Fixer-uppers aren’t for everyone.
Sure, some real estate investors create equity by renovating properties. But hiring, managing, and negotiating with contractors comes with its own headaches. And some investors don’t have the stomach for hassling with permits, lender draw schedules, and surprise repair costs.
Fortunately, investors looking to diversify their assets and buy rental properties can skip renovations entirely with a turnkey property through a website like Roofstock. Turnkey real estate is exactly what it sounds like: a property that’s either in rent-ready condition or already rented to a paying tenant.
Sound like a dream come true for a new real estate investor? While it can be a low-involvement way to get started in rental investing, it isn’t like clicking a button to buy a stock or real estate investment trust. From high initial investment costs to low liquidity, real estate – even in the form of turnkey properties – comes with its quirks and challenges for investors.
Top Considerations for Turnkey Properties
Before you go on a turnkey buying spree, you need to know what you’re getting yourself into. With each property costing tens of thousands of dollars in closing costs and down payments alone, you can’t afford to make many mistakes.
Here are eight things to consider as you start evaluating potential turnkey properties as investments.
1. Cap Rate
The biggest drawback with turnkey properties is the difficulty finding good deals.
Think about it. Someone else has already done all the work for you in updating the property and putting it in perfect, rent-ready condition. They’re selling you a finished product, ready to start churning out passive income.
That leaves little meat on the bone for the turnkey buyer in the form of value for money. The seller, often a flipper, has already forced equity by updating the property and possibly even placing a tenant in it. They’re cashing in on that equity when they sell to you.
So, you’re buying at or near the full market value of the property.
As an income investor, your focus lies more with the property’s ongoing earning potential than its current market value. Income investors often measure that earning potential through capitalization rate, or cap rate.
Cap rates are one measure of the property’s return on investment. The formula looks like this:
Net Operating Income (NOI) ÷ Purchase Price
Net operating income is the annual income the property can generate minus all operating expenses, such as repairs, maintenance, property management fees, vacancy rate, property taxes, and insurance.
Imagine you’re considering two identical properties across the street from one another. Both properties bring in an annual net operating income of $20,000. But one seller is asking $275,000 while the other is asking $250,000, for a cap rate of 7.3% versus 8%, respectively.
Note that while cap rates provide a way to compare properties objectively, they don’t account for your return on investment. For that, you need to calculate cash-on-cash returns.
2. Cash-on-Cash Returns
When you finance a turnkey property, you only come up with a certain amount of your own cash out of pocket. Specifically, you come up with funds for the down payment and closing costs.
You’re investing less cash, but you’ll also see less net income each year since you’ll have a mortgage payment. Cash-on-cash returns measure your return on the money you had to put down.
Say you buy the property in the example above for $250,000. You put down 20%, or $50,000, plus $10,000 in closing costs for a total cash outlay of $60,000. But that leaves you with a $200,000 mortgage, which we’ll say costs you roughly $1,200 a month for a 30-year loan with a 6% interest rate. The mortgage payment drops your annual net income from $20,000 to $5,600.
Your cash-on-cash return for the property now looks like this: $5,600 in annual income divided by your $60,000 investment, for an annual return of 9.3%. That shows you the power of leverage in not only reducing your cash investment but also accelerating your cash returns.
As just demonstrated, financing changes your calculations – sometimes for the better, but not always. You need to know what kind of financing terms to expect for any given property before making an offer.
For example, let’s say you have a local lender in your home city willing to lend you 80% of a property’s purchase price at 6%. But they don’t lend out of state. So when you look at turnkey properties further afield, you’ll need to look for a different lender, which may have different lending terms.
Establish relationships with several lenders in each market where you plan to invest in case your first-choice lender doesn’t allow a given property for whatever reason. Each lender has their own underwriting guidelines, and even those don’t always prove predictable. Sometimes, a lender just won’t like the look of a property and turns down the loan.
Also, keep in mind that for turnkey properties, you need long-term financing rather than a short-term hard money loan. Look for portfolio lenders and local community banks, particularly those that don’t report on your credit for investment property loans.
4. Property Management
Before buying a rental property, you should have a plan for who’s going to manage it.
That could be you, of course. Managing your own rental properties, particularly when you first start investing, is a great way to learn the industry faster. It makes you a better investor with a deeper understanding of how expenses and management labor vary between different types of properties, neighborhoods, and renters.
But it’s not always practical to manage your own rental properties. If you live in another state, give birth to triplets, take a demanding new job, or amass dozens of properties, you must prepare for the day when you can’t self-manage them. For that matter, many landlords discover managing rentals comes with too many issues, and they simply hate doing it. So even if you intend to manage the property yourself, have a contingency plan for property management.
And make sure you budget for property management, even if you don’t plan to use it at first. Property management is a labor expense, whether you’re performing that labor or someone else is. Rental properties are not a completely passive source of income.
If you do opt to hire a property manager, make sure you research and interview companies in the market before buying a property there. As a starting point in your property manager search, check out Roofstock, which maintains a nationwide list of certified property managers.
5. Existing Tenants
Does the property already have tenants placed? If so, how long have they been there? How’s their credit? Their income? Have they ever been evicted? What’s their payment history?
It’s convenient to buy a property with a clean, reliable long-term tenant. But just as easily, you could inherit a nightmare tenant who will default in your first month of ownership.
If the property has a tenant in place, screen them the same way you would a new applicant. Review their payment history, all their background checks, their rental application, and their income.
Remember, the quality of your tenants determines the quality of your returns.
