  Do ads and signs linger for weeks or months?  Or do they pop up and disappear a few days later?

4) Does it meet your investment goals?  For many (though not all) rental property buyers this means cash flow.  Many sellers, turnkey and otherwise, omit some of their expenses.  Many, many MLS listings will say something like "this will cash flow with 20% down".  What they mean is "if you put 20% down on your loan then the PITI payment will be less than the rent you can get."  That's not positive cash flow.  A better estimate of cash flow, especially with a property manager, is "cash flow = rent / 2 - P&I payment".

I will acknowledge some folks buy cash flow negative properties speculating on appreciation.   If you're willing to gamble and can afford the negative cash flow, this can work out.  Lots of folks make a ton on money in the bubble run up.  Lots of folks got stuck with cash flow negative rentals that they were too underwater to sell.

For a turnkey, you have to do all the above "due diligence" just like for any rental.  Turnkeys are often marketed to far away buyers who won't really do this.  The sellers are counting on these buyers, often from expensive areas, to evaluate the property based on where they live.  They think its a screaming deal because if would be if it was in their area.  But its not.  So they can get suckered into overpaying for a property.  They rents the seller claims may be guaranteed for a year, only to discover the real rents after a year are significantly less than claimed.  Even good rentals only spin off a few hundred or less, so if the rent is $100 less than you thought its a big deal.  Turnkey properties can be poorly rehabbed.  The target buyer is never expected to actually look at it.  This results in ongoing and expensive maintenance, often handled by the same property manager the turnkey company set provided (or runs.)

Not all turnkeys are bad deals.  None are great deals, though, because there are other parties extracting some of the profit out of the deal.  You may be willing to pay that price for a low effort investment.  If you truly do your due diligence you may find some that are acceptable.  But you MUST do this due diligence.  You MUST travel to the area and look at the houses in person.  If you're going to invest at a distance, you MUST be prepared to buy a last minute plane ticket and travel to the location if a serious problem arises.  You MUST find people on the ground you truly trust.  You are literally handing over your money to them and allowing them to manage your investment.

You list your location as St. Louis.  Before even considering distant turnkeys, I'd do some serious looking more closely.  I strongly suspect you can find good (i.e., cash flow positive) rentals within a short drive of wherever you live.

As Bill also points out, notes are a more advanced investment.  I've not had any luck trying to buy existing notes, but I've only tried a couple of times.  I do have some money that's invested in originating notes.  If you want to be in this business, you really have to have actual cash to invest.  The big lenders do sell notes.  But often to Fannie Mae, Freddie Mac, or to big investment companies.  I don't know if its possible to buy a single note directly from a lender.  But I suspect their are also small lenders in your area that do originate loans for rehabbers.  Attend some REIA meetings in your area and start asking around.

Jon Holdman · Answer

That's the pitch.  All too often these are really shoddily rehabbed junkers, sold at inflated prices with overly optimistic projections of cash flow to naive newbies who don't want to put any effort into buying good rentals.   At the very least you need to do your own due diligence.

Don't confuse buying a property with loaning someone money to buy a property or something else.  When you originate a note (i.e., make a new loan to someone) or  buy a note (i.e., buy an existing loan from someone else who owns it) you're a lender.  You get payments, which are typically a combination of principal and interest.  If you have cash to invest, I think notes have a lot of merit.  They're generally less work than owning rentals.  They are not, however, risk free.

Because most turnkey properties are sold with mortgages, you could buy the notes from a turnkey seller.  Or, work with a turnkey seller to provide the funds to make loans to their buyers.

Matt Devincenzo · Answer

A "turnkey" refers to a rental property that is already rehabbed and rented with management in place. There are companies that specialize in providing turnkeys in cash flow markets to investors in non cash flow markets. For example I'm in San Diego where cash flow doesn't exist, but I could buy a turnkey property in Memphis from one of the providers there.

A note is a loan it can be any kind of loan home, auto, personal, boat... the list goes on. When people talk about "buying notes" they are buying that loan. So the note buyer will now receive the monthly payments and the interest that goes with it. If the person is able to buy the loan cheaper than the unpaid principle balance (UPB) then their "yield" or the interest that they are getting goes up even though the borrower's payment stays the same. That is how people make great returns buying discounted notes.

