Real Estate 043: Turn-Key Properties, too good to be True?

What is a Turn-Key property?

There is no formal definition of "turn-key", and its meaning can differ from region to region, company to company. However, I can better explain this by sharing what I believe is a turn-key property and you can make  your own informed judgment.

To me, turn-key properties mean that they are generally older homes that have been restored and are considered "rent-ready" by you or the property management company. During the initial purchase of your turn-key property, you should receive a seller's disclosure and statement of work (SOW) from the seller informing you of the items that were replaced or serviced during the rehab.

Typically, if you have purchased a "turn-key" property from a legit provider, you should have received a property with little to no deferred maintenance (i.e. big ticket items that cost $1-5K or more such as roof, HVAC, hot water heater, furnace, etc. with useful life less than 5 years).

BENEFITS

As mentioned in my previous post, if you work with a TurnKey Company, you will eliminate 3 (acquisition, rehab, maintenance/management) of the 4 steps of the investment property process. These are very beneficial for people who do not have time to conduct the research, oversee the rehab, and manage their properties.

Acquisition: 
The TurnKey provider identifies the distressed property (REO, foreclosure, etc.) and purchases the property. They own the title. If they do not own the title, you are working with a middleman/marketer!

Rehab: 
The TurnKey provider will perform the rehab and replace CapEx items and make them "rent ready". Be very wary of "lip stick on a pig" where bad turnkeys will purchase a property, apply some paint, clean the floors, and sell them as "turnkey". These properties may look nice and show good returns on paper, but they will cause maintenance problems down the road and bleed you out slowly. Make sure you talk to other investors, ask for the Statement of Work (SOW) of what was replaced/seller disclosures, and ask about the warranties on the rehab (most places give 90 days, good turnkeys give up to 1 year).

The last thing you want is to buy a lipstick on a pig thinking you have great numbers and a beautiful property during year 1, only to find out that there are thousands of dollars worth of work needed in years 2-5 that will put you in the red.

Simple illustration (Bad Turnkey): if you have purchased a property for $100,000, downpayment and closing costs of $24,000 and rent is $1,100 (1.1% rent to value ratio), now take into account mortgage estimated $400, insurance $70, management $110, taxes $70, vacancy $88 and maintenance $88 for total expenses of $826. Your Gross rental income of $1,100 - total expenses $826 = $276 which is a 13.8% cash on cash - awesome, right? 

Not so fast. $276 a month will equate to $3,312/year, but a lipstick on a pig may result in replacement of the HVAC $5K, roof $5-10K, hot water heater $1.2K, furnace $3-5K. In addition to these major repairs, the $88 reserve/month for maintenance not be enough to cover  routine maintenance calls on plumbing, toilets, etc. if they were not properly reviewed/rehabbed from the beginning. Hope I didn't scare you as this is an extreme example and one to ensure that you do your due diligence before working with TurnKey providers.

Management/Maintenance: 
The Turnkey providers will typically charge 8-12% of the monthly rental income in fees as well as have other fees such as lease up fees (marketing/placing a new tenant), lease renewal fees, and other fees. In exchange for their fees, they provide services such as finding a tenant, periodic check up on your property, proper bookkeeping, and answering maintenance calls, to name a few. I feel that these services alone are well worth the fee. Its less headache for you and more time for you to enjoy doing things you love and spend time with loved ones.

Maintenance calls vary by property management company, as they may have an in-house handyman or outsourced contractor. They may charge only cost of the repair + markup, or cost + standard $40/hr (example). Typically, property managers will maintain a $500 reserve for each rental property and will approve repairs below this threshold, anything above this amount is communicated to you (owner) for approval of the repair.

DRAWBACKS

Now that we have covered some of the benefits of turn-key providers, let's dive into some of the cons of using a turn-key company.

1. You are paying market price: 
If you work with a turn-key provider, the fact is that you will be purchasing the property at market price (little to no equity). There is a saying that money is made in real estate when you buy (low) or sell (high). When you are buying at market value, you are technically going in knowing that your transaction costs alone will keep you from selling the property before 5 years at break even (exit plans are limited). You will need to hold the property for at least 10-15 years for you to break even (unless there is crazy market appreciation - this will not be true for linear markets in the midwest). However, not to fear, if you have analyzed the property carefully, it should cash flow, and that is what buy & hold investors, like myself care about.

