The Truth About Turnkey Investors and “Having It All”
Turnkey Property: A turnkey property has historically been defined as a piece of real estate that can be purchased as-is and immediately rented out. Turnkey has expanded in recent years to include anything that can be conducted from a distance (i.e. a turnkey fix and flip) but generally refers to rental properties that are purchased, often with a tenant in place, by an investor who will not be interacting directly with the property.
Turnkey Rental Property: A property purchased for the express purpose of renting it out. A turnkey investment may already have a tenant in place, or a turnkey provider may sell a property with the promise of an appropriate rehab and then leasing the property.
Turnkey Provider: An investment company that offers turnkey properties or transactions to other “passive” investors. Turnkey providers locate properties, renovate them, usually place tenants, and may provide property management after the purchase.
Passive Investing: Passive real estate investors power real estate investing transactions by providing funding for deals and allowing active investors to manage the actual investing process, be it leasing a property, renovating it, or selling it.
Five years ago, in early 2012, billionaire investor and “Oracle of Omaha” Warren Buffett now-famously said on CNBC’s Squawk Box, “If I had a way of buying a couple hundred thousand single-family homes and had a way of managing [them]…I would load up.” While at the time Buffett added that he felt owning that kind of rental real estate portfolio would be too huge of an undertaking even for him (“The management is enormous”) the sentiment resonated.
Shortly thereafter, individual and institutional investors alike entered the turnkey real estate market en masse as industry players happily began broadly marketing and providing what is now a real estate investing byword: turnkey rental properties. Buyers of those turnkey properties often purchased them sight-unseen and left their management entirely to the property company that accompanied the rentals at time of purchase. They simply collected their rent checks and left everything from acquisition to renovations and maintenance to management to the turnkey experts and their service providers. It was not a new investment strategy, but it certainly had new life.
“The phrase ‘turnkey rentals’ has evolved over time and generally means done-for-you rental properties where someone else has found the deal, rehabbed the property, placed a tenant, and is going to manage the property for you,” explained Mike Hambright, the self-proclaimed “chief nerd” at FlipNerd.com, where he has interviewed dozens of turnkey real estate investment providers on his podcast by the same name.
“It may not be all the same company that is doing every activity, but the key to turnkey investments is that they are done without your efforts,” Hambright said. When purchasing a turnkey rental, investors often focus on monthly income rather than appreciation. “Cash flow is everything, [but] most importantly, the asset needs to be properly managed to minimize vacancy and repairs,” he added. “If you find the right turnkey provider, financing, and property management, the turnkey route is a great opportunity.”
Mike Jordan, CEO and founder of turnkey rental provider Strategy Properties, agreed. “We pride ourselves on providing quality rental homes to our tenants and homes that meet all the criteria to produce strong returns for our investors…[but] our main goal is to shrink the window between tenants,” he said. “If we shrink that window, then we don’t interrupt cash flow for the owners, and that is a turnkey provider’s main job.”
A New Nation of Renters and Landlords
In the years following the housing and financial crises, buying a home was far less expensive than renting one in most areas of the country. However, with much of the population still recovering from the trauma of foreclosure, financial duress, and the Great Recession, even households that could afford to make a hefty down payment and qualify to get a mortgage often opted simply to rent rather than own.
According to the U.S. Census Bureau, homeownership hovered just under 70 percent between 2003 and the end of 2006, at which point most economists agree that the housing crash, while not yet fully blown, was well underway. By the time Buffett made his pronouncement in February 2012, homeownership rates had fallen to 64.8 percent. Today, they hover around 63.5 percent after hitting a historical low of 62.9 percent in mid-2016.
Regardless of why homeowners are not reentering the housing market (and the hypotheses are many and varied, see sidebar on p. 88), today’s reality is that far more Americans than ever are renting. The real estate industry has positively leveraged what many consider to be a terribly negative aspect of today’s housing market thanks to turnkey rental properties. This has expanded the investing population substantially because those who do not wish to actively invest are able to allocate a certain amount of funding to having someone else manage the entire process for them, although the majority still handle a certain level of due diligence on their own.
The Birth of an Industry
While the idea of hiring someone else to manage your investments in any asset category is not a particularly novel one, turnkey rental real estate did not truly enter the vernacular until after Buffett made his famous pronouncement and, shortly thereafter, founded HomeServices of America, Berkshire Hathaway’s real estate brokerage firm. However, as the idea of owning cash-flowing, turnkey rental properties entered the investing mainstream, all sorts of providers of turnkey properties emerged.