David C. · Answer

@Brandon Gamblin

Turnkeys cost 'more' than buying a property and rehabbing it yourself - because there is a company buying and rehabbing the property, plus adding on some profit margin.  However, if you are not good at it, it might cost you more to buy and rehab than to buy one done by someone else.  Turnkey implies 'with paid property management' - its more expensive to pay someone to be your PM than to be your own PM(free?  or how do you value you own time?).

Once you add on a Turnkey company's profit margin plus the cost of a property manager, these deals are often left very 'thin'.  The experienced rehabbers and buy-and-hold people here look at the numbers and say you are one capital expense, or long tenant-turn-over from a loss.  They prefer to find the houses themselves, buy them much cheaper and then rehab themselves, preventing the turn-key operator markup.

Experienced guys here try to use the 2% rule - or close to it - where the rent is 2% of the purchase price.  So rent x 50 = price of house.

$500/month rent = 25,000 house

$1000/month rent = 50,000 house

$2000/month rent = 100,000 house

No turnkey company is going to sell you rents at that rate.  They are normally closer to 1% houses.

The experience here says: 50% of the rent of your 2% house will go to operating expenses(owner paid utilities, taxes, property manager, vacancy, tenant screening, property turnover(painting, cleaning), lawn care, snow removal, etc...), leaving the other half for profit + mortgage payment.

If you are buying at 1%, you need to estimate your expenses are lower than 50% for the math to work out.  There is much debate here if its ever OK to use less than 50% for expenses.  The turnkey providers need you to believe that 50% is unreasonable, because their deals fall flat if you stick to it, they need you to estimate 20% expenses.

The only other 'rescue' on these properties at these prices, is that if you believe you are buying in a good market, and that the values will increase, then you can use these properties to 'speculate' - you may be slightly cash-flow-negative, but if home prices go up 10% or 20% and you are leveraged, that will make up for your negative operating income.  Most of the longer term experienced people here have seen this strategy burn their friends and themselves, others believe that over a long horizon appreciation from current levels is a safe bet.

Alex Craig · Answer

Several good points brought up in this thread.  First, I would like to address the turnkey model in general.  Just like any business, there are good and bad, Turnkey is no different.  I have always said, the profit margin of a Good turnkey provider would get very close to eliminating any savings someone could make if they decided to buy, renovate and rent from out of state. I have seen local investors pay 2x the amount I pay for a HVAC system.  But I give my guys consistent work day in and day out.  A good turnkey provider is able to leverage the volume of their Property Management company to get the best pricing.  A individual doing a one off deal will not get that type of pricing consideration.  If you live within the market your are buying, then I suggest going to a local REIA and finding the GOOD low cost individuals that can rehab yourself.  I stress GOOD b/c it is easy to find people to work cheap, but most of the cheap individuals you find will not be professional, do lousy work and quite possibly quit before the job is done.  Cheap is not always better.  If you hire a good contractor, you have all but traded his profit for the turnkey providers profit. If you hire a bad contractor, you will most certainly trade his profit in the short and long term.  Good turnkey providers will also stand by their product.  We warrant our HVAC systems for 180 days and maintenance for 90 days after the tenant moves into the home.  We also encourage our investors to order inspection reports and appraisals too.  The point of the 90 day warranty is that this will help find any defects in the house that we missed or the inspector missed. After all, a inspection will miss things that will be found once someone is actively living in the house, cycling off plumbing valves, maxing our electrical outlets, running appliances simultaneously, etc.  The most expensive post sale check I cut was $1,500 for a plumbing back up in the front yard that caused us to lay new pipe from the yard to the house, install a clean out and repair the front yard from the plumbing work. Those are just a couple of items of why working with turnkey can have its advantages.   Jon is always quick to point out that turnkey is over priced, but when was the last time your fund manager offered to mitigate your losses the day after you open an account with them?  I was curious, so I looked up the best fund managers of all time.  I found that Sir John Templeton was rated the 2nd best fund manager of all time; his fund from 1954 to 1987 had a annualized return of 14.5%.  If a turnkey provider is quoting a 12% return and we all know that some years will be much better and some years will be much worse.  But even if the return panned out to only 10% over the lifespan of a 30 year loan, then  that house would be 4.5% below (which I understand is a lot) the 2nd greatest fund manager of all time.  I think some of the fault of individual investors is thinking that problems are not going to happen with your rental home.  ISSUES ARE GOING TO COME UP!  If your turnkey provider tells you any different--then run! There are several good turnkey providers in my market, some of which are active in Bigger Pockets.  On the flip side, there are very bad turnkey providers. The internet is a great thing, the due diligence you can find on individuals is amazing.

