Love the idea of investing in a rental property but not the idea of hassling with renovations or constantly hunting for deals?
Turnkey properties, which can be purchased through Roofstock, let you skip the headaches and jump straight into being a landlord. By its very definition, a turnkey property is either immediately ready to rent (no work required but “turning the key”) or is already rented to a tenant. No muss, no fuss, just rental income right away.
For all their ease, though, turnkey properties come with their own pitfalls. Here’s what you need to know before investing in one to make the process smooth and your profits strong.
Mistakes to Avoid When Buying Turnkey Properties
Many first-time real estate investors find themselves lulled into a false sense of security. They think to themselves, “I know real estate. I’ve bought and sold several homes. Besides, I’ve been living in real estate my whole life!”
Then, they promptly go out and make mistakes costing them tens of thousands of dollars.
Buying a turnkey rental property is not the same as buying a home. Here’s what investors need to know to avoid costly mistakes and ensure their first deal is a successful one.
1. Overestimating Returns
Yes, turnkey properties offer predictable returns. But that doesn’t mean all investors run the numbers correctly.
Far too many new investors underestimate or even ignore expenses like vacancy rate, property management, and repairs and maintenance. I did when I first started investing.
Similarly, investors sometimes get starry-eyed about rents, using the best-case rent in their calculations instead of the worst-case rent. These two mistakes combine to leave many new investors’ cash flow calculations woefully overstated.
Before buying your first investment property, do your homework and collect accurate figures for rents, neighborhood vacancy rates, and other expenses. Use conservative numbers, always plugging the worst-case scenario into your calculations.
Otherwise, you might find yourself with a property that loses money every year rather than earning passive income.
2. Confusing “Turnkey” with “New”
Just because a property is tenant-ready doesn’t mean it’s in perfect condition or that every component in the property is new.
To be considered turnkey, a property must simply be ready for marketing to renters. Everything needs to work, but “functional” doesn’t mean “new.” A furnace can be 20 years old and still work just fine. But there’s a huge difference between a 20-year-old furnace and brand-new one.
Turnkey properties still need ongoing maintenance and repairs, often major ones. Six months after buying a turnkey property, the air conditioning condenser, hot water heater, or refrigerator may need repair or even replacement.
Investors must take the long-term average of ongoing expenses to forecast returns. Once you own the property, those numbers should go from theory to practice. You need to actually set aside money for those expenses every single month. Then, when these expenses inevitably rear their heads, you won’t have to wonder how to pay for them.
3. Failing to Do a Home Inspection
To estimate the potential expenses mentioned above, you need to know the condition of the property before buying it. That means getting as many expert eyes on the property as you can.
That starts with a home inspection. While Roofstock requires sellers to get a home inspection before listing their property and to include the report with the listing, buyers should also conduct their own due diligence.
Review the inspection carefully and ask someone else with real estate experience to review it as well. Ask the inspector questions about anything you don’t understand. If you’re using a real estate agent, ask their opinion about the age of each major appliance and mechanical system in the property, as well as the age and remaining lifespan of the roof.
There’s nothing wrong with buying an aging property — if you know it’s aging and budget accordingly. But far too many new investors get complacent when shopping for turnkey real estate, assuming everything in the home is in great shape just because the property is in “rentable” condition.
4. Failing to Build a Support Team Before Buying
Likewise, just because the property doesn’t need renovation now, that doesn’t mean it won’t need repairs in a year — or even a month — from now.
Start screening and networking with contractors before you buy. When you do get that 3am phone call about a burst pipe, you need to have a plumber and general contractor lined up and ready to spring into motion.
That goes for every specialty of contractor, plus several low-cost handymen as well. The property will need repairs, and you need to be ready with trustworthy people to make them.
Your support team doesn’t end with contractors. If you plan to hand over management to a property management company, you should be screening and interviewing managers before you even take title.