You will notice that the appraisal of the property will come in at or slightly above purchase price. In situations where the appraisal comes in lower than the purchase price, I highly recommend you re-evaluate the deal to negotiate with the seller to reduce the price, or walk away/find another deal. There are simply too many deals for you to bring cash to the table to close, simply because the property is not appraising for the asking price.

2. Requires large capital: 
As mentioned in the previous post, there are many ways to obtain financing for your rental properties. The most common approach is conventional financing through a portfolio lender. Portfolio lenders are lenders who specialize in working with investors and offer conventional products such as the Freddie Mac/Fannie Mae loans. Portfolio lenders typically have rates 1% above the current interest rates that you may be able to obtain for your primary residence (i.e. 4.25% + 1% = 5.25%). However, these lenders are well versed in working with investors, turnkey companies, and market realtors and can provide guidance in financing your first 10 properties with Fannie Mae.

Note: your first 4 properties require 20% down payment, but properties 5-10 require 25% down payment. This is something you may want to think about when strategizing the purchase price of the first 4 homes. For example, if you buy low end homes at 50K for your first 4, its a 10K downpayment per home. However, if you planned to acquire homes in the 100-150K range, that could result in an additional 5-7.5K downpayment per property.

I believe that scaling your rental portfolio carefully and quickly is critical in your success. I like to use the Pareto principle/Law of Averages and assume that at any given time, 20% of my portfolio may losers and 80% may be winners. That is, 20% may have bad/trouble tenants, high turnover, maintenance, etc. However, if I am careful, the income from the other 8 (out of 10) should be more than enough to cover the issues found in the 2.

3. Lipstick on a pig: (sub-par rehab)

I hope this helps you understand the key pros and cons of using a turn-key company (I used one for my first rental). Some questions that you might want to ask yourself before choosing to go the turn-key route are:

• Does it make financial sense (rent to value, cash flow) to invest in my local market

• Do I have the right team and knowledge to do this on my own?

• Am I willing to manage my own property in a local market?

• How passive do I want to be (Note: Turn-Key does not mean its fully passive, however, a good turnkey company does mean you have the support of an experienced provider at your fingertips to provide guidance)

• What are my exit strategies? (Sell on MLS, sell to an investor, re-sell to a turn-key, owner finance sell to a tenant)

Whatever you decide to do, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Advisor before making any investment decision.  Work with people who have vested interest in your success! 

Good Luck!

Real Estate 039: My interview with Jump Into Real Estate

Hey Everyone!

I’ve been working hard on my podcast and getting awesome content for you guys (be on the lookout for interviews with J Scott from BiggerPockets Business, Marco Santarelli, Bill Manassero, and Al Williamson, to name a few). It seems like we’ve had alot of new members subscribe to the podcast and blog so I wanted to do something different and share an interview I had with one of my good friends Tyler Jahnke, Jump In Real Estate about my background, how I got started in real estate, and much much more. Hope you enjoy!

Jump In Real Estate #JumpIn Stories Interview – Bo Kim

• Bo, tell us a little about yourself.

Hey guys! My name is Bo, and I was born in South Korea. My family and I immigrated to New Zealand when I was 5 and subsequently came to the USA when I was 11 (I wish I kept my British Accent, my Real Estate negotiations would be so much easier!). 

I grew up in Southern California all through high school and college where I received my Bachelors in Business Administration and Accounting. As a result, I currently work as a Senior Consultant for a mid-sized CPA firm and I have been working in this industry for about 6 years.

Aside from work I love to travel with my wife, eat good food, and read a ton of books (mostly non-fiction business/self-help/real estate related). 

• Where do you invest?

I currently invest in the markets of Indianapolis, IN, Little Rock, AR, and Kansas City, MO.

• Why did you jump into real estate?

I grew up with a very traditional way of thinking of going to college, getting good grades, and finding a job where I can climb up the corporate ladder for 30-40 years and hope for a lush retirement. However, seeing my dad and aunt start and maintain a business for over 10+ years starting from scratch and at times helping them both with their businesses, made me realize that I had the blood of an entrepreneur. I wasn’t entirely sure so I went to school for accounting to learn the language of business and get better at reading the numbers/financials.