When analyzing the Pro Forma on a property, I always suggest you do that yourself.  We budget set amounts for vacancy and maintenance, but any real estate investor will know that these numbers fluctuate.  If you buy a home that needs a roof within the first few years, then you pretty much blow your projected ROI real quick, so you would need to adjust your Pro Forma to reflect a large capital expense within the first few years.  If that is the situation, the house should be priced accordingly.   I always suggest looking beyond the Pro Forma and look at the condition of the largest expenses and make sure the area is economically substantially to maintain the rents of the house--the ares is more important then the house.  A few other points to consider when evaluating a Turnkey company:

• Do they own property and are they actively buying in the areas they sell
• Length of time in business--I have seen many come and go
• Do they live within the market they operate?
• Can they provide you with General Liability insurance? I think this is important because any reputable business will be concerned of an accident that can lead to a lawsuit.  This is an additional cost that an unsophisticated business will not have
• Is their PM company licensed and operating under a broker or any other certification that is required by the State Real Estate laws
• Do they offer rent guarantees? I think that is a red flag that a turnkey provider is making a fat profit.  I understand warranting the maintenance, but to warrant a tenant seems a little suspect.  We can screen tenants, but if a tenant has died (has happened) then that is out of Property Management control, or if the tenants get divorced and have to move (has happened to), or lose their job, then again that is something that PM can't control.  I am not so sure any intelligent business owner would warrant something like this that can be out of their control
• When you talk to them and ask them the tough questions, do they always have a "to good to be true answer?"
• Do they manage the property--I think this is important as it creates accountability and connection to the property rather then passing off the house and moving on

Those are just a few of the things off the top of my head that I would consider when selecting turnkey. Also, go to the market, check out the house and the area.  I think someone mentioned you are from the St. Louis area--there are deals up there, you should go to your REIA and see if you can learn to do it yourself--that is if you have the time.

Good Luck!

Bill Gulley · Answer

Brandon, I didn't see Jon suggest at all that you should do turnkey deals, in fact, you'll do better staying away from them.

You certainly don't want a note from a turnkey sale, the transactions are usually overpriced which means the note would not reflect a good value to rely on as collateral.

You need a good understanding of RE before you get into thinking about notes, need to be able to fly a single engine fixed wing aircraft before flying a 747. :)

Ali Boone · Answer

I don't know anything about buying notes so can't answer that one. For turnkeys, no you can finance. They are more expensive because all the work is done for you, but to me it's worth it.

Not sure if you are far along enough for this to be helpful, but you asked how to know you are getting a good turnkey-

http://www.biggerpockets.com/renewsblog/2013/04/20/due-diligence-turnkey-property/

Other than those things that you can verify, understanding what makes a good rental in general is helpful. I have some other articles in there you can peruse that may answer more questions.

Brandon Gamblin · Answer

Yes. I know theyre both passive streams of income. But my question is why would they be more expensive? And when you purchase them, you would have to purchase turnkeys outright with cash? Am I correct?

And are you saying that note buying is cheaper and a better investment than turnkeys?

Brandon Gamblin · Answer

John, so what do I need to do to make sure I invest in turnkey properties correctly? How do I know If Im buying a good rental? 
	
	And who can I get in touch with to buy notes? Do I get in touch with lenders that give mortgages to homeowners?

Ali Boone · Answer

I assume you are asking about the two things (turnkeys and notes) separately and not as one option combined? Yes, you can buy rentals in various markets where all the work is done for you. They are more expensive than if you do everything yourself but very helpful to those of us who don't want to do all that work. Note-buying is usually totally separate. I've never heard of anyone combining buying a note from a turnkey purchase (or whatever that wording would be).

Turnkey investments and note buying?

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