Turnkey sellers - why are expenses ignored?

Turnkey sellers - why are expenses ignored?

Investor · Cincinnati, OH · Member since 2010 · 1k+ posts · 928 votes

It seems that turnkey sellers are sprouting like mushrooms, not unexpected giving all the distressed inventory being snapped up.

Current practice by the largest turnkey sellers strikes me as questionable. Here are actual properties for sale on the sites of two of nation's largest turnkey companies, who enjoy preeminent reputations in the industry.

Company 1:
Sale Price: $109,900
Down Payment: $21,980
Closing Cost: $5,500
Total Investment: $27,480
Monthly Rent: $1,125
Monthly PITI: $725.68
Monthly Management: $90.00
Monthly Cash Flow: $309.32
ROI: 14%
Price Per Sq Ft: $73.00

Company 2:
Purchase Price= $89,150
Monthly Rent= $825
Taxes/Insurance -$135
Management Fee -$35
Monthly Expenses -$170
Monthly Income x12= $7,860
Yearly ROI= 8.82%

OK, if you've on BP longer than 30 seconds, you'd quickly see that there is no vacancy, maint/repairs, or capital reserves. Really?? How do they ignore these items, you ask? Well, in most cases they offer a Year 1 guaranty of net operating income, and teh possibility of purchasing a maint. plan for later years (though the cost of this plan is not included, and at any rate it's not going to replace your roof or your old furnace).

Plus, they point out that the properties are nicely rehabbed, in solid neighborhoods with high rental demand, tenants are rigorously screened, and to cap it off, the buyer may well sell the property at a big gain well before these repairs and capital expenses start hitting (remember, you presumably "captured" a boatload of equity when you purchased), at which time you can roll into another property.

At any rate, if you hold the property, the assumption is that Years 2-30 will experience none of these expenses.

Yes, these other items (vacancy, maint/repairs, capital reserve, evictions, etc.) are assumptions, but they are nonetheless highly predictable over time. We all know this, it's common sense.

So the question is: why do they do it? Does using higher expense assumptions depress the yield assumption to the point where no one will buy? Perhaps, especially if you're selling at relatively low gross yields anyway. But still, the net yield (assuming a more realistic 45-50% expenses/vacancy/capital) is considerably better than most alternatives.

Maybe it's this: they like you to lever up so that you can use your capital to buy multiple properties (meaning multiple sales and higher prop mgmt and maintenance residuals from tending to all these properties). However, this levering wouldn't make any economic sense for you if the true net return (cap rate) barely exceeded the borrowing rate. So it's vital that net returns be portrayed as materially higher than the borrowing rate.

It's usually the smaller, newer companies that are at least acknowledging these expenses, though they often understate them (vacancies at 5%, maint/repairs/capital at 5% is common).

I'd love to hear insights from others on this. It would seem to be in everyone's best interest in the industry to have reasonable standards for illustrating expected performance on rental real estate. No one wants, gulp, heavy handed government regulations to address all the disgruntled future investors/constituents...

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J ScottPro Member
Moderator
Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
14y
Originally posted by Curt Davis:
Regarding not seeing vacancy or maintenance, we do not ignore them and we tell all our clients whom we are working with about that being a reality.

But, by specifically stating a "Cash Flow" number that doesn't include these expenses, you ARE ignoring them.

To not ignore them, your cash flow statement should be, for example:

Cash Flow: $309 MINUS OPERATING EXPENSES

At very least, you should include a disclaimer to the effect of, "The Cash Flow and ROI numbers do not reflect the inclusion of operating expenses; actual cash flow and ROI will be lower." If you did that, I would agree you're not ignoring operating expenses.

You can argue semantics all day, but if you state a cash flow and ROI numbers that don't take into account operating expenses (and doesn't mention that you're not taking them into account), you are by-definition ignoring operating expenses.

I'm not saying you're acting unethically and I'm not saying that you're not running your company completely above board; but I am saying that -- assuming the OP's cut-and-paste of your deals is accurate -- your claim to not be ignoring expenses is inaccurate.

See this reply in the discussion

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  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
    14y
    Originally posted by Chris Clothier:

    The bigger companies all are trying to give less info. on the front end...

    There's a HUGE difference between giving less information and giving inaccurate information.

    An example of giving less information would be not to list cash flow or ROI numbers for a particular property right on the website.

    An example of giving inaccurate information would be to list the cash flow and ROI numbers, but to exclude operating expenses in the calculations.

    The OP was specifically referring to companies that do the second thing (inaccurate information), not the first thing (less info).

    So, while I agree with you Chris that there is nothing wrong with giving less information (for example, omitting cash flow and ROI), I personally believe it's highly unethical to give purposefully inaccurate information (for example, giving cash flow and ROI numbers that don't include OE).

    Do you agree with that?

  • Curt DavisBusiness Member
    Flipper/Rehabber · Memphis, TN · Member since 2008 · 5k+ posts · 2k+ votes
    14y

    So what your saying is that if a company shows Rent minus PITI and property management fee to get a cash flow number that is highly unethical?
    Curt Davis - KAIZEN Realty538 Reviews
  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
    14y
    Originally posted by Curt Davis:

    So what your saying is that if a company shows Rent minus PITI and property management fee to get a cash flow number that is highly unethical?