Through working 6+ years in the industry, I realized that there were trends in successful companies as well as high net worth individuals who invested their money, especially in real estate. 

After I got married, I quickly saved up a downpayment and bought my first primary residence. I “house hacked” and rented one of the rooms that allowed me to reduce my mortgage to levels close to my apartment lease payments.

I soon had a lightbulb moment and wanted to create more passive income through real estate, but I knew Southern California was not a cash flowing market. As such, I started my journey of researching, buying, and holding out of state rental properties for the long term!

• What’s your investing strategy?

My strategy is buy and hold real estate for cash flow. Not wholesaling, not flipping, just simply buy and hold. Based on 2 years of my experience investing in real estate, I see A LOT of wholesalers and flippers who make great money in real estate, much higher than the average W2 worker. However, when I talk to them, I realize they mostly say the same thing, they want to purchase buy and hold rentals, but they have to continuously flip for their income. They have created another job for themselves. As much as it is tempting to make a $15-25K profit on a flip, I BRRRR it and keep the equity for myself and for cash flow.

• Why do you invest outside of your local market?

I invest out of state for a couple reasons: 1) California is not a great cash flow market. The rent to value ratios here can be anywhere from 0.3-0.5 if you’re lucky. I did the math and in most cases Id barely break even if I purchased a $400K townhouse/condo that rents for $2,000 factoring in all expenses, debt service and maintenance/vacancy reserves. 

Not to mention CA is a very tenant friendly state, as such I have had friends with non-paying tenants file bankruptcy and cause them 6-7 months of losses. Imagine paying 6-7 months of mortgages, utilities, and legal fees on a $400K property! Ouch.

Lastly, I invest out of state as the price points at $80-100K allow me to sleep easier at night. If I make a “mistake” on a $80-100K purchase, its nowhere near as painful as a $400-500K property. The potential upside may not be as high (appreciation), but I am in it for cash flow.

• What’s the first step you took to invest in long-distance real estate?

The first thing I did was purchase a half dozen books on investing. I love to read so I bought: Book on Rental Property Investing, Millionaire REI, ABCs of REI, Long Distance REI, Retire Early with REI, and Raising Private Capital. Then I started to attend my local REI meetups (Tip: Go to meetup.com and you will find atleast a dozen meetups in major metropolitan areas) and network with other experienced or novice real estate investors. 

I also signed up for a free BiggerPockets.com membership and messaged local investors and bought them coffee or lunch to pick their brain on real estate investing. Atleast 30-40% took me up on my offer and about 5 of them I talk to regularly about real estate investing. 

(Tangent: One of my friends told me a trick where you should spend 1/3 of your time with those who are a couple levels above you and where you want to be (mentors), 1/3 of your time with those on the same path as you (colleagues to help motivate and keep you accountable), and 1/3 of your time with those who are coming up behind you to give back, reinforce what you have learned by sharing your knowledge, and be thankful for the help you have received along the way.)

• What’s been your worst moment as a real estate investor? (please touch on a very specific moment or story if possible)

My worst moment would be when I trusted the wrong people and ended up losing about $5,000 on my first deal. The property itself was okay, as I recently got it appraised for $7K above purchase, however, Management was terrible and they placed an unqualified tenant who was eventually evicted and caused some major damage and stole all appliances. Further, this Property Manager did not winterize the property during the colder months causing a pipe to burst and damage the electrical and furnace in the basement. 

• What’s your greatest takeaway from that moment?

Like Ronald Reagan said, “trust, but verify.” I should have talked to a couple more investors where I would have found out they grew a bad reputation. However, I was blinded by the cash flow and fell in love with the property and ignored my gut. 

Overall, it was a good lesson learned as I quickly flew over to the market, built new relationships and now have a strong team in place. Your first one is always the worst, whats important is that you take action before you fall into analysis paralysis.

• How has real estate changed your life?

Real Estate has definitely changed me in more ways than one. Most importantly, I have created pretty good cash flow (averaging a net of $3K/month) during the past year which has relieved me of my burden of “needing” to climb the corporate ladder for more safety and pay.