And as important as all of this is when you buy local turnkey properties, it goes doubly when buying properties long-distance. Your support team is your eyes, ears, and boots on the ground. Screen them carefully and build trust and rapport with them. The day will come when you need to rely on their judgment because you aren’t there to handle an issue yourself.
5. Fixating on Traditional Mortgage Financing
When new investors go to buy their first property, they typically stick with what they know: traditional mortgage financing.
It’s what they used to buy their own home, and they understand the process. But while it may work, especially for the first property or two, it’s a one-dimensional way of thinking about funding.
Real estate investors should instead start thinking in terms of building a “financing toolkit.” Different situations call for different types of financing, and investors need to get comfortable with a range of options.
Turnkey properties are well-suited to portfolio loans kept in-house by the lender rather than sold off on the open market. Many portfolio lenders specialize in working with investors and offer discounted interest rates and fees to experienced investors.
In contrast, traditional mortgage lenders restrict the number of mortgages an investor can have on their credit report. Most often they cap borrowers at four mortgages.
Other types of financing include seller financing, private financing from friends and family, and hard money loans, which are best for short-term purchase-rehab loans. Start familiarizing yourself with different types of financing, and start networking with lenders in each category, particularly portfolio lenders for turnkey properties.
6. Failing to Screen Existing Tenants
Turnkey properties that come with existing tenants are a double-edged sword. While it can save you the hassle of advertising the unit, running credit checks on applicants, and signing a new lease, it also leaves you stuck with a tenant who may not be everything the seller claims.
I knew an unscrupulous turnkey seller once whose only criteria in screening tenants was the amount of rent they were willing to pay. He’d stick some deadbeat in the property paying above-market rent so he could advertise the property as generating higher revenue and therefore justifying a higher sales price.
Never mind that the deadbeat tenant would default within a month or two. That was the buyer’s problem, not this seller’s.
As a buyer, your due diligence doesn’t end at evaluating the property. You also need to evaluate any existing tenants and make sure they’re reliable, clean, and respectful of your property.
Ask to see the original tenant screening reports, including credit, criminal, and eviction history. If the seller can’t or won’t release them, consider it a huge red flag.
Conduct your own inspection of the property with minimal notice to the tenants. You want to see how they live and keep the property on an average day, not after cleaning up specifically for your visit.
You can and should ask to see the property’s rent roll, but take it with a grain of salt, because the seller can fudge the numbers.
7. Allowing Mediocre Tenants to Stay
Along similar lines, if you inherit tenants who turn out to pay rent late or treat your property roughly, you need to get them out of there as quickly and peacefully as possible.
That could mean filing for eviction if they’ve violated the lease contract in a tangible way. For tenants who don’t merit immediate eviction yet aren’t ideal renters, the other option is simply not renewing their lease agreement when it comes up for renewal.
Word to the wise: Each state imposes a minimum notice requirement, usually between 30 and 90 days, before the lease is due for renewal. So plan accordingly.
As a landlord, your returns are only as good as your renters. Reliable, respectful, low-impact tenants mean strong returns and few headaches. Unreliable, dirty, and downright bad tenants make your life miserable and lead to dramatically higher expenses.
If you inherit bad or just plain mediocre tenants, do yourself a favor and show them the door. The world is full of good people who will treat your property respectfully and pay their rent on time — rent to them instead.
Far too many new investors dive headfirst into turnkey rental properties, falsely assuming that just because they don’t require renovation, they don’t require knowledge and skill to invest in.
Turnkey properties do help you avoid the headaches of corralling contractors for rehab work, pulling permits, and carrying a vacant property for months on end. But direct real estate investment still costs time and labor on your part.
Before laying out thousands of dollars on a down payment, invest in your own education. Learn how to accurately forecast cash flow. Assemble a team of experts to help you find and manage turnkey properties. And if you decide to manage the property yourself, learn the ropes of property management.
Not everyone is cut out to be a landlord. But for those who are, rental properties can make outstanding income-generating investments.