Large real estate investment firms have been riding a large wave of opportunity and profit margins by providing turnkey rental investment properties to out-of-town investors. We recognized that small investors failed to pursue this opportunity because they didn’t have all of the necessary components. This inefficiency led us to create the solutions that will help investors purchasing from two to 100 properties a year provide turnkey solutions with the efficiency and scalability of the large investment firms.
For the past several years, traditional stock, bond and mutual fund investors have been seeking alternative investments for their discretionary and retirement funds. A high percentage of these investors turned their focus toward rental property; more specifically, turnkey rental property.
Investors prefer turnkey properties because all of the hard work has already been done. The property has been renovated to rent-ready condition, and a qualified tenant is already occupying the property. With property management already in place, these investors can focus simply on the numbers and purchase properties nationwide.
- Data from numerous real estate and investment sources indicate that this trend will likely continue into the foreseeable future:
- 25 percent of investors chose real estate as the best investment for the next 10 years
- Since 2010 renters increased from 37 million to over 43 million
- Investors shifted from West Coast rental properties to rental properties in the Southeast and Midwest
- Markets with the highest cap rates on single-family rentals (SFR) are in the Southeast and Midwest
These investors did not have the time, expertise or the inclination to purchase properties, renovate them and load them with a tenant. Rather, they preferred to buy a rental property that was already rented and had management in place.
Large investment companies recognized three market inefficiencies that led them directly to specific types of properties in specific geographical areas. Once they identified the opportunity, these firms created the solutions to the inefficiencies. Their pioneering efforts in this area have attracted individual investors worldwide.
These three inefficiencies combine to create the perfect storm for turnkey rental investment property:
- Lack of financing
- Lower price band properties
- Wholesale versus retail pricing
Dodd-Frank rules and regulations have made it, difficult if not impossible, for some buyers to obtain financing. Although new, more recent changes with FHA and Fannie Mae have started to enable potential homeowners to once again qualify for financing, a survey by Bankrate.com indicated that 45 percent of non-homeowners say that finances keep them from buying.
Lack of financing hit the lower price band property buyers particularly hard because it costs lenders more money to create a loan than they could profit on it. By limiting the profit to 3 percent to 5 percent of the loan origination caused many lenders to simply stop lending on properties that are worth less than $60,000. That has resulted in lower homeownership opportunities for consumers in this segment of the market.
Another inefficiency is that smaller investors, lacking all of the components to provide turnkey rentals to national buyers, are selling properties using the comparable sales approach to value and therefor selling at wholesale prices. Larger firms that have all of the components in place are able to fill the strong demand for these properties at the full retail value by using the income approach to value.
Would you rather be selling wholesale or retail?
Retail, of course. To be able to sell at retail pricing you have to provide all of the solutions, services and documentation that the large firms offer.
Once the large investment firms identified these inefficiencies, they created solutions to exploit the opportunities. The turnkey business model involves five steps:
- Determine the right rental neighborhood
- Acquire the property
- Renovate the property to rent-ready code
- Use professional property management
- Find a turnkey rental property buyer
Large companies were able to induce vendors to create national networks, data solutions and marketing platforms. This is what made the model scalable.
Large firms were now able to use data to determine the best rental markets in the country. They could acquire tens of thousands of homes in a single purchase from Fannie Mae and Freddie Mac. A national network of renovation companies could renovate the homes efficiently and get them up to code.
Having professional management is very important for the passive cash investor. The property management companies they use have national standards on tenant qualifications and online account access. National property management companies are able to qualify and place tenants into these homes while marketing-platforms targeted investors who were interested in or had already purchased rental properties in targeted areas.
A full marketing spectrum of direct mail, web presence and even mobile marketing are all easy platforms to utilize today. Combining those platforms with a proven lead source enables turnkey providers to build a scalable business model.
This proven model, while very profitable, is missing a key component that can make it even more profitable. This key component will also attract more investors to do more transactions.
The component that has been missing from the turnkey model, until now, is the ability to offer seller financing to the turnkey rental property investor. Adding seller financing in today’s financial market opens up the opportunity like never before.
What we have found is:
- Seller financing can be structured so that the net operating income (rent after expenses) can cover the debt service (monthly seller financed mortgage payment)
- Interest on the seller financed loans can be as low as percent
- The term on the seller financed loans can be as short as 5 years
- The down payment by the borrower can be 10 percent to 50 percent
Passive rental property and IRA investors are extremely attracted to this model because:
- They don’t have to pay all cash, so they are able to purchase more assets
- The debt service is covered by the rent
- The short-term financing means that they will own the properties free and clear in a short period of time
This model works exceptionally well in the Midwest and Southeast, where rental rates are very strong as compared to property values. Rental property investors seek out these same geographical areas because they offer the highest returns nationwide.