6. Age of Mechanical Systems
You found a property in livable condition that’s ready to advertise for new tenants or with existing tenants in place. But that doesn’t mean the furnace won’t die on you next month or that the wiring isn’t an inferno waiting to happen.
“Livable” is not synonymous with “new,” “renovated,” or “modern.” Even when a seller markets the property as “updated” or “renovated,” that doesn’t mean they replaced every component on the property.
Look at every mechanical system and structural component of the property to assess its age and remaining lifespan. Ask your real estate agent’s input, and corroborate these opinions with a home inspector.
Just because one or more systems are aging doesn’t mean you don’t want to move forward with the property. But you need to know what you’re getting yourself into and budget accordingly.
7. Quality of Renovations
Similarly, just because a property was recently renovated doesn’t mean it was renovated well.
Flippers don’t need to live in the property or maintain it long term; their priority is profit. They aim to spend the least amount of money to create a finished product. That sometimes means spending less on second-rate contractors or materials.
Pick over the property with a fine-toothed comb and ask your home inspector to do the same. Ask the inspector and the real estate agent their opinions about the quality of the renovations.
If the three of you don’t like what you see, skip the property and move onto the next one. Visible evidence of shoddy work is only the surface of the problem – it’s what you can’t see that should really scare you.
8. Long-Term Economic Health of the Local Market
Buying rental properties, unlike flipping houses, involves a long-term investment. You want to invest in a city and neighborhood with increasing population, jobs, and demand for housing. You also want a city with decreasing crime rates, vacancies, and social problems.
I no longer invest in the city where I grew up because I don’t trust its long-term economic and political health. I learned the hard way that lower-end neighborhoods often look good on paper with high cap rates, but those cap rates obscure less visible costs like turnover, crime, and protectionist laws.
There’s a niche of investors who earn good profits in struggling cities and neighborhoods. But it’s precisely that: a niche with unique dynamics. Resist the temptation of low purchase prices and high on-paper returns. It takes specialized expertise to make money there.
If you aren’t 100% confident a city and neighborhood are moving in the right direction, don’t invest there.
Where to Buy Turnkey Properties
Ready to diversify into turnkey rental properties but not sure where to find them? Diversify without the headaches by using options that don’t require years of experience in real estate investing.
Over the last few years, Roofstock has emerged as the premier platform nationwide for turnkey rental properties. It’s cheaper for sellers than hiring a real estate agent, and it provides buyers with a massive amount of data.
That data includes neighborhood details, such as the quality of the local schools, median home values, and appreciation history. For the property itself, the platform includes adjustable calculators and data on cap rates, internal rate of return, and projected appreciation.
Roofstock also includes two guarantees. The first is a money-back guarantee. Buyers can relist the property for sale if they aren’t happy with it within 30 days of purchasing, and Roofstock guarantees they recover their purchase price. The second is a tenant-placement guarantee. If you buy a vacant property and fail to place new tenants in it within 45 days, Roofstock pays 90% of the market rent until you do.
Retain a Real Estate Agent
You can always go old school and hire a real estate agent. Most homes in the U.S. still sell on the MLS, after all. Besides, the seller pays most – if not all – of the agent’s fee. It costs you very little as a buyer to hire a real estate agent.
Just make sure you hire a stellar real estate agent experienced in working with investors – and preferably one who’s an investor themselves.
The problem with homes listed publicly on the MLS is that, by definition, they’re selling for market pricing. If there’s a deal to be found, it’s through either hard-nosed negotiation or sheer luck. You won’t be scoring a deal no one else knew about among homes openly listed for sale.
Private Turnkey Sellers/Flippers
Many real estate investors make their living by flipping homes to long-term investors. They find a good deal on a dilapidated home, renovate it, and sell it as a turnkey property. Some place tenants in it to cover the carrying costs while they market it.
While some of these sellers list their properties on the MLS or Roofstock, others operate through private contact lists. You can find them with a Google search for turnkey sellers in your market of choice or in real estate investing Facebook groups or forums.
Sometimes, these sellers allow some wiggle room for negotiation without the additional costs of real estate agent or Roofstock fees. But as always, keep the considerations above in mind before buying a turnkey from a flipper.
Approach Existing Landlords
People love to hate landlords. But the fact is that being a landlord comes with a slew of headaches, from 3am phone calls from screaming tenants to unpaid rent to constant complaints and demands.
Many landlords are so miserable, they’ll unload their properties to the first person who expresses interest. They aren’t necessarily planning to sell right now, but they’re so unhappy, they give in to the temptation when an offer comes along.
Direct mail, social media messaging, even phone calls can all work as outreach tactics to existing landlords. Often, the properties feature paying tenants already in place, making them not only turnkey but also already rented.
But that doesn’t mean they’re good tenants, of course. Put together a plan for managing these properties better than your predecessors, and take a firm hand in collecting rents, inspecting the unit, and enforcing your lease agreement.
If you’re looking to diversify into real estate and don’t want the headaches of direct ownership, you have plenty of options for investing in real estate indirectly.
But for those ready to become a landlord, turnkey real estate makes for a relatively quick and easy way to diversify into rental properties – no hammer and nails required.
Beyond the other advantages, there are plenty of tax benefits of investment properties. And if you sell a property and don’t want to pay capital gains tax on the proceeds, you can always do a 1031 exchange by buying a turnkey property with them.
Just make sure you run the numbers and double-check the property and tenants before investing tens of thousands of your hard-earned dollars.
Are you thinking about buying a turnkey property? What’s holding you back from investing?