Not Created Equal: Analyzing the $100K Deal
- January 30, 2017
- Author: Tom Wilson
Let me tell you about two great real estate deals for the busy professional. Both are single family homes that have been renovated and are offered as turnkey rental investments. Investor Special #1 is priced at $100,000 and rents for $1,200-a 1.2 rent ratio. Investor Special #2 is priced at $100,000 and rents for $1,050-a 1.05 rent ratio. Which property do you choose?
One really is a better deal than the other and I'll let you know why later. However, if instead of choosing, you thought, "I can't make a decision based on such limited information," then you're in the top 50% of real estate investors. In a moment, I'll help you get to the top of the class by understanding the crucial data required to properly analyze a turnkey deal. Your test will be to use this information going forward to make investment decisions based on information gathered, not on the slickest presentation or the personalities involved.
First, why turnkey investments are not created equal. To the top tier turnkey property providers, turnkey means that all the elements of the investment are in place so that all the investor has to do is "turn the key" on their bank vault and watch the money flow in. Clearly there is more to it than that, but not all that much more. By our (and I mean the top providers) definition, a turnkey investment property has ALL of the following attributes: (1) The provider is in possession of the deed, (2) The property has been carefully selected and renovated with renters in mind, (3) The property has been leased, 4. A property management company is actively engaged in managing the property. After the investor purchases the property, the property manager simply redirects the rent checks to the investor.
Some providers call their offerings turnkey, but are missing some or all of the four essential elements. If the company selling you the property does not possess the deed, it is not a turnkey. If the seller has yet to complete renovations, the property is not turnkey. If the property does not have rent paying tenants, the property is not turnkey. If the seller offers to "look after" the property until you find a property manager, the property is not turnkey.
Now that you understand the four essential elements that define a turnkey property, how do you evaluate the myriad opportunities available to you and get to the top of the class? By analyzing how each deal rates in four major categories: Location, Property Condition, Provider, and Property Management.
- Metro Economy: Is this a one economy or one company dominant town? A broad based economy makes for a more stable rental market.
- Submarket Economy: The city may be doing well, but don't buy in a depressed neighborhood.
- Population Growth: State, metro, and submarket. This is ultimately what drives the future rents and house values. You want your future income and values to appreciate.
- Demographics: Income, crime, turnover rates, education, age.
- Neighborhood: What is nearby: busy roads, noise, multifams, utility towers, flood zone.
- Vacancies: Number and trend
- Foreclosures: Number and trend
- SFH Price: History and trends
- Government Policies: Business friendly, landlord friendly, zoning, master plans
- Age: Generally older houses require more maintenance.
- Structural Condition: Is the foundation stable? Number of usable years left for the roof
- Quality of the Renovation: Was rotten wood painted over or replaced? Will the carpet wear out in a year or last through a tenant or two? Are appliances sturdy enough for the rental market and attractive enough to appeal to quality renters? Was every aspect of the renovation geared to attract an excellent tenant and to minimize the likelihood of having any significant maintenance for several years?
- Extent of Rehab: Just interior cosmetics, or were the appliances upgraded, landscape improved?
- Tenant Friendly: Good floor plan, usable back yard, 3 or 4 bedrooms, at least 2 baths, 2 car garage.
- Conformance to Neighborhood: Is it the largest house on the street and therefore not likely appreciate as much. Does the architecture fit into the neighborhood and appeal to tenants and future buyers?
- Reputation: References, internet, Better Business Bureau
- Direct Source: Is the person you are dealing with just an agent or referral service? Are you dealing directly with the company that owns, rehabs, and manages the products?
- Experience: Years of experience and stability? Number of units sold?
- Realistic Performance Claims: Do they project too-good-to-be-true cash flow and ROI? Is the rend estimated or actual?
- Transparency: Does the provider give all of the facts up front and on the website about the property: Age, lots of photos, public records, actual current expenses, house specs?
- Value: How is the provider justifying their price? Are they giving you sales comparables up front? Are they dancing around the subject of appraisal and market value? Are they trying to sell the property for cash so as to avoid an uncertain appraisal? Ask them how many of their investors get loans and how often they fail an appraisal. A reputable provider will seldom fail appraisal.
- True Turnkey? Is the unit really leased? Do they want you to take over a contract for a raw property and cover all of the unknown expenses for conversion to a rental? It typically cost 15-30% of the raw product purchase price to get it to positive cash flow. Beware of the seller who says that with a little carpet and paint it will be rented in 3 weeks.
- Investment Credibility: Do the provider's principals own properties in the same area that they are recommending for you to purchase?
- Ownership: Do they own and have clear title to the properties or do they just have a contract with the seller because they cannot get loans to purchase the properties themselves?
- Team: Do they have all of the professionals needed to make the transaction easy? Does each member of the team work mostly with investors, not owner occupants? This is important.
- Warranty: Do they provide any warranty?
- Experience: Years for principle and staff? Licensed agents?
- Fees: 10% is typical for up to 4 properties with full service. Half of one month's rent is typical for new leases.
- Provider Endorsement: Does the recommended property manager manage the provider's own personal portfolio?
- Number of units managed: Are they too small to have back up coverage or too large and have a lot of overhead?
- Staff: Is it sufficient to cover the needs?
- Product compatibility: Is what they manage mostly the same as what they will be managing for you (houses, not apartments or commercial?
- Management in your area: Do they have other rentals in the same area that you are considering purchasing or do they not know that area well and have to make a special trip to check up on your property?
Yes, there's a lot that goes into analyzing a turnkey property, but it is YOUR money. Ask questions until you are satisfied, and by all means, visit the property before you buy.
Back to the two investor specials at the beginning of this article, which are real case studies. (Names have been changed to protect the duped!)
Investor Special #1 priced at $100,000 and rents for $1,200, purchased by "Sam." During the loan process the appraisal for the property came in short and Sam shells out another $5K to close the deal. After closing, Sam finds out that the rent was a "market estimate" and after waiting for 3 months and dropping the price twice, he finally gets it rented for $1,000 / month.
Within 6 months Sam is notified that the 50yr old house has exterior trim that needs replacing because the seller painted over rotten wood, the hot water heater needs replacing (and there is no warranty), and the HVAC needs repair. His bill is greater than the net income that was predicted for the first year. The city he purchased in has only one industry, and within a year, the one new UK manufacturing plant that was scheduled to come to town and employ 2,000 people gets postponed indefinitely because of economic uncertainty in Europe. Adding salt to the wound, Sam's tenant fails to renew his lease. Sam experiences another 3 month vacancy and he has to drop the rent to $900 because of the now weaker rental market. Sam is very sorry he didn't do his homework.
Investor Special #2 is purchased by "Mary" for $100,000 and rents for $1,050. The house is only 10 years old, comes with a premium home warranty, is already leased and the appraisal came in at value. The employment in the state is the highest in the country, the city has 25 Fortune 500 companies with diverse economies, the population is growing, rents and values are appreciating. Mary's first tenant leased for three years. When it did turn over, the property required minimal make-ready. It was leased again at $1,125 before the current tenant moved out. The cash flow exceeds Mary's expectations. Mary earns an A+ because she purchased in a top, low-risk, metro and from a reputable provider.