    There is no universal code of ethics, so it's subjective, but in my opinion, this is certainly unethical.

    It's no different than walking into a grocery store, buying a box of cereal for $4.99, getting to the counter, and having the cashier say, "Oh, the $4.99 doesn't include the packaging...the total price, with the box, is $7.99."

    But again, ethics is subjective, and it's just my opinion that leaving out pertinent information on an investment analysis in order to attract business is highly unethical. Others may disagree.

    (Btw, if your investments were subject SEC regulation, my guess is that the SEC would determine that what you are doing is not just unethical, but also illegal. So, there's another data point.)

  • Investor · Cincinnati, OH · Member since 2010 · 1k+ posts · 928 votes
    14y

    Hi Chris, I know I’m getting some topic fatigue on this!

    #1 - Your response about big company/small company practices rings sincere, though I don't think I'd arrive at the same conclusion. Having worked in the insurance industry for many years, I can attest that performance illustrations are important. They are not just ‘marketing tools to drive sales leads’ without regard to whether they’re completely accurate, and to treat them that way is inviting problems down the road. Apparently Personal Real Estate Investor Magazine agrees, as they intend to push an effort, along with an accounting firm, to establish and publish standards for companies to follow on a voluntary basis, which would entail the inclusion of these expense items in advertisements. Should the magazine’s publisher, Andrew Waite, be dismissed, like the green financial planner, or the one-deal guru?

    #2 – I disagree. I have looked at dozens (maybe hundreds, they blur together) of multi-family marketing packages in the past year (and have purchased one), from the big name firms that I noted, as well as brokers specific to my market, and in their pro formas for computing cap rates, they most definitely have assumptions for vacancies, replacement reserves, and repairs. I can't think of a single exception to this. I'm sure Joel O. can weigh in . A broker who did not account for these items in generating a pro forma NOI would be considered utterly and roundly incompetent. I'm not saying your info is wrong, but I do consider myself pretty competent in this area, and I'd advise you to inspect more closely. I'll be happy to supply numerous examples, as I receive these email distributions constantly from commercial guys.

    I return to the fact that it’s noteworthy that a large percentage (a majority at the other large Memphis company, per their site) of sales at large companies are completed using private lenders at interest rates you've indicated previously are in the 8.5-9.5% range. So private money is driving sales growth, no question. The sales model is thus highly dependent upon the buyer being confident that they are receiving a net return above 8.5%-9.5%, otherwise they are LOSING money by leveraging (unless they are absolutely convinced that they are truly buying substantially below market value on day 1, in which case they *might* want to endure the losses to 'capture' all that equity). However, if an investor truly ran the numbers with reasonable assumptions for all these additional vacancy and expense items (the old 45-50% guideline), I don’t see how they’d arrive at the conclusion that paying 9% for private money makes sense.

    I think your niche business sits in a unique spot. I can’t think of many passive investments like this, sold to non-accredited retail investors, at large ticket amounts per transaction, that has no specific regulation aside from just standard consumer protection laws. I just think it makes sense to get out in front of things and be more proactive.

  • Sharad M.Pro Member
    Carlsbad, CA · Member since 2010 · 1k+ posts · 1k+ votes
    14y
    Originally posted by Curt Davis:
    most investors use their own formula regardless of the market.

    Just curious, why not leave insurance and property management out also? Why not let the investor figure that out as well? Taxes are what they are, but an investor may want to go with his own choice of property management and insurance company.

    Let's say for one of your properties, ROI is 20% after PITI and PM and a new investor ask you this question "If I invest my money in this property, will I see a return of 20% on my investment?" Will you answer Yes or No?

  • Investor · Cincinnati, OH · Member since 2010 · 1k+ posts · 928 votes
    14y

    One more followup: It's stated that Year 1 NOI guarantees are the "huge issue" in the industry. It's also been stated that the buyers are sophisticated, that they run "their own numbers" for expense assumptions, so it really doesn't matter if these expenses are included in the web site illustrations. Yet they can be fooled by something as flimsy and relatively valueless as a Year 1 guaranty? You state that the clients can be misled into thinking that the investment return is guaranteed for life. Really?

    If they're truly sophisticated, they'd look at a Yr 1 guaranty and conclude: "Ok, that's a nice little add-on of little value, since the chance of anything happening in Year 1 are remote, at best, but I'll take it, fine, and the other company I talked to didn't offer it".

    If industry players are so worried about these guarantees, it follows that many buyers are not in fact sophisticated. And it further follows that for unsophisticated buyers there should be more information and transparency, not less.