“I believe that more and more investors and would-be investors are waking up to the benefits of passively investing in rental properties. This has been and still is ushering in new technologies, more reliable management companies, and more visibility to investments made in other markets [outside of an investor’s local market] than ever before,” said Hambright.
Not surprisingly, with the increased attraction and accessibility of turnkey rental real estate, the population of service providers in the sector also is on the rise and has been growing and evolving for some time. The shift began in earnest about a year after Buffett made his famous pronouncement.
Investors already running fix-and-flip operations began offering their services to passive real estate investors: locating properties, renovating them, and installing tenants before passing them off to property management and selling the entire package. Some companies debuted their own property management services to buyers, thereby keeping a nice, healthy stake in the property after it was sold in the form of management fees and offering attractive continuity to the purchasing investor.
Real estate and investment education providers also got in on the action. Established educators in the industry hired analysts and economists to comment on market conditions, identify the best locations for turnkey real estate purchases, and even make recommendations about where to buy and from whom.
Taking the Fear Factor Out of the Equation
As the marketing initiatives expanded, so did the broad appeal of the turnkey investing concept. Real estate, still reeling from the housing bust after years of being viewed as the “safest asset” available, was a water-cooler topic of conversation once again. This time, however, the topic was ownership of rentals as investments rather than simply owning your own home.
“People love the idea of owning real estate. They always have. But a lot of people who want to invest don’t do so because after the housing crash it was just too overwhelming and scary,” observed Marco Santarelli, CEO and founder of Norada Real Estate Investments. Norada provides turnkey real estate opportunities in markets across the country.
Turnkey investing solved the “overwhelming and scary” factor for a lot of investors with the capital to buy investment properties and pay someone else to manage them because it enabled them to let an expert handle the entire process.
“Furthermore, turnkey investing allows you to simply invest where it makes the most sense to buy,” said Santarelli, whose “market agnostic” approach to investing carried Norada through the housing crash. It was one of the few real estate investment providers founded before the bubble to survive the bust.
“You don’t have to be married to a market if you’re not going to live in the property or manage it personally,” he noted. “Being market agnostic means you don’t invest in a market because you were born there, live there, or are familiar with it. It’s about basing your decisions only on the economics and the fundamentals.”
When Letting Go Makes Sense
With turnkey rental providers present in nearly every real estate market in the country in some form or fashion, many investors find the wealth of selection almost too much to bear. Sometimes, this may lead them to back out of turnkey investing and attempt to simply manage the properties on their own, particularly if they are buying in a local market.
If an investor does not have the time or experience to purchase and manage rental properties, stepping into the driver’s seat can have a number of negative consequences. Ultimately, opting out of turnkey without the right resources at your disposal can lead to overspending and other decisions that might negatively affect an investor’s return.
For example, Kristin Weekley, a Century 21 Commonwealth agent in Boston, Massachusetts, said that most of the buyers in her market are looking for new properties for themselves rather than for investment properties. An investor who fails to transition out of that “me” mindset before heading out to look at potential rental investments may make an expensive mistake, particularly in a hot market like Boston.
“Most buyers these days definitely want renovated kitchens and baths and open floor plans,” said Weekley. She added, “Most of the real estate here is so old that my clients are also looking for newer roofs and heating systems.” While these are definitely reasonable things to want in a property, not every one of these items will always contribute to higher returns in a rental.
Weekley added that the professional turnkey rental investors she has encountered tend to have very different requirements for their purchases than individual investors who plan to manage the properties themselves or traditional owner-occupants. “The last property I found an investor was a fixer-upper. She got a very good deal and clearly had different priorities than my other buyers,” she said.
That investor was willing to purchase a very different type of property than Weekley’s owner-occupant buyers: “The two-family unit actually came with a resident who was already living on the second floor. The investor is presently converting the units to condos and will probably sell sometime next year for over a million dollars.”
Clearly, Weekley’s investor stands to profit upon the sale of the property, but in the interim that investor will be spending a great deal of time and money managing the project. For investors who have the desire to be actively involved in this type of investment, it’s a great situation. For a turnkey investor, however, one of the biggest benefits is that this level of involvement is not required.
