There are lots of turnkey property companies out there, and some are more reputable than others.  This question deserves a fair shake.  I’ll try to give it one, but I have some strong opinions about this.

WHAT IS A TURNKEY PROPERTY – DEFINITION

A turnkey property is a fully renovated home that is purchased by an investor.  It can either be rented out immediately by the investor, or more commonly, comes already rented out with a property management company in place.

In essence, it’s answering one of the most common real estate needs out there:

I live in an expensive area, and I can’t invest here, but I want to invest somewhere, what should I do?

Use a turnkey property company!!!

It’s a potential solution to long distance investing.  Turnkey property providers usually buy distressed properties in good rental markets (not high cost of living areas).  They buy at a discounted price, and then rehab the property so it’s move-in ready.

At this point, they can either sell it to an investor, or go a step further.  They’ll find a local management company, get a tenant placed, and sell the property to investors with tenants and property management in place.

It’s supposed to be a win-win.  The turnkey property company flips the property to the investor for a mark-up, but there is still supposed to be enough “meat on the bone” for a decent return on investment (ROI) for the investor as well.

Typically, these companies will estimate an ROI of 7-12%, although that’s if nothing ever goes wrong (stuff always goes wrong).

Let’s show the numbers on what a turnkey property might do:

TURNKEY PROPERTY NUMBERS

They buy a house for $35,000 that needs lots of work.

They fix it up for $15,000

They sell it to you for $100,000

It rents out for $1000 a month.

As you can see, they profited $50,000 on the flip to you, but you still got a house that rents for $1000 a month.  Doing some very simple math, you could estimate this ROI to be about 6%.

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The terms return on investment and capitalization rate get thrown around a lot in fancy-shmancy real estate circles.  We’re going to demystify them.

Return on Investment (ROI) is a performance measure used to measure the efficiency of an investment.  In other words;

How much money is this house making me?

It is used in many forms of business, but we will focus on how it applies to real estate.

ROI measures the return on an investment compared to the investment’s cost.  To calculate this, the return on an investment is divided by its cost.  The result is expressed as a percentage.

For real estate, it’s the income from a property minus costs.

There are many things to keep in mind when you see an ROI from a property, such as whether you are paying cash or financing, will you include closing costs, interest, and loan paydown.  The ROI can look higher than it is when certain costs are being ignored.

When you see someone bragging about their ROI, take it with a grain of salt.  They may not be accounting for all their costs.

Today, we are going to focus on a specific type or measure of ROI called a capitalization rate.

Capitalization Rate (Cap Rate)

If you are calculating the ROI on a real estate deal as if it was being done in cash, you are calculating the capitalization rate, often abbreviated as cap rate.

The reason cap rate is one of the most popular measures used in real estate is it allows you to compare investment opportunities to each other.

Sometimes ROI’s are calculated by using the down payment as part of the formula.  This means the ROI can change based on the size of the down payment.  This isn’t the case with cap rates.  The formula for a cap rate has nothing to do with down payments or mortgages.

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Being in the military presents unique challenges.  We are burdened with moving every one to three years throughout our careers.  While moving that often can be exciting, it can wreak havoc on our finances.

While I think most people make mistakes with real estate, those mistakes are magnified in the military because of frequent moves, especially when sent overseas.

Today I address the two biggest mistakes I see military members make with real estate.  First, buying in high cost of living areas.  Next, buying a home at each duty station.  Both bad ideas.

Let’s take them one at a time.

Buying in a High Cost of Living Area

I just ran into this issue a few days ago.  Somebody told me they were moving to Hawaii and everybody told them they have to buy because the prices of houses just keep going up!   They usually say things like, “you can’t lose!”

I told them, don’t buy!  Whatever you do, don’t buy in Hawaii!!

Why would I say that?  Don’t I want everyone to be Rich on Money?

They sighed and remarked that I was the first person to tell them they shouldn’t buy in Hawaii.

Clearly, I don’t know what I’m talking about.

There are two problems with buying in high cost of living (HCOL) areas.  One is the appreciation myth, and the next is cash flow.

The Appreciation Myth

There is a wide-spread belief if you buy in a HCOL area, you can’t lose because you’ll get massive appreciation, and even if your rent doesn’t cover the mortgage, (which is likely) you’ll still come out ahead.

Here’s the problem with that thinking.  Appreciation is a fickle thing.  In HCOL areas, it sometimes comes in spectacular fashion for a few years, and then disappears for several years.  Those spectacular years are what get people’s attention, but you never know what years that will happen, where it will happen, and how long it will last.

In the end, appreciation in HCOL cities usually ends up being only slightly better the appreciation in any other city in the U.S.  For instance, Honolulu may see a 4% appreciation per year on average over the long term compared to 3% for most cities.

I’ll give an example of the appreciation myth from my life.  I bought a townhouse in Washington D.C. for $280,000 in 2003.  Two years later it was worth $400,000.  I was ecstatic!  I could only imagine what it would be worth in ten more years!

I sold that house in 2016.  How much did I get for it?

$400,000.  All my growth (appreciation) happened the first two years, and then a net of no growth over the next eleven years.  This works out to less than 3% appreciation per year.

Not impressive.

You can’t count on appreciation when you buy in a HCOL area, especially in the military.  During the one to three years you are there, it could easily stay flat or even go down in value.  That would not be a good thing on a million dollar home!

Read my full article on The Appreciation Myth

Cash Flow

If you buy a property at an assignment and realize it didn’t appreciate much, you made need to rent it out instead of selling it.  Maybe your plan was keeping it as a rental anyway.

Rental properties in HCOL areas almost never work out!

Why?

Well, we know the first reason is because of the appreciation myth.  It’s also because the numbers don’t work!

Let’s talk about the 1% rule.  It’s the most basic and important rule in real estate investing.

The 1% Rule – A house should be able to rent for at least 1% of the acquisition price.  This is purchase price plus fixing it up.

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There are four ways to make money in real estate.  Cash flow, taxes, mortgage principle paydown, and appreciation.

Three of these four are often misunderstood in how effective they are.  Appreciation is one of those, and I’m focusing on that today.

Before I bash appreciation too much, here’s what the leverage lovers want me to explain first.

If you buy a house for $100,000 cash, and that house goes up by 4% in a year, the house is now worth $104,000 and you’ve made 4% on your money.  Not amazing.

However, if you buy a house with $20,000 down on a $100,000 house and it goes up 4% in a year, it is now worth $104,000.  You’ve made $4,000 on a $20,000 investment.  You’ve made 20% on your $20,000 investment. The mortgage magnifies the benefits of the appreciation.

That’s a benefit of appreciation with a mortgage.

Of course, if you mortgage a property and it goes down in value, remember, you still owe that monthly amount to the bank no matter how low the price of the house goes.  If the market crashes, you still got to pay that mortgage back at whatever price you originally borrowed for.

This was the big problem with the last real estate crash.  It’s called being upside down on a mortgage.

Borrower beware!

Here is something I hear people say a lot about appreciation that makes me cringe.

It goes something like this:

“Well, I know I’m not making any cash flow on this house, maybe even losing some money, but that’s ok, because I’m in this for the appreciation.”

WHOA!!!!

This attitude is especially common in high cost of living (HCOL) cities.  Why?

It’s really hard to get good cash flow in a HCOL city.  The price to rent ratios are way off.  There is also this belief that these cities are great for appreciation, and you can’t go wrong buying because they will go up enough in value to make it worth it, even without the cash flow.

I’m here to tell you, this is not always the case.

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