    Across large amounts of advertised inventory at large companies, the average gross rent yield appears to be around 15%. Admittedly, these are nice properties in B neighborhoods, usually 3/2 houses. The 50% expense guideline would suggest a net long-term yield of 7.5%, though 8.0% is reasonable given that these are better properties with rents of 850-1100. Advertised yields are typically around 10.5% if only using taxes, insur, and mgmt fees. This is a highly material difference. At 8.0%, it's still a nice investment, beats the heck out of 5-yr CDs at 1.8%, with some added tax benefits, inflation protection, MAYBE day 1 equity capture, etc, etc. But I wouldn't borrow at 9.0% to buy it.

  • MI · Member since 2011 · 228 posts · 75 votes
    14y

    I can assure you from personal experience, that all the spreadsheet estimates, regardless of how inclusive, are of little comfort when you end up with a property that sits vacant for months on end because of the poor management provided by the turnkey seller.

    All the debate above, which is good, looks pretty darn academic, even esoteric, when your shelling out mortgage payments for months on a vacant "turnkey" unit.

    Sellers need to be more forthcoming about a lot of other things than ROI estimates. There are many things I got told only AFTER the trouble started, which had we known ahead of time who have stopped us from buying in memphis long distance. But hey, Caveat Emptor.

    It's like buying a car. You wouldn't consider "due diligence" to be just asking the sales person a bunch of questions. They are likely to tell you what you want to hear and even embellish. And when you end up with a "lemon", they will just put it back on you. In the case of the turnkey sellers I've dealt with, they sing a pretty different tune on the back end when there is trouble. It's a much different tone than the slick marketing message you got on the front end. I guess what I am saying is that you are dealing with SALES PERSONS, not RE investment advisors! Don't get the two mixed up.

    This is why I like this and other sites. You can talk to other investors and learn ahead of time.

  • Chris ClothierBusiness Member
    Rental Property Investor · memphis, TN · Member since 2009 · 2k+ posts · 3k+ votes
    14y

    Wow - Lots of activity since I last logged on!

    David, Joel, J Scott (and anyone joining in on the conversation) I really respect your opinions and I think honest discussion is what makes this site so great - so I don't take offense and I don't have a problem with critique and comment. I am going post this one and it's going to be long (sorry in advance).

    When reading the discussion, I think it is devolving into debating the merits of apples, oranges, bananas and grapes all at the same time. A lot of questions now are separate issues - some related and some not.

    1. We are talking about spreadsheets or stated numbers on listings created for marketing. J Scott, I personally do not have a problem with a company quoting an estimated monthly cash flow or ROI that does not include a number for reserves. Those are predictable costs, but they are not fixed costs. They will not occur every month. IMO, most companies quote a monthly number and if that is a monthly cash flow or monthly return they are getting on fixed monthly costs then I see no problem. That is a reliable, expected monthly income on that property. If their next statement was that those are the only costs you will have on this property, then there is a problem. If an investor asks for expected variable expenses like vacancies and maintenance and a company can give those numbers as suggested reserves, then I see no problem.

    Reserves are taken from that cash flow and set aside for when that property does go vacant or does need repair and that is an action taken by the investor. Every investor is different as to the level of reserve they want to keep and some keep $0. They use every additional dollar they receive each month to reduce debt service. Others will want to keep as much as 30% of gross monthly rent in a separate account. Each investor has a different risk tolerance level and it is up to us as a company helping them to mitigate that risk and give them the pertinent data so that they make an informed decision. I think lumping everyone in and labeling them as unethical is a bit strong. So much of it depends on their ENTIRE process of working with an investor.

    2. David - Commercial companies and how they operate is nothing like our company in any way shape or form, but I tested what you said and I want to give you the results and make sure that you see my point. You stated that you receive hundreds of offerings by email. These companies had to have had communication with you at some point to even know you had interest in real estate. More than likely, they have profiled you and are targeting you with properties that you have identified as being interested in buying. They sent you detailed numbers to help you make a decision. This is the same thing we do only in a more personal way over the phone or in person and with the investors full attention.

    I went to CBRE's website and looked up Memphis multi-family properties and went thru listings. On their listings which are designed to MARKET their company - not sell the property - they do not do a detailed breakdown of all costs. They did include a line item called operating expenses but no lines for taxes, insurance, management fees, or any variable expenses. I will say the operating expenses were very high and probably included everything listed above in one line. I am sure if I requested more info., they will send me a more detailed pro-forma, but after I initiate a relationship. Of course, they'll do that after I sign a non-desclosure agreement and only after having qualified me as a buyer. So these companies are doing exactly what we do. They are not posting detailed proformas on line for all to see (as far as I can tell) and some are showing high expenses, others are showing only gross rents. It is what they do after heading down the road of doing business that they begin to show really detailed info. and the difference between them and me is they don't care if I'm smart enough to make money on the income property or not. If I CAN buy, they WANT to sell. In my business, I own that relationship for as long as that investor owns that property and I am absolutely invested in their success.

    3. Governance and regulation. Considering that I personally own every property we sell - these are private real estate transactions and let's hope the government doesn't decide they know best how that should work.

    4. In order for me to grow as a company, I have to be open, transparent, honest and MOST of all ethical. It does not work as a long-term business any other way.

