Thinking of Investing in “Turnkey” Rentals? Proceed with Caution

Boston area real estate values continue to climb, and as a result, some investors are finding themselves priced out of the market, or finding that the rates of return are too low to justify the risks. Some don’t want to give up on real estate investment altogether, so they’ve turned to an alternative strategy: buying “turnkey” rental properties in undervalued markets.

A number of third-party “turnkey” providers have sprung up recently to meet increased demand.

But is this really a wise investment strategy, or is it all just a cleverly marketed gimmick? Let’s take a look.

What are “Turnkey” Properties?

When we use the term “turnkey property” we are referring to the loosely defined investment strategy in which the investor buys, rehabs, and manages a property through a third-party. The process of working with a third-party typically looks something like this:

1. Finding a property. The company will help you identify and build a portfolio of properties that meet your personal investment goals. Some offer a pre-vetted database of properties for your consideration.
2. Funding the investment. Turnkey providers will help you evaluate a range of financing alternatives depending on your individual circumstances and goals.
3. Acquiring the property. Once you’ve identified the property you’d like to purchase, the turnkey provider will assist with all paperwork, home inspections, appraisals, loan documents, etc. They act like real estate agents but specialize in working with long-distance buyers who want to take a hands-off approach.
4. Renovating the property. If a property needs renovations or maintenance of any kind, the turnkey provider will typically manage this process for you.
5. Property management. Turnkey providers help stabilize a property by finding tenants, etc. and then handle the day-to-day operations for owners.

Generally speaking, most turnkey firms will charge around a 3% fee for property acquisition, and then anywhere from 7% to 10% for ongoing property management.

There are hundreds of turnkey firms across the U.S., and no two are exactly alike. Some will buy, rehab, rent and THEN sell a property to you (an investor). Others specialize in helping you find cheap properties (as low as $20,000) that need renovation and then will help manage those renovations for you. The range of services can vary greatly, so always be sure to research turnkey providers well before you commit to anything.

Buyers Beware

There has been an explosion of turnkey providers since the downturn, and not all are legitimate. Some target uneducated buyers and sell the promise of a stress-free, cash flow generating investment opportunity.

As it turns out, many of these turnkey providers are expert internet marketers—not expert real estate professionals. Many don’t even know how to professionally manage the properties they’re selling you.

Here are a few warning signs that a company may not be legitimate:

• Inexperienced operators. Find out how long the company has been in business, where they’ve invested in real estate, how many buyers they’ve worked with, etc.
• Lack of direct investments. Has the company invested in its own portfolio of rental properties? If so, what types of returns are they getting? If the company doesn’t own and manage its own rental properties, how will they know how to properly look after yours?
• Weak support structure. Is the person who’s selling you on the investment the same person responsible for property acquisition, rehab, tenanting and maintenance? If so, that’s an indication that there’s a weak support structure in place. Legitimate turnkey firms typically have a deep bench with professionals of varying expertise.
• Shoddy renovations. Before going into business with a turnkey company, take the time to tour a few of the other properties they manage. What condition is the property in, and have renovations been done properly?
• Rental guarantees. Experienced real estate investors know there is no such thing as a “rental guarantee” – a property may be more or less likely to rent quickly, but there’s no guarantee that it will be rented at the price the turnkey operator has stated. Spend some time doing your own market research.
• Overpriced properties. Similarly, spend some time researching the local market. Turnkey providers are notorious for selling overpriced homes to out-of-state investors who are used to expensive real estate markets. A home that sells for $200,000 might seem like a bargain compared to the Boston area—but if local comps are selling for half that, then there’s a good chance you’re being duped by the turnkey company.

To Buy or Not to Buy

Ultimately, the decision as to whether or not you should invest in turnkey rental properties is a personal one. Your experience in the real estate industry, knowledge of local markets, and investment objectives should all influence your decision.

Turnkey rentals can be a great way to diversify your portfolio, especially if you’ve been priced out of the local market. But be cautious about who you invest your money with – always, always do your due diligence before committing to a specific turnkey provider. Make it your point to understand the vacancy rates in the area and the general cap rates in each specific marketplace you choose to do business. Go online and see what different bedroom sizes are renting for and notice how long they stay on the market.

Understand the Area

No investment is foolproof. But keep in mind some investment properties maybe cheap but doesn’t mean they are good. Turnkey properties are often easier to buy than they are to sell, so be sure to prepare your exit strategy in the event things don’t work out as initially planned.

You must also be aware of your long term goals. What is happening in their local economy that you are investing in? Are jobs leaving the area because of high tax rates? Are jobs being driven out because of poor policies? Is the job creation environment a friendly one because if not businesses and capital are highly mobile. Capital and private enterprise that is being treated poorly will often leave. Notice how big companies are leaving certain states because their tax policies are driving out job creators. You should inspect the local environment. Jobs are the biggest driver of filling apartment rentals. No jobs, no reason to live there. At the end of the day it is nearly always all about the jobs.

The key is to research an area, see if it is on the upswing and what the future holds. Do you think the area is improving? Do you see businesses sprouting up there; are there innovations that are attracting capital and brainpower to the location? Timing in real estate, like everything in life, makes a huge difference. There can be nothing more rewarding than finding a downtrodden area that is showing signals of a turn around. 

Nothing last forever in real estate. Great areas come and go. Many areas eventually tap out and can’t go higher because the returns become too thin and then the properties their prices and their conditions start to go in the other direction. Yesterday’s great city or town is not today’s great city or town.  The economy has fits and spurts based on a myriad of economic factors. But if you have done your research, and your gut is telling you this is a great area to place your capital; then go with your gut. Chances are it will be correct!