I realized that being safe is dangerous, and taking calculated risks is the safer bet. I also realized that not many people know what they are talking about when they give advice, so you have to take a hard look at them and ask yourself if you would trade places with the person giving you advice. Not only talking about monetary things, but does that person seem fulfilled with their health, relationships, spiritually, and mentally. If not, don’t give up on your dreams or your desire to buy real estate, start a business, or create passive income because “Uncle Jack tried it in 2008 and lost all of his money.” It’s not what you know, but what you think you know that can hurt your growth.

• If you could learn any real estate related skill right now, what would it be?

I would love to learn how to become a better marketer, negotiator, and capital fundraiser (doesn’t everyone, right? Ha). One of my mentors told me that “you have to ALWAYS be marketing (generating leads) and raising capital. It doesn’t matter if you don’t have a deal yet, or it doesn’t matter if you don’t have 10, 50, 100 units. Those two things are the lifeline of any business and you have to get better at it each day.”

I took this to heart even when I only had 3 properties, and on my 4th one I raised private money, and my 5th-11th property have all been off market deals (wholesalers, direct-to-owner marketing, broker relationships, and through social media).

• If you had an extra $100,000 what would you do with it?

I would buy a duplex nearby where I live with 5% down, so that I can make my current primary a rental property. Even in an expensive market like Los Angeles, if you pick the right neighborhood and financing options, you can make the properties cash flow (e.g. 5% conventional financing househack). It may not be for everyone or for extremely expensive markets like SF or NY, but my primary residence has appreciated $70K since I bought it in 2017 and it was purchased with only 5% down (roughly $30K). I have realized major tax benefits, pride of ownership, rental income (house hack), appreciation, and debt paydown. Buy a tri or fourplex if you can.

• What’s the best book you’ve read recently? Why?

Maxout by Ed Mylett. (I wrote a book review about it here)

The book is based on mindset, and not specifically, but I believe that 80% of anyone’s success begins with our thoughts. That’s why successful people shield what information they consume as they become thoughts, habits, and result in being our identity. Ed talks about creating positive habits, goal setting and developing a “will to win.” It definitely gets you pumped up to go out and life a “MAX OUT” life. I had the pleasure of hearing him speak at a real estate conference in San Diego and he has definitely inspired me to work 110% every single day as I am not creating something just for myself and my wife, but something for both our families and future generations to benefit from.

Favorite Book Quote: “The average person has 75,000 thoughts every day, and 91% are exactly the same as the day before. It isn't hard to see why so many people stay in the exact spot in life as it relates to relationships, careers, finance, fitness, etc. Do you ever think about what you think about? Thoughts are like magnets; they draw to you that which you think about regularly. They also create the filters you see the world through. If you want real change, you must first change what you are thinking about.”

• What’s your end goal?

My 5 year goal is to create $15K a month in passive cash flow. I currently started a blog at www.biggercashflow.com and also release weekly episodes on my Bigger Cash Flow podcast as I always wanted to be a personal financial advisor. I think I may grow this passionate out in some shape or form where I can help other people like me create passive income and chase what really matters to them.

I had a quick conversation with my coworkers where I asked them, if money was no object (i.e. lets say you have $10K month in passive income far exceeding your expenses), what would you be doing right now? Initially, they gave me blank stares as nobody had asked them this question before, but eventually I got answers such as DJ, producer, blogger, full-time traveler, and actor.  This made me realize that we may be trading up our dreams and passions for a paycheck to work in a cubicle building out someone else’s dream life. If I choose to work in that W2 job because I love it every single day, that is different, but for the many of us that may not feel that way, I think passive income is the answer.

• What’s your greatest piece of real estate advice?

My advice would be to educate yourself (podcasts, audiobooks, REI meetups, pay a mentor if you have to – it all depends on everyone’s goals, resources, and ability), and take action, no matter how small, by your 3rd month.

This can be in the form of underwriting 10 deals a week, making 5 offers, or buying a turnkey property. You may be wondering “what if all 5 offers get accepted?” that means your offer was too high. Making many offers may scare you, but make them at the right prices where if all of them were to be accepted, you’ll find a capital partner in no time.