    5. Several years ago, we made a decision to move away from marketing to buyers looking for "Cash Out" properties or "No-Money Down" deals. These were not the type of buyer we were looking for and we began to remove these possibilities and any mention of them from our marketing postings and web site. We are working with more sophisticated investors and even more accredited investors than ever before. And we constantly survey our clients, so if we get indications that there is a problem with our process, then I am sure we will change again.

    6. David - these words "guarantees are the "huge issue" in the industry" are your words not mine. I stated that a much bigger issue - implying this is the one that deserves the scrutiny - is companies using guarantees to attract investors. Your post proved my point. Those that are attracted to guarantees are not seasoned investors but often the ones that know the least about investing. They are the investors that need protection from bad decisions the most. You do not see seasoned investors or heck seasoned business people buying these guarantees.

    So to Joel, we have no interest in making guarantees or doing two year guarantees (I do appreciate the suggestion though) to help us stand out.

    6. The magazine. I think it's best that I don't say anything at all here. But David, yes, I completely dismiss anything from there and for very good reason. We no longer lend our names, our advertising or our credibility to them. When looking for information on real estate investing, IMO, you would do much better checking out either REI Voice or even Canadian Real Estate Magazine. I find both of them to provide actual content, not advertorial and the articles are written by professional writers and actual investors. Especially the Canadian magazine. The advice articles in that magazine are so well written and they apply to real estate in general no matter where you buy it. I have advertised in all three and provided content for REI Voice and hope to provide content for the Canadian magazine in the future. I am not interested in paying for someone to speak nice of me - I want to provide solid advice and good content that means something to the reader and if that raises my profile and earns me respect and good words, then I'll take it.

  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    14y

    On commercial properties there are many reasons why a properties full information is not disclosed.

    1.The property is a vacant REO building and has no numbers besides taxes.

    2.The bank or receiver took the property over recently and no data was given to them by the old property management company or by the previous owner for adversarial reasons.

    In these situations you price in the worst case scenarious to be safe.

    3.In commercial you get many off market properties because the seller doesn't want the sale made public.

    4.The seller has demanded that minimum info be listed on the listing and only when a buyer is qualified as credible and serious and has signed a confidentiality and disclosure disclosure agreement then the info will be shared.

    The seller might not want the information of how their property is operating to get into the competitions hands.

    I do agree that many investors will keep different reserves based on individual preferences.Where this comes in big though is there are industry averages where unless the buyer will be paying all cash or owner finance they will be getting a loan from a commercial lender.

    This commercial lender will price in reserves to the numbers and marketing costs because if the lender giving the loan has to foreclose they will operate it and value it based on their expenses and not the owner who self manages,does their own pest control,makes their own repairs,etc. to increase margins.

    This is a number one reason loans do not get funded.An investor shows a deal cash flowing 5,000 a month on a apartment building and the numbers are real.However the commercial lender comes to 3,500 a month cash flow after their analysis of how they would run it an dhow it would perform if they took the property back.

    This is why owner finance and putting little to no money down to preserve liquidity is the name of the game.Leveraging yourself into as many properties as possible UNDER THE RIGHT TERMS with smart growth taking advantage of the down markets is key.

    We have real estate niches for a reason.There are different flavors for everyone.It also depends on the investors goals.

    If they have millions already and are just trying to get a certain return and stay above inflation each year with not much headache then yes turnkey might be the answer for them.

    If you are going to do that I would go for triple net corporate rated tenants and collect mailbox money than deal with toilets,tenants,and termites,and eviction headaches.

    I deal with this on my apartments but my returns are way over 7 to 8%.So what you take on versus the expected return is key to doing a deal or not.

    I find generally landlords once they hit a certain age and life just get tired and want someone to take over their problems.This is when at 36 I still have gas in the tank and I am willing to take on big headaches for big returns.Later in life that might change what kind of portfolio I want to hold and grow.

    I personally stay away from buyers wanting these little houses for 35,000 that give off 700 a month rent.The investors are out of state and want you to micro-manage for them at 60 bucks a month and it's not worth it.I own many apartment units and even with a maintenance guy and a property manager living on site it can be very intensive to run correctly.

    It is not as easy as everyone thinks it is especially when most investors will be buying older buildings on value add deals.

    It's easy when a building is brand new and tenants want to sign up left and right and there are little to no repairs to speak of.

    When you buy new though you pay a premium for it.If you want to create wealth you need accelerated returns.

    I have really enjoyed this discussion so far.

  • Investor · Fort Worth, TX · Member since 2011 · 1k+ posts · 450 votes
    14y

    I look up properties on a particular website that is provided by a real estate agent, not a turnkey outfit. I like this particular website because it has fields to enter purchase price, expenses, interest rate, etc. The outputs generated are monthly cash flow and capitalization rate. There are some preset values in the changeable fields suggested by the agent, but they are easily changed by the prospective buyer. I find it very handy.

    Although the talk around "apples and grapes and oranges and bananas" has been interesting, my bullcrap meter says that not all expenses are included because it makes the deal look less appealing.