What Makes a Market Work for Turnkey Rentals
The key to selecting a solid market for a turnkey investment is to run the numbers [read Kevin Ortner’s article on this topic on p. 110] and then evaluate a few slightly less tangible factors as well. If your numbers make sense, then take a closer look at the community in which you are going to buy. Are you able to make solid, positive predictions about the market?
Because turnkey rental properties are inherently a buy-and-hold proposition, investors should look for markets that have the potential for solid, steady growth over time. Volatile areas that are skyrocketing in value can represent opportunity, but a location with solid employers that tend to hire long-term renters for long-term positions represents far more security. Examples of this include the healthcare industry, manufacturing, and employment with a high concentration of millennial employees, such as some sectors of IT.
Look for areas with reliable means of accessing public transit, if your tenants are likely to need or prefer it, and, if your provider places tenants with the help of the local housing authority, check into that agency’s background and reputation as well. Your investment and the associated cash flow should be as secure and predictably profitable as possible.
“I always say that turnkey buyers should plan to hold a property for at least five years, otherwise you don’t reap the benefits you should be getting,” said Jordan. “With a good turnkey purchase, you should start out with cash flow and good returns, but the really good numbers start to kick in on year three, year four, year five, when you are starting to recoup substantial portions of your initial investment.”
Taking Back Control
At first, the idea of turnkey rental investing can feel like a distressing loss of control for a turnkey investor. However, most find investing a portion of their capital in real estate without also investing a comparable amount of time into managing that investment results in feelings of control and financial security they may not have been expecting.
“In today’s political climate and financial markets, I think that Americans are feeling that they have less control over their financial futures if they are restricted to ‘traditional’ investments,” said Hambright.
“Real estate is tangible. You can touch it or drive by it. Unlike traditional investments, your returns can be magnified through leverage. More and more investors and would-be investors are waking up to the benefits of passively investing in rental properties, and this is a trend that will only continue for the years and decades ahead.”
5 Reasons Americans are Renting, Not Buying
Not surprisingly, the American public’s emerging reluctance to reenter the traditional pursuit of the “The American Dream” of homeownership has many real estate professionals worried. In fact, the National Association of Realtors (NAR) recently commissioned a collaborative research study on the topic. The results were prepared by Rosen Consulting Group (RCG) and jointly released by the Fisher Center for Real Estate and Urban Economics at the University of California and the Berkeley Haas School of Business. Researchers cited five “main barriers that have prevented a significant number of households from purchasing a home,” including:
1. Post-Foreclosure Stress Disorder
While most Americans say that they feel positively about homeownership, many simply do not wish to risk undergoing the hardships they experienced or watched family members experience when they lost their homes to foreclosure. As a result, many qualified buyers are simply opting out of owning.
2. Mortgage Availability
The NAR report states, “Credit standards have not normalized following the Great Recession. Borrowers with good-to-excellent credit scores are not getting approved at the rate they were in 2003.” Further complicating the issue of mortgage availability, qualified buyers often opt to rent because they do not believe they are eligible for a mortgage or that they can afford a down payment. In reality, they often are eligible for a mortgage and qualify for reduced-down-payment programs.
3. Burden of Student Loan Debt
Student loan debt is delaying home purchases by at least five years in younger households. The high monthly payments make it difficult to save for a down payment and to qualify for a mortgage.
4. Single-Family Housing Affordability
RCG’s predictions that affordability is going to fall by nine percent nationally by 2019 led their analysts to advocate for more home-buying assistance programs. Good or bad overall, the decline in affordability will likely increase the population of renters even if new programs go into effect.
5. Single-Family Housing Supply Shortages
During the housing crisis, single-family home construction plummeted and has not regained its footing. RCG estimated a 3.7-million-home deficit in the single-family sector, primarily in low- and middle-income housing ranges. For turnkey rental providers, this means that the demand for this type of housing is strong and rents are likely to remain competitive.
While this study may not bode particularly well for homeownership rates over the next few years, it does contain a number of positive signals for real estate investors buying turnkey rentals. Based on this study, a large portion of the renting population is making a decision to rent rather than simply being compelled to do so. This creates a population of reliable tenants who are relatively likelier to stay in place and pay competitive rates in return for good, reliable, rental housing like the inventory in your turnkey rental portfolio.