In summary, you don’t have to be great to start, but you have to START to be great. So JUMP IN REAL ESTATE!

Good luck!

Real Estate 038: Self Management vs. Hiring a Third-Party Property Manager

It’s been a while since I've written a blog post, mainly due to focusing more on acquisitions, managing the rehab, and stabilizing my portfolio. A question I receive often from my readers is whether or not they should hire a property manager (PM) or self-manager their properties. So I decided to reflect on my past two years of rental property ownership and share my thoughts below.

Should I self-manager or hire a property manager?

Investors understand the importance of buying below market in good locations with enough cash flow to pay its debts, expenses, and whether market cycles. However, all of these assumptions and proformas are only on paper, and a rental property is only good as its executed properly. Like Gary Keller describes in part 3 of his book "Millionaire Real Estate Investor", owning a million, landlords must keep the property in good condition (no slumlording) as well as find quality tenants to live in your rentals. A subset of those two functions is understanding the local markets (e.g. landlord laws, market rents, tenant demographics) as well as efficiencies of a sole proprietor vs leveraging a team (e.g. contractor discounts through volume, bookkeeping, and other administrative functions).

Hiring a Third-Party Property Manager

I have made a conscious decision on day one to hire a third party property manager to manage my rental properties and here are the reasons why:

• Cost efficiency: Each property manager is different, but based on the number of doors they manager (e.g. 100 -> 1000), they may work with designated teams of handyman, or even have in-house contractors that save you time and money when dealing with rent ready repairs and/or maintenance calls.

• Scalability: In addition to maintenance repairs, the process of searching for tenants, marketing, answering calls, collecting rents and bookkeeping takes time and effort. You may be able to handle the administrative functions easily when you are at a handful of single family properties, but as you scale up to 10, 20, 50 doors, you may end up finding yourself becoming overwhelmed with the tasks at hand.

• Liability protection: With my properties, the leases are between the tenant and the property management company, and the property management companies carry legal liability insurance in case there are issues that arise during showings, open houses, and maintenance visits. Furthermore, experienced PMs should be able to advise their clients on understanding local laws and regulations that can be a potential liability.

• Increased profit: You may have heard the advertisement "We've seen a thing or two, so we know how to deal with these claims". Its spoken from a large insurance company who have been in the industry for many years and have dealt with issues and challenges day in and day out. Unless you are fully confident in your ability to manage rental properties with maximum efficiencies, you may be leaving money on the table. For example, not pricing your rental rates appropriately, not using the right lease agreement, and understanding what type of rehab is needed for what tenant demographic and type of property. If you are paying your PM $100/door, but through reduced maintenance, longer term tenants, and increased rental rates you are able to recoup even half of that ($50/month), isn't it worth saving yourself hours of labor you can use to buy more cash flowing assets?
  

Self Managing your Rentals

Although I have made a personal choice to let a third party PM to manage my rental properties, there may be exceptions where others may choose to manage their own rental properties. Here are some of the scenarios I have found with other fellow investors who choose to self-manage their rentals:

• Active Real Estate Investor: There are folks who choose to be a real estate investor full-time and have the bandwidth to screen tenants, handle maintenance calls/repairs, and maintain the bookkeeping.

• Close proximity: If you invest locally in your backyard (generally <1 hour away), it may be easier for an investor to tour with prospective tenants, handle emergency issues, and keep a close eye on the property.

• Low number of rentals: If you are not looking to scale to a large portfolio, it may be easier to self manage your properties from both a economic and time-commitment perspective.

• Real World Education: It may not be a "cheap" education, but it may be worthwhile to see first hand how rental property management operates. Especially if you are a newbie investor just starting out, it may be possible to self-manage for a couple years (or months) and then hand it off to a third party PM if it does not work out. However, its important to note that sometimes bad PM work may be harder to unravel than starting from ground zero.
  

In summary, I plan to continue using my third party PMs for all of my rental properties for the aforementioned reasons above. I have rental properties in three different cities, mostly over 2,000 miles away, and do not have the bandwidth to find tenants, field maintenance calls, and do the bookkeeping. As it is with any professional services such as CPAs and Attorneys, my mantra is "you get what you pay for".

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!