    In fact, I don't know about Memphis, but I have ran many analyses on Turnkey properties where I live and NONE of them make any sense from a profitability perspective. I had no idea these outfits offered high interest loans to boot. That makes even less sense (from the buyers prospective at least!).

    But hey, if you can suck all the nectar out of a deal and still find a sucker to buy it...

    I mean,if these deals are so great that they can be fully rehabbed and flipped at retail, financed at high rates and managed out of town and STILL be profitable; why in the world would these Turnkey outfits who will be providing the maintenance and the funding, anyways, not just hold the properties themselves? Is the down payment from the buyer that attractive? Or is it that the fees for maintenance and financing offered by the turnkey outfit are offered at a premium and would be unsustainable (without negative profits) if they were holding on to the properties themselves? I vote the latter.

    I bought my first house in Dallas (cheap housing market) just prior to moving there after having lived in Austin (expensive housing market relative to Dallas) for years. ALL the houses seamed so CHEAP. I thought, at these prices I can't go wrong no matter what I do! Well, I was wrong. I've lived and learned and learned a lot more after getting involved in real estate as an investor since then. My guess is that the same "can't go wrong at those prices" idea is going through the minds of many of these out of state/country Turnkey buyers. Later on, much to their chagrin they will learn as I have, but by then its too late. Pray for appreciation.

  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
    14y
    Originally posted by Chris Clothier:
    J Scott, I personally do not have a problem with a company quoting an estimated monthly cash flow or ROI that does not include a number for reserves. Those are predictable costs, but they are not fixed costs.

    First, Chris, my posts in no way are meant to comment on or to critique your business or your business model. In fact, I'm not talking about a specific wholesaler or company...I'm just commenting on the discussion in a general sense. So, I hope nobody here takes personal offense at anything I say (unless it's warranted, of course :D).

    In my mind, not listing variable costs in the analysis is akin to the following:

    You walk into a hotel chain you've never stayed at before, get a room quoted at $100/night plus taxes. At checkout, you find out that the $100/night plus taxes did not include water usage, television usage, HVAC usage, etc, and your $100/night has now turned into $150/night plus taxes.

    Would you complain? Of course you would.

    What if the hotel manager explained, "Well, those costs are variable, so we didn't quote them to you. In fact, had you not used the water, TV or air conditioning, there wouldn't have been any additional charges."

    Would that be a reasonable justification to you?

  • Chris ClothierBusiness Member
    Rental Property Investor · memphis, TN · Member since 2009 · 2k+ posts · 3k+ votes
    14y

    Bryan -

    We'd be naive to think some companies that call themselves turn-key are not using spreadsheets to make their properties look better. But, I only know of one that offers their own in house financing (I am sure there are many others) and this one company offers their financing as interest only which I think is ridiculous - but I'm not who they are offering the financing to.

    As far as I know, most of the other financing comes from Thrift & Loan institutions and they are writing loans for investors who CANNOT get loans elsewhere such as offering non-recourse lending on SDIRA accts., self employed buyers and owners who have more than 10 properties financed. That financing option is usually the only option for an investor wanting to leverage. Does it make sense, not for everyone, but for some buyers- its the only option they have and they want it.

    Me and my family own over 130 properties here in Memphis and in Dallas. We manage just under 1,000 properties for investors mostly from around the country and that number will grow to somewhere between 1,300 and 1,500 next year. Along those lines, we currently have 353 investors who are building portfolios with our company right now and that number grows by 8-13 investors on average each month. We complete between 25 & 35 transactions each month and there is no way we could ever put those properties in our portfolios!

    I can assure you too that you do not manage 350+ investor portfolios and grow your business through referrals if all you're doing is gigging a client with management fees, maintenance fees and crappy deals with crappy service. I am not a spokesman for this niche and I know there are plenty of companies, as there is in any industry, that give everyone a black eye. Again, I may be naive, but I think that is a minority.

    On that note, I would love to pick your brain a little on the houses you are buying. We are expanding in 2012 into Dallas now that we are making money there on our own portfolios. We have huge interest from our clients (earned by hitting our quoted numbers) in the market and will start offering the market in January. I was born and raised in Dallas and still have family there and I am intimately familiar with the metro-plex, but would love to hear where you have found success.

    All the best,

    Chris

  • Chris ClothierBusiness Member
    Rental Property Investor · memphis, TN · Member since 2009 · 2k+ posts · 3k+ votes
    14y
    Originally posted by J Scott:
    Originally posted by Chris Clothier:
    J Scott, I personally do not have a problem with a company quoting an estimated monthly cash flow or ROI that does not include a number for reserves. Those are predictable costs, but they are not fixed costs.

    First, Chris, my posts in no way are meant to comment on or to critique your business or your business model. In fact, I'm not talking about a specific wholesaler or company...I'm just commenting on the discussion in a general sense. So, I hope nobody here takes personal offense at anything I say (unless it's warranted, of course :D).

