Posted 4 months ago

Turnkey Versus Hybrid Real Estate Investing

Both models are similar in some ways while having differences that investors should seriously consider. Factors to consider when comparing models are cash flow, expenses, return on investment (ROI), and risk. While turnkey is a completely valid investing strategy, the purpose of this post is to open your eyes to how Hybrid real estate investing can maximize profit, reduce the downsides of traditional rentals including turnkey and help people in the process.

What is Turnkey investing?

Turnkey companies typically acquire older homes, renovate them so they are move-in ready, then sell them to investors as rental properties. Turnkey companies often help find tenants and provide property management for a monthly fee based on a percentage of the monthly rental rate.

What is Hybrid investing?

Our model of investing is a ‘hybrid’ of the tried and true models of Buy & Hold and Fix & Flip. With Hybrid Real Estate Investing you’ll enjoy the high returns of an active investor plus the tax benefits, cash flow, and appreciation of a passive investor. It’s a short-term (1-2 years) investing strategy where people who want to buy a home and cannot currently get traditional financing are thoroughly screened for eligibility. If they qualify, they choose a home, and an investor (or group of investors) buys it. The tenant-buyer pays rent to the investor and lives in the property until they are eligible to get a traditional loan and buy the home from the investor (rent-to-own aka lease option). Another option is to sell on a Contract for Deed (seller finance aka land contract).

Why consider Hybrid over Turnkey investing?

Turnkey is commonly viewed as a good way to get into investing because the turnkey company finds the property, completes the remodel, finds the tenant, and handles property management. These are all things that a new investor can run into trouble with. They also take time to learn, implement, and manage.

For busy professionals that simply want to get into real estate investing this is a good model for getting into the game. It’s one of the most passive ways to invest. With both models, you can invest out of state and not have to deal with tenants, toilets, and trash like you would if you self-manage regular rentals in the market where you live. They also give you options for investing in markets that have different price ranges, cash flow, and appreciation rates.

Hybrid investing has many advantages.

1. The first and most major difference is that the investor receives money upfront from the tenant-buyer in the form of a non-refundable option fee - typically from 10 to 15% of the purchase price (compared to a small rental deposit). This upfront money is “skin in the game” from the tenant-buyer because it makes them very unlikely to stop making monthly payments or damage the property, which are two of the biggest fears that all landlords have.

They also have an owners’ mindset because they pick out the property for themselves, have invested tens of thousands of dollars, and have the intention of fully owning the property in the near future.

This upfront cash also means that the net down payment for the investor is 10% or less instead of 20% or more with a traditional non-occupied investor loan. You have half (or less) of your cash tied up which allows you to invest in more properties than the traditional way. There is also no need for buying distressed properties and completing risky, complicated, expensive remodels.

2. The second major difference is that the tenant-buyers are responsible for most maintenance and repairs, so you aren’t getting random calls about issues that you get from regular tenants. And you don’t have to give up 8 to 10% of your cash flow each month to a property management company if you don’t want to self-manage. This way capital expenses for repairs are little to none.

3. The third major difference is that these deals are created before you make an offer to buy the property. You know who your tenant will be, what your cash flow is going to be, and your back-end profit will be when you sell.

Because you have a lease and option signed with the option fee money in your account before you close escrow you don’t have to worry about the home being vacant until you find a tenant and guess what you will get for rent.

Note that cash flow can be higher than a turnkey or regular rental because the tenant-buyer is often willing and able to pay for the privilege of picking the home and living in it until they can get long-term financing.

As with turnkey, Hybrid investing also gives you options to diversify your portfolio by investing in markets that have different price ranges, cash flow, and appreciation rates.

To make it completely passive you can opt for selling on a Contract for Deed (aka Seller Finance or Land Contract) where you are basically acting as the bank.

What are the risks of Hybrid investing?

What if the tenant-buyer stops paying rent or damages the house?

They are very unlikely to do that because they have significant skin in the game with their option fee (or the down payment on Contract for Deed). They also have an owner’s mindset because they picked out the house and intend to buy it in the future.

What if the tenant-buyer walks away?

Again, they are very unlikely to do so because of the reasons noted above. But if they do, you keep the non-refundable option fee which is nice insurance to have to cover vacancy and make-ready costs.

Then you have many options. You can offer to extend the lease and option period to continue getting cash flow. You can get another tenant-buyer with another option fee as insurance. Like any rental, you can get a regular renter. You can turn it into a short-term rental (Airbnb or VRBO) or a corporate rental or rent to traveling nurses. Or, you can sell it.

What if the market turns downward?

The deals are structured so there is a gap between current market appreciation and the agreed-upon sale price, so the tenant-buyer has some flexibility with some built-in equity.

Also, you can simply extend the lease and the option period for the tenant-buyer until the market catches back up. That way they won’t have to cover an appraisal gap. Since these are shorter-term deals of 1 to 3 years typically and they have put 10-15% down, so the chance is reduced for a market dip creating a problem in that time period.

What are the risks of Turnkey investing?

With turnkey, your profit can be slow since there is low appreciation in most of the markets with good cash flow and you expose yourself to the usual risks associated with being an out-of-state landlord. Since you are only getting a small deposit you risk having renters that don’t take care of your property and may break their lease or leave after the lease term ends. You will incur expenses for maintenance, repairs, and property management.

Your monthly cash flow is unknown until you get a renter to sign a lease. You may have periods of vacancy in the beginning or in the future. You also must trust the turnkey company and property manager. I’ve heard nightmare stories about shoddy work and broken promises.

Conclusion

If you are considering your options as a new investor or you have felt the pain of being a traditional landlord the Hybrid model is likely a great fit for you. Feel free to reach out with any questions.



Comments (3)

  1. This is an awesome breakdown! I have some clients that this could be perfect for. 


    1. Yeah. It's a great model for busy professionals, tired landlords or any investor for that matter. I'm happy to answer any questions and see how I can help you and your clients.


      1. Man! I wish I had known about this model before investing in a turnkey rental. I’m sure they can be great for a newbie investor with a full time job like mine, but my experience has not lived up to my expectations. I did a lot of research into turnkey companies and went with one that I won’t name. It took them many months to get it rented. I will credit them because they covered my mortgage for those months it went empty. But I wasn't getting any cash flow either. When they finally did get a renter lined up for me, they didn't get the rental amount they had projected. And, the renter has been terrible about paying on time and paying the full amount. They are now way behind and I’m trying to figure out the best way to stop the bleeding. I’m thinking of selling but the initial value my realtor pulled up is $20k less than what I paid. Ouch.