This property in Dayton, Ohio, shows comparable sales of $40,000. Three-bedroom/two-bath homes in this area rent for $750 per month. After taxes, insurance and management fees, the monthly net operating income is $459. The annual net operating income is $5,508.
While a real estate agent placed the comparable sales value at $40,000, real estate investors today are utilizing the income approach to value. This approach to value is applied because of the market inefficiency of property valuation in the lower price band space.
This approach shows that an investor looking for a 10 percent return on investment would pay $55,000 to receive $5,500 per year. Think of it this way: if a cash investor placed $55,000 into a moneymaking machine and it spit out $5,500 per year to that investor, his return on investment would be 10 percent per year.
Is 10 percent an acceptable return on a tenant-occupied property? Absolutely. According to DSNews (2/16), the best rental market in the country is producing a 7.3 percent return!
If we apply seller financing for this investor, the cash-on-cash return will be even higher. In this example, the sales price was $55,000.
Seller financing is a real game changer in this investment vehicle. Traditional banks and other lenders are not active in this space and therefore a lending void is left in the market. At NoteSchool, our executive team has purchased more than $2.5 billion in seller-financed notes over the past 35 years and our experience shows that when the banks say “no,” seller financing immediately fills that void.
Based upon the monthly NOI, if an investor put 50 percent down, we could offer to finance the balance at 6.25 percent for 6 years. This way the tenant is essentially paying for half of the purchase, and the cash investor will own it free and clear in 6 years.
If the cash investor put less down or wanted a longer term or different interest rate, we could certainly create a different loan to fit the transaction.
A turnkey seller who followed all of the six steps properly would make an even better return. In this example, the turnkey seller acquired the property through purchasing a non-performing loan and receiving a deed in lieu of foreclosure. Once acquired, he renovated the property and was all-in for $20,237.
The down payment of $27,500 provided by the cash investor covered the entire expense and about a $7,000 profit upfront. In addition, the turnkey seller receives a passive $459 per month for 72 months secured by the property!
Conclusion and Game Changer
The demand for turnkey rentals is very strong, and every indicator shows that the trend is likely to continue into the foreseeable future. The time to make this a part of your overall investment plans is now. The best investment is fulfilling a demand by creating solutions to market inefficiencies.
This turnkey model does not work on every property. It is best to apply the model and calculations before purchasing the property rather than after purchasing the property and trying to force it into this model.
Although seller financing is the perfect solution for lower price band properties, you do not have to use seller financing on every property. Third-party financing works on more expensive properties and all-cash works as well.
Always keep the end product in mind. If you will be providing a seller-financed turnkey rental investment property, make sure that the projected numbers work for both you and the cash investor. If third-party financing is available, run that scenario as well. A full cash option can always be added to a lower or higher price band transaction.
Although this model works anywhere, if you are going to build a scalable investment business out of it, focus on strong rental markets in the Midwest and Southeast. The monthly rent on the property should be greater than 1 percent of the after repaired property value. For example, if the property is worth $55,000, the rent needs to exceed $550 per month for the turnkey model to work.
Anticipate investor questions by documenting everything: neighborhood rent reports, renovated items, inspection reports, tenant qualification paperwork and property management information. Your investors will certainly want to see that information and having it all available will show that you are professional.
NoteSchool, through its Turnkey Flipping Academy, has invested countless hours of strategic planning and was able to engage national vendors in all steps involved in providing turnkey rental properties to individual investors nationwide.
We have a vendor for neighborhood rental reports, access to discounted non-performing notes and REOs, national property preservation and renovation, national turnkey cash buyer lead list with a complete marketing program, a national seller to follow up on your marketing leads, and even closing assistance for creating the seller-financed note.
This vendor network gives individual investors the same access to national vendors as the large multimillion-dollar firms. It is what allows the small investor to unlock this opportunity and build a scalable national business. It is a true game changer that levels the playing field.
For over 35 years, I have worked with real estate investors through both Colonial Funding Group and Note School. That same foundation of innovation and industry leadership can be found in Colonial Capital Management, the Seller Finance Coalition and NoteSchool’s Turnkey Flipping Academy (TFA). For more information, go to www.turnkeyflippingacademy.com.