    In my mind, not listing variable costs in the analysis is akin to the following:

    You walk into a hotel chain you've never stayed at before, get a room quoted at $100/night plus taxes. At checkout, you find out that the $100/night plus taxes did not include water usage, television usage, HVAC usage, etc, and your $100/night has now turned into $150/night plus taxes.

    Would you complain? Of course you would.

    What if the hotel manager explained, "Well, those costs are variable, so we didn't quote them to you. In fact, had you not used the water, TV or air conditioning, there wouldn't have been any additional charges."

    Would that be a reasonable justification to you?

    Like I said, no offense taken at all! I'm not even sure this post is about my company! But, I do recognize that we are a pretty well known company and I have nothing to hide so I just jump in and start talking.

    On your question let me say that yeah - I'd be pissed if I found that out at check out - by that point, it's too late for me to make an informed decision on whether or not to stay there.

    Of course, if the attendant gave me the rate and when I decided that was something I was interested in I was informed of the additional costs, well that changes the story. Now I have the whole story before I book the room.

    Just make sure the buyer has the whole story before they spend a dime.

    In case anyone wants to lash out at me - the above response was written tongue in cheek!

    I appreciate all of the viewpoints and the advice and I'm never simply dismissive of what someone says because I disagree.

    I learned a long time ago that there are two things you should always listen to:

    1. Someone who disagrees with your viewpoint.

    2. A customer that complains.

    Those two are more likely to be sincere than someone who agrees with everything you say and someone who only wants to praise you.

  • MI · Member since 2011 · 228 posts · 75 votes
    14y

    There are a lot of investors who reside in high priced markets (CA, NYC...etc) who decide to buy in "cheap" markets like Memphis lured by the low prices and "cash flow". What many don't realize is that you can do that without becoming an out of state landlord. Hard enuf being a landlord locally, let alone on the other side of the country trusting strangers to look out for your best interest.

    YOu don't have to buy and hold properties. There
    are lots of ways to earn high cash flow, with fewer hassles. HM or private loans to the very local investors in these cheap markets and in a position to find the best REOs/foreclosures to buy and flip.

    We make 14% plus points without having to deal with tenants, evictions, unexpected roof jobs, new furnaces...etc. That's what I call CASH FLOW.

    What would you rather do? Shell out 10's of thousands to a turnkey seller, who has no skin in the game, and makes his/her money up front, will pass the buck and give excuses should things go wrong, or shell it out to a local investor, who has found the property, has their own $$ in the deal, and doesn't want a foreclosure on their record.

    Then there are joint ventures, discounted mortgages, a whole bunch of ways to make cash flow. We haven't. This is what we've done, and have been fortunate enuf to have found some investors here on BP to do just that.

    I'll bet my bottom dollar that people buying these turnkeys haven't made 15%, hassle free. We haven't. Especially with the new roof jobs, new furnaces...etc. paid for not long after buying. And from people who are posting in the very thread!

    PG

  • Investor · Cincinnati, OH · Member since 2011 · 12 posts · 15 votes
    14y

    Jumping in late, but let me say that this practice, which is widespread in the TKR industry, DRIVES ME INSANE.

    I've written multiple articles about this, but let me summarize by saying:

    I'm a second generation landord, and I've owned single family rentals for over 20 years. Years of experience and "real numbers" tell me that the evaluations that come out of TKR companies are ridiculous.

    For one thing, the insurance numbers are usually based on the seller's rates, not the buyer's, which are generally around twice as much b/c the buyer owns too few properties to get the commercial discounts available to larger owners.

    Secondly, the "real estate taxes" expense is almost always based on the seller's current, lower evaluation. When the property sells and is re-evaluated, the taxes will often increase by 50% or more.

    Thirdly, a 20% of gross rents factor for maintenance and vacancy is only accurate if 1) the property is FULLY stablized (new roof, new furnace, new windows, and so on)--and most of the TKRs I've seen do NOT meet this standard by a long shot, 2) if the property is VERY aggressively managed--heavy screening, prompt eviction, quick re-rent--a practice not common amongst most property managers, and 3) aggressive maintenance is done to maintain the capital repair items (changing furnace filters bi-monthly, cleaning gutters in the fall to avoid failure, maintaining metal roofs, cutting back trees to avoid roof damage, etc--again, uncommon amongst property managers). If these things are NOT done, 30-40% maintenance and vacancy is COMMON.

    Fourthly, as pointed out previously, many of these "turn-key" rentals appear to have higher-than-market rents upon sale, and from what I can tell it's because the sellers grab the first (unscreened, unqualified) person they can who will sign a lease at that amount. Simply checking with the local landlords (and seeing this done in my own market) quickly uncovers this.

    And finally, the management costs of 10% of gross + rent up fees + overrides on repair costs are almost always obfuscated by the "one year free management" offer.

    When I evaluate TKRs in my own market and others under the "correct" income and expense numbers, many are, in reality, negative cash flow deals. NONE meet the 14-22% return numbers being quoted by the sellers.

    And when *I* market turnkey rentals with the correct expenses included and the *real* returns (which generally work out to 5.5%-6.5% cash on cash, 8%-10% with mortgage paydown), some potential buyers counter with, "why would I buy that deal? so-and-so is offering 27%!"

