Editor's Note: Today’s guest post is from Andrew, a New York lawyer who decided to invest in out-of-state real estate without even visiting the property. He blogs at Living Rich Cheaply. Andrew and I have no financial relationship.
I’ve always heard that investing in rental real estate is a great way to build wealth. It is hard to deny the benefits of investing in real estate, with cash flow from rent payments, principal pay down by the tenant, the use of leverage, appreciation of the property as well as rents, and the ability to depreciate the asset. Living in New York City, I thought my real estate investment would be relegated to buying a REIT fund. Housing costs here are prohibitively expensive and even if I could afford a property, would it even cash flow? Of course, I’m not saying real estate investing doesn’t make sense in NYC. I’m sure those who bought properties in up-and-coming neighborhoods in Brooklyn are doing just fine. However, solely relying on appreciation is speculation.
When I read about real estate investors in other parts of the country buying houses for $100,000 and renting them out for $1,000, I was pretty envious. I wish I could invest there, but I’d have to research what neighborhoods make sense for rentals. I’d have to find a realtor, find the property, hire and manage a contractor to get the property rent ready, and manage the property from afar or hire a property manager. For someone with a full-time job and little experience in real estate investing, it was not something I could take on.
Enter turnkey real estate providers
After reading the Biggerpockets blog and forum as well as blogs of people who invested long distance through turnkey providers, I started to think I could also invest in real estate. These providers provide a solution to this common problem to out-of-state investors. Generally, a Turnkey provider buys a property at distressed prices, renovates it, and sells them to investors. They also provide property management: screening and placing a tenant as well as dealing with the day-to-day operations of the property. It is a one-stop shop for your real estate needs. They generally charge about 10% of monthly collected rents to manage the property. While investing in real estate is never truly passive, this is as close as it gets. You check your owner’s dashboard online to see that you got paid and if there were any repairs needed. he property manager contacts you if the repair is above a preset amount.
Turnkey real estate investing sounds like it is too good to be true. While there are many benefits, there are also some things to watch out for.
You Are Paying a Premium
Many experienced real estate investors aren’t fans of buying property from a turnkey provider. They prefer to buy properties at distressed prices, fix them up and then rent them out. With this method, they have much more equity in the property. When you buy a property from a turnkey provider, you are most likely paying market value. There is a reason turnkey providers are selling the house at market value. They did the all the work and took on the initial risk. I don’t necessarily see anything wrong with this business model. However, many out-of-state investors look at these houses in the South or the Midwest sold by turnkey providers and say, “wow, they’re so cheap!” Be careful though, as cheap is relative. Sure, you might think the property priced at $150,000 is cheap but if all the comparable houses sell for $125,000, you’re overpaying. Many times, the turnkey property will be higher priced than many properties in the neighborhood because the turnkey provider has completely renovated it. Paying market value is not necessarily a bad thing, but just come in knowing that fact. If you have to sell soon after buying the property, you’ll likely lose money, unless it has appreciated in value. (Biglaw Investor: Which seems unlikely in most of these markets.)
Some turnkey providers seem to sell properties in lower-priced neighborhoods. Maybe it’s because it makes the numbers look good on paper: Buy a $50,000 house that rents for $800! However, sometimes a house is really cheap for a reason. If it’s a really cheap house, it’s possible that it is not a great neighborhood, in which case the prospective tenants might not be financially stable or have other issues. While it’s possible to make money investing there, it might not be the best move for an inexperienced investor who does not live in the area. Furthermore, that type of neighborhood will likely see less appreciation so make sure you do your research.
Run the Numbers
Some people have taken the monthly rent and subtracted the monthly mortgage payments (including tax and insurance) and the property management fee and say that’s how much they will cash flow. That may be true for some months, but you better take into account vacancies, repairs, and capital expenditures when you do your calculations because those costs will come up. Run the numbers yourself and don’t just rely on the pro forma statements provided by the turnkey companies. (Biglaw Investor: The numbers I’ve seen have all been pretty “rosy” as well. The pro forma statements are essentially the marketing copy that a turnkey provider will use to sell the property. It doesn’t mean that they’re lying to you since any reputable turnkey company that inflates numbers will soon find itself out of business but you definitely need to run your own numbers. Nobody cares more about your money than you.)
When I decided I would invest in a rental property out-of-state, I narrowed it down to cities where housing was relatively affordable and where it would cash flow, but also a city where the economy was strong. I contacted turnkey investors to see how their experiences went. Ultimately, I chose a turnkey provided in Kansas City, Missouri. One main reason was because it offered a “hybrid approach” where I would have more equity from the start. The company I worked with first acted as my realtor in bidding on properties, generally foreclosures. Then it acted as a project manager in hiring and managing the contractors in making renovations to the property. I purchased the property at foreclosure for $60,000 and the renovations cost about $11,000. It appraised for $83,000 and a tenant was placed paying $850 a month. The closing took place at the cafeteria of my work place during lunch with a mobile notary. Things are going relatively well but I would say that there have been more repairs than expected which have taken a significant bite out of my monthly cash flow. In 2016, my repair costs totaled $2500 and in 2017, $1400. From what I hear from those who bought a property from a pure turnkey provider, they had much less repairs as with this model, the company supposedly does a complete renovation of the house whereas the route I went, they did repairs to make it rent ready. I am still happy with the investment as I had much more equity going in and it has also appreciated since that time. Then rent has also increased to $895. If it wasn’t for the appreciation, I might not be too happy with this investment and I’m not sure if such strong appreciation can be expected going forward.
This company no longer does this “hybrid approach” as the real estate market there as well as many other places are pretty hot and very competitive. There are still companies which will help you buy a distressed property, renovate it for you, and then manage it for you. However, you will likely have to pay cash and then refinance afterwards.
I still think turnkey real estate investing is a good idea for someone who lives in an area where there is no cash flow, someone who is inexperienced and wants a little more hand-holding, and someone who is too busy to be a landlord. Just make sure you do your due diligence and research before you make your investment. You can always take a more hands-on approach later on but at least get started investing in real estate.
You can read Andrew’s latest real estate update here, including how he’s shifting his strategy to Buffalo.
Joshua Holt is a practicing private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He spends 10 minutes a month on Personal Capital keeping track of his money. He's also exploring real estate crowdfunding platforms like Fundrise which are open to both accredited and non-accredited investors.