4 Risks of Owning A Turnkey Rental Property
One of the first strategies investors stumble upon when researching real estate rental properties is the term “turnkey”. A turnkey rental property is a property that has been fully renovated and oftentimes already has a tenant in place. Investors simply need to “turn the key” as the property is rent-ready before the purchase is complete. Even better, your property will be overseen by a property management company so you as the investor just need to collect the monthly cash flow!
Sounds fantastic, right? Unfortunately, there are 4 key risks that investors need to think twice about before deciding to purchase a turnkey property:
1. Not Passive
Some real estate investors want to be actively involved with their investments but most busy professionals do not. If you’re not sure which strategy is best for you, check out our helpful guide. The problem with turnkey properties is they appear to be passive investments, but they actually require the investor to actively manage the investment in order to maximize the investment returns.
Yes, your turnkey investment will have a property manager in place but these companies often do a very poor job taking care of your property as they make the vast majority of their profit from selling you the property in the first place. Be prepared for extremely poor communication, outrageous maintenance bills and countless administrative fees. Because of these property management issues, you as the investor will need to spend your valuable time actively managing your property manager to ensure that your turnkey property is getting the attention it deserves.
To minimize some of these issues and ensure your portfolio is performing as you expect, you will need to spend a significant amount of time on due diligence. This will include qualifying the turnkey provider to review the value of their deals, the quality of renovations and the property management track record. Since you are limited on the number of residential loans, you must choose the right investments to scale efficiently. This could mean spending months reviewing turnkey providers and properties until you find the right fit.
2. Little to No Appreciation
Experienced investors are keenly aware that your ability to purchase a property at a discount and increase the value through improvements is the way to guarantee appreciation. In the case of turnkey properties, you are paying full market value (if not more) as the property manager has already completed work and is now making a huge profit on the premium you are paying.
In addition to not having the ability to force an increase in equity in your turnkey property through value-add improvements, the sound execution of your business plan, or operational efficiencies, will also not play a role in the property’s value. The appreciation of your turnkey property is solely dependent on the market, which is most likely a market that does not experience appreciation. This is because most turnkey providers operate in cities where real estate prices do not increase over time due to lack of interest and demand. This presents a massive problem for investors as they are no longer gaining the benefits of appreciation and in some instances will have to come up with additional out of pocket funds in order to complete a sale of their turnkey property.
3. Inconsistent Cash Flow
An investor may be willing to overlook the lack of appreciation on their turnkey property due to the strong cash flow that is projected, and on paper, these numbers do look enticing. In reality, these rosy projections quickly fall apart as investing in single unit properties mean much more fragile returns. This can put the investor in the position of having to provide thousands of dollars every month in mortgage payments and repair bills.
a. Reduced Income
When your tenant moves out of your turnkey property (or even worse needs to be evicted) you as the investor are on the hook for paying the mortgage, utilities and costs associated with getting the property back into a rent-ready state. You might think this entire process happens quickly but it can often take anywhere from 3-6 months (if not longer in our experience!).
b. Increase Expenses
Routine turnovers assume the previous tenant left your property in decent shape which is far from a guarantee. It's not uncommon to hear horror stories from experienced investors about tenants destroying and in some cases, stealing from your property. In fact, on one of our previous turnkey properties, we had the hot water heater stolen TWICE in less than four months! Unsurprisingly, the property manager offered zero assistance or explanation and we had to fund the entire cost.
Even though you will likely put a portion of your monthly income towards a maintenance budget, unforeseen issues can occur at any moment, and often will, that can wipe out that entire budget and require the investor to cover the additional cost.
To make matters worse, your risk is highly concentrated as owning even a handful of turnkey properties still lacks the needed diversification to protect your investment portfolio. If a couple months of vacancy or one costly repair can wipe out an entire year’s worth of profits, you can imagine how quickly your turnkey properties can turn into money pits for years to come.
4. Personal Liability
Compared to the other three risks, this final one seems minor but could potentially be catastrophic. Purchasing a turnkey property is not all that different from purchasing your own home as you need to get a mortgage and insurance plan in your name. This means you own 100% of the property, and the upside or downside that comes with it. This opens the turnkey investor up to personal liability from tenant lawsuits and means you have to carry additional mortgage debt on your personal balance sheet. This can seem like a remote possibility but imagine getting a lawsuit out of the blue for a tenant slipping, falling and injuring themselves at your property. Or getting turned down for a new personal home mortgage because you have too much debt from your turnkey properties. This is not what you signed up for when you wanted to invest in real estate.
We have personally experienced many of these issues with turnkey properties which is why our company now invests exclusively in multi-family real estate syndicationsas they have proven to offer the best access to no-hassle, hands-off real estate investments. If you’re interested in discussing our experience further or would like to see if real estate syndications are a better fit for your investing goals, do not hesitate to reach out!