    Thanks to the many, many bad guys in the TKR business, passive investors are getting their greed glands milked to a ridiculous degree. Since when was 6% NOT a great return on an investment you didn't find, didn't rehab, didn't fill, and aren't going to manage??

    And don't even get me started on the companies that have set up their own personal pyramid schemes by offering free management for years or forever...

    This is the current equivalent of the "buy pre-construction" and so-called wholesale deals scams of the middle of the last decade. Knowledgeable, slick salespeople convincing uneducated, unsophisticated "investors" that they can get rich for doing practically nothing, and with no risk...it's got a new face, but apparently it's never going to end.

    I predict both regulation and litigation over this in the future, and it makes me both angry and sad, because we ALL get painted with the same brush as the black-hat scammers.

  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
    14y
    Originally posted by Chris Clothier:

    Of course, if the attendant gave me the rate and when I decided that was something I was interested in I was informed of the additional costs, well that changes the story. Now I have the whole story before I book the room.

    We're in complete agreement then...

    I guess it boils down to what the seller is doing to provide this information to their clients prior to sale. Again, not referring to your company (personally, everything I've read from you gives me a feeling that you're all about doing the right thing), but I'd venture to guess that many people out there looking to sell turn-key properties aren't going to risk a sale once they have an interested buyer, even if that means "neglecting" to mention the variable costs.

    Maybe I'm wrong, and perhaps most turn-key sellers are ethical in this respect, but given the ratio of ethical to non-ethical people in this business in-general, I'd venture to guess this isn't the case.

    Though, now I'm deviating from the original post discussion... :D

  • Chris ClothierBusiness Member
    Rental Property Investor · memphis, TN · Member since 2009 · 2k+ posts · 3k+ votes
    14y

    J Scott -

    I agree with your statement and would be stupid to think that was not reality.

    I can only worry about how I conduct my business and try to give the best advice possible to other companies. Our mastermind has been very beneficial to not only the other companies but us too. It's like one big BP forum with a lot of back and forth, a lot of education and a lot of talk about best practices and I'm sure this will come up again in January when we meet in Jacksonville. None of us have any interest in churn and burn. That's been the refreshing thing about saying yes and no to certain companies. We vetted them too, just like clients, because we're not interested in wasting time. We want to be the best at our business and after this forum I'm sure this will be a great topic for us as we continue to grow and improve.

    All the best in your business.

    Chris

  • Investor · Fort Worth, TX · Member since 2011 · 1k+ posts · 450 votes
    14y

    Chris,

    I watched your interview BP interview a month or so ago and you sounded like you are doing well for yourself. Your numbers for transactions and managed properties stated herein are incredible.

    Given your vast real-estate experience and intimate knoweledge of the metro-plex, I doubt there is much I can contribute to your success. But I'd be happy to share my thoughts with you any time.

    What kind of returns are your clients getting to remain loyal to you?

  • Investor · Cincinnati, OH · Member since 2010 · 1k+ posts · 928 votes
    14y

    Vena -- love the line about "greed glands milked".

    However, with all the risk attendant to an equity investment in residential real estate, even turnkey in very nice neighborhoods, a return of 5.5-6.5% in the midwest just plain sucks, IMO, given the bargains in the market today. That would be an extraordinarily over-price property, in my view.

    Your points about "real expenses" are well-taken. Thanks for sharing your (strong) opinion on the subject.

    By the way, I bought a property from a wholesaler who said she was trained by you. I had some difficulties with the transaction, specifically the protocol for paying the assignment fee, as indicated on a nearby thread about wholesalers. Maybe you can shed some light as to whether she departed from your training guidelines? Please answer on the other thread at http://www.biggerpockets.com/forums/93/topics/68990-how-to-deal-with-wholesalers. ** I remember because you've got one of those unforgettable names :)

  • MI · Member since 2011 · 228 posts · 75 votes
    14y

    I'd be interested to know this as well.

    We discussed one of his properties in a thread 4 months ago (recently resurrected).

    http://www.biggerpockets.com/topics/65128-chris-clothier-memphis-invest?forum_id=92&page=2

    It became clear he wasn't including vacancy or maintenance costs into the equation:

    Chris posted

    Cost - including $16,000 in completed renovation $74,900
    25% down payment $18,725
    Financed amount $56,175
    Assumptions

    Financed at 5.25% for 360 months $310
    Taxes - City & County $137
    Insurance $ 25
    Property Management $ 74

    Monthly costs for the property are $546.

    We estimated the property would rent for $825 and that is the number we used in calculations. The property actually is awaiting the closing of a two-year lease with first year at $825 and the second year at $850 with a $1050 deposit retained by the owner if and when the tenant moves out.

    Rent $825
    Costs $546

    Monthly cash flow is $276.

    Phil posted

    No response.

    I don't know if it was just an inadvertent oversight to leave out these costs, but companies do it all the time. I guess this is why the OP titled this thread the way he did. Duh?

