Real Estate investing is hot in 2015. Everyone, and I mean everyone wants to be in this space. And in particular, Turn-key real estate investments have gained considerable notoriety as of late. There are more and more searches in Google, and there are never-ending questions on all of the internet real estate platforms, specifically BiggerPockets.
So is turn-key real estate a good investment?
Turn-key is on people’s minds. They want to know how if it works. They want to know if it’s a good idea. They want to know if it is safe. They want to know how much money they will make. They, frankly, simply want to know if they should do it…
There is a lot to discuss as part of this conversation. Let’s see if we can answer some of these questions here. I broke this up into 2 articles so as not to overwhelm you, so when you are done reading this, look for a link at the bottom to the part 2.
In this 1st article I will paint the big picture – what is turn-key, who are the players, how it works, and why people do it. In the follow-up article we’ll focus on the pitfalls – things that are not black and white, but things you must consider when deciding if turn-key is right for you.
And with this, let’s begin…
What is Turn-Key Real Estate Investing?
Turn-key real estate investment in concept is very simple – you are buying a building (usually a SFR house), which has been fixed up, and with a tenant paying rent already in it. turn-key is marketed to you as buying existing cash flow, hence the term turn-key; as in – nothing for you to do but stroke a check and watch the rents come in.
The process is simple:
A turn-key retailer (or in many case a turn-key company) on the ground buys a building. He then rehabs the house and puts a tenant in it. He then sells the building to you at a mark-up whereby he not only recovers his cost, but also makes some margin of profit.
I am not passing judgment, by the way, whether or not turn-key guys should make this profit. In fact, of course they should – if they did the work, they should make the profit. The only question here is whether it’s a good investment opportunity for you, the buyer of turn-key.
Since you, the buyer, are likely in a different State and cannot manage the asset on your own, most of the time the turn-key retailer sells management services of the asset as part of the deal, for which he charges you the going rate. The management fee is most likely something around 10%.
Why Do Companies Sell Turn-Key Rentals?
For them it makes a lot of sense. As you can see, there are not one but two profit centers for the turn-key guys. First profit center is the mark-up at the time of sale to you. And secondly, there’s the on-going management fee that you will pay them for presumably as long as you own the asset.
This is sort of the best of both worlds – take some equity gain up-front, and take some cash flow as you go. It’s a blend of a flip and a rental, only instead of rental cash flow, which is not guaranteed, the turn-key guys get cash flow via contractual management fee which you pay, and since it’s contractual – it’s guaranteed.
Not too bad of a set-up. Would you agree…?
Is a Turn-Key a Good Investment?
This is pretty simple to see as well. A lot of the folks who earn big money, folks like you, happen to live in areas whereby cash flow is hard to achieve since the asset prices are so high. And since everyone wants cash flow with which to substitute for their W2 income, since hardly anyone likes to work for “the man”, these folks tend to look outside of their area.
This is off subject a bit, but have you considered why house prices get high? Yes – it’s more difficult to create cash flow, but the reason prices are high in your area is because there are economic and demographic trends to support growth. If people are coming, because there is money to be made, and if people coming create a shortage of housing which drive up the prices, doesn’t that mean future equity? And if this is so, the question becomes – do I want cash flow on cheap houses in Ohio or Indiana, or do I want appreciation in an economically progressive market…?
But I’ve digressed. Coming back to turn-key, since it’s too far to either manage a rehab or the tenant base from another State, many people see turn-key as a perfect solution – have someone else do the rehab, and have them manage your tenants. You just collect checks every month, and so what if it costs a little more up-front…
Such is the rationale.
A Turn Key Rental Example
Let’s just take Ohio, since this is where I am and what I know. And let’s say the turn-key retailer purchases a house for $20,000. He then markets to you that $12,000 of repairs have been completes and the house is now rented for $800/month. The marketing materials indicate that value of the house after these repairs is now $55,000, and the asking price is $45,000 – meaning you will instantly gain $10,000 in equity. Finally, the management fee will be 10% of gross.
The advertized expenses most of the time, include these items:
- Property taxes
- Fire Insurance
Let’s just say that property taxes are $100/month, Insurance is $50, Vacancy is 10% or $80, Maintenance is 5% of gross or $40 (because the maintenance is done in house, you are sold on the notion that your maintenance costs will be very low), and Management is $80. Thus, total expenses are $350/month.
At rent of $800/month and expenses of $350/month, the NOI would seem to be $450/month. The marketing brochure multiplies this by 12 to arrive at $5,400. Finally, the marketing brochure advises you that at the suggested purchase price of $45,000 the NOI of $5,400 constitutes a 12% Capitalization Rate.
Turn Key Rental Conclusion
Where else am I going to achieve 12% returns on my money? I better consider this…
Well, I agree – you better consider this. There are quite a few moving parts in the above example which may not be exactly what they seem. In the next article I’ll paint you that picture. Turn-key might very well be the thing for you, but you will have all of the pieces of information to make an intelligent decision.
And now that you’ve read this intro, head over to read Is Turn-key Real Estate a Good Investment Part 2, where I dive into actual numbers and economics.