    Sorry, it doesn't pass the "smell test" that a property in that neighborhood of Memphis selling for 75k and renting for 825 would be a big cash flow cow.

    Unless he was just calculating Year 1. But what about the years after? If you advertise "buy and hold" cash flow up the kazoo, then sorry, you should INCLUDE MAINTENANCE AND VACANCY EXPENSES!!

  • Investor · Cincinnati, OH · Member since 2010 · 1k+ posts · 928 votes
    14y

    Phil, I read the previous thread, and Chris said that he advises prospective clients, in the consultation stage, to use 10% for vacancy and maint (presumably 5% each), though he says that many use their own assumptions. These are within the ballpark range of 'acceptable' for these assumptions, particularly for properties that have been rehabbed as nicely as these apparently have, and in decent neighborhoods.

    I don't know why you felt you needed to bring the proceeding commentary over to this thread, when your linked thread was already serving that purpose. I posed a general question. Chris Clothier became a focus of this particular discussion solely because of his willingness to don a flak jacket and wade right in! I think that's very much to his credit. I'm sure there are other TK company reps on this site that preferred to lay low.

    I was just commenting on the format of the proforma performance illustrations, and highlighting whether it would be advantageous for the industry to adopt some standards.

  • Investor · Diamond Bar, CA · Member since 2009 · 446 posts · 233 votes
    14y
    Originally posted by Phillip Gainey:
    We haven't. This is what we've done, and have been fortunate enuf to have found some investors here on BP to do just that.

    Am I to understand that you are part of some type of investment company that is competing for investors against those whom you are criticizing?

  • MI · Member since 2011 · 228 posts · 75 votes
    14y

    In the other thread, we were talking about a specific property he had advertised on BP. We were debating how much that property would realistically cash flow. He claimed estimated cash flow of $256 a month in the thread, and was about the same in his BP ad. That seemed unrealistically high because he wasn't including vacancy and maintenance.

    So are you saying it's okay to exclude these items from ad listings, so long as you cover it during the "consultation phase"? Whatever the heck that means?

    PG

  • MI · Member since 2011 · 228 posts · 75 votes
    14y

    I am a private investor who has purchased turnkey properties in Memphis. I also make private and HMLs. I have nothing to sell.

    I'm trying to help other would be out of state investors not fall for the hype, and hear the "other side". How sellers will leave out expenses in their advertising.

    I've received numerous pms from other BP members thanking me for calling out turnkey sellers and sharing my experience. I wish someone had done that for me. Of course it will ruffle the feathers of people with something to sell.

    OTOH, if I post anything incorrect or untrue, I would hope people would point it out to me.

    PG

    P.S. And yes, like the the gentleman above, I'd love to hear some actual return's clients are making.

  • Chris ClothierBusiness Member
    Rental Property Investor · memphis, TN · Member since 2009 · 2k+ posts · 3k+ votes
    14y
    Originally posted by Brian Hoyt:

    What kind of returns are your clients getting to remain loyal to you?

    Brian -

    I don't know that any client is loyal to our company or even that I would want them to be. For most, the return is very important, but even more important is trust, security and long-term stability.

    On the low end, I believe returns average between 7.5 and 9% and on the high end between 10.5 and 11%. There are absolutely properties that have returned less and properties that have returned more in any given year, but I would say the averages are going to fall between these ranges on cash purchases. With bank financing it would be even more varied but on the low end 16-19% and on the high end 27-29% with a majority somewhere in the middle.

    Investors are not building portfolios with our company and introducing us to family and colleagues and friends because of returns. They do it because they are not going to invest in real estate any other way. Time constraints or lack of knowledge or even fear are their hurdles and most simply want to deal with a company they develop a high level of trust with.

    Believe it or not, there are investors who place a higher priority on capital preservation and a lower risk return than on higher returns. They know they can buy cheaper, they know they could earn more doing it themselves, they even know that there are other TK companies here in Memphis and in other markets that are way below us in price point. But, they know exactly what they get with our company and they know it will be consistent and come with a level of security that they don't feel they can get elsewhere.

    So, Brian, we know we are not the right fit for everyone and do not want to just"sell" to everyone that raises their hand. There is a type of client that values doing business with a company that is set up for their success and those are the ones we excel at serving. For the record, my father and two brothers and I didn't start this as a way to make money. We wanted to build a company and our mission was always to help people invest who otherwise would never do it. We could have made MILLIONS selling the cheap crap houses here in Memphis and made the returns look astronomical by doing less work up front and keeping price points low. We could have made a ton of money and never thought twice.

    Today, we are a credible company because we didn't do that and will not to this day. We make mistakes and have had unsatisfied clients before. You don't manage 1,000 houses for over 350 clients and not have people who are not 100% happy. But we have never shrunk from our responsibility and have always gone out of our way to be transparent and up front with investors.

    BTW, I was serious about talking to you about Dallas. It is different than Memphis and many of our clients are asking us to develop another market to diversify. Dallas is the only one we feel comfortable with today because we have owned there and have most of the infrastructure in place to do it. But, it's always good to hear from local investors.

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