The Approach

Turnkey Rentals in 2017: Why You Need to Adjust Your Approach

June 14, 2017

Old people do the silliest things.

Yes, maybe it once made sense to wear a suit everyday, but that’s not how it works anymore.

No, you don’t have to wait for the Sears catalog to get Christmas present ideas. That’s what top 10 lists on the internet are for.

The things oldies do are funny because they don’t match the times. Years of change happens, but at some point they quit adjusting their approach.

When it comes to purchasing a turnkey rental property in 2017, you are going to need to adjust your approach as well.

How it Worked for My First Two Properties

I purchased turnkey rental properties in both 2011 and 2014.

Turnkey means I go through a company who flips properties specifically to be rentals for investors.

In 2011 no investors were buying. It was an excellent time to learn how everything worked because people were more willing to work with a newb like me. They actually took the time to talk to me, in an effort to generate some sales.

Even in 2014 it was typical for the turnkey companies to finish the rehab before lining up the investor to sell it to. This let you see the final product. I could browse properties on Jason Hartman’s investor network website to see great options from multiple turnkey providers in the city.

But that’s not how it works in 2017!

My New Process

Properties are moving fast.

I have noticed that the turnkey providers are less willing to jump on the phone to discuss their operation. Yes, it is still possible, but you have to be the one following up – they aren’t struggling for sales.

Some of the deals still make it to the point of getting emailed out to multiple investors or posted to an investor network like Jason Hartman or Norada.

But you’ll really have to act fast if you want the deal. It might be scooped up within an hour, so you have to decide quickly if you are in:

It’s best to not compete with the masses. How can you avoid it?

Move up in the process.

The turnkey providers are flippers. It might take 2 months for them to purchase a property, fix it up, and sell it to someone else – or even less time in a highly desirable area – I hear that puerto rico turnkey properties are becoming increasingly popular. I want to know about the properties before everyone else.

This requires establishing a relationship with the provider and frequently checking in to see what is in the pipeline.

It’s a little more work and you have to call dibs before the rehab is finished. This requires putting up earnest money, but you still have the opportunity to back out if your research uncovers anything unexpected.

But that’s what it takes in 2017. Even though it is competitive, the numbers still work. You can still hit the 1% ratio on a quality rehabbed rental.

How Have You Adjusted?

Has your strategy adjusted in 2017?

How about how you operate your strategy?

Any tricks or tips you can share on how to move up in the process?

Starting the Search for My Next Rental Property Investment

May 31, 2017

How long can you hold your breath for?

Most haven’t done it since they were kids, when we dipped under the water and to see who could stay down the longest.

Really safe kids… it might be smarter to go play in the street.

Breathing is natural. It is what we want to do, we have to force ourselves not to.

For a rental property investor, acquiring properties is like breathing.

I’ve waited patiently for 3 years since buying my last rental. Now it is time to shop for rental number three!

Why the Long Wait?

I was living life my man.

My goal in rental property investing is to put my money to work for me. Fairly passive returns – with a bit more work that index funds, I believe I can earn closer to 20% a year.

My approach requires money to invest. 20% down on a $100k property requires around $20-25k.

Of course, there are ways to get into real estate without money. Plenty of people do it, but that is more of a job, but you can find tips online that could get you started. For instance, you can check out these tips on investing in Costa Rica property. However, it is different for each place you decide to invest. Hustling to create something out of nothing. Like getting a deal under contract and handing it to someone with money. The property you invest doesn’t simply have to be a house. You may decide that you want to do something like invest in a supermarket instead, especially if you can purchase such a property from an expert management business that has connections within the supermarket industry.

How does someone absolutely pumped about investing in rental properties only own 2 after 6 years?!

The first three year gap I left my job at 25 years old, traveled for 6 months to amazing places like New Zealand, Costa Rica, and Tahiti. Then I got back and bootstrapped my business giving kid coders a personalized and fun chance to keep learning over a much longer time frame than anywhere else.

Does it look like I regret that decision?

Little did I know then, that Memphis purchase three years ago would be the beginning of another long gap.

Just around the corner was an even more important and expensive life milestone. I somehow wooed an amazing woman and got married!

But now it is time.

Using the Proceeds of My Cash Out Refinance

The people who don’t understand the benefit of owning rental properties look at the return in year 1.

A couple hundred dollars a month in cash flow, hardly worth the hassle right?

We know better than that. Look at it over a couple decades.

One of the things that makes it so crazy awesome over a long time horizon is the ability for your properties to clone themselves.

See: Let’s Double Down! Cash Out Refinance on a Rental Property

After 6 short years owning my Atlanta property, I was able to refinance and turn $36k of equity into cash.

See: Cash Out Refinance on a Rental Property – My Actual Numbers

That money is currently sitting in a high yield savings account, waiting to be put to work.

(Yes, 0.75% is high yield these days…)

Starting the Search

One of the most important steps is to figure out the city to focus on.

There is a range of markets for investors that make sense at various times. Given where we are in the cycle, things are pretty expensive, I want a more conservative market. Low-cost cash flow.

See: How to Visualize the Real Estate Cycle

Since I already have a property in Memphis, I’m going to start my search there. That way I would have fewer property managers to work with. If the numbers don’t work, I will expand to compare to other cities like Indianapolis or Kansas City.

When I find potential properties I will also check them thoroughly. Structural issues might cause extra expenses that could be undesirable. If I found a house with an issue such as a roof that needs to be changed or fixed then I might consult a company similar to a roofing company in Denver or a local expert to get an idea of potential costs, and weigh up the value of the house overall.

Photo: Thomas Hawk

I’ll also consider the neighborhood my current property is in. I’m not as committed to the specific neighborhood, so I’ll more thoroughly compare various areas.

For example, some friends of mine have just purchased a property in Wayne in Philadelphia after browsing a few different properties on the Main Line Homes real estate website. It is always worth speaking to any friends who have recently purchased a property as they can tell you more about any ongoing real estate trends in their area.

Reviving Old Contacts

I worked through Jason Hartman’s company for my first two properties. They are a national marketer of turnkey properties, working with local providers in each market, and providing investors a counselor to work with.

They get a referral fee when you purchase a property, you get help along the way, their contacts, and a little bit more oomph behind your purchase (you are part of a group with some scale, not a one-off investor local providers can screw over).

Pretty cool business model for beginner investors or people who highly value their time. The other big company with the same model is Norada. I’ve connected with a counselor over there who was very knowledgeable, but went with my Jason Hartman counselor due to our earlier success.

I also got in touch with the local provider in Memphis who I purchased from three years ago. They are still plugging away, doing 60-90 flips to investors a year.

They are just one of several Memphis providers Jason Hartman’s company recommends right now, so I got an introduction to a couple others as well.

How it Works in 2017

The investor market is hot. Properties are moving much more quickly than when I purchased three years ago.

There is likely close to zero wiggle room on pricing for these turnkey properties. If you don’t pay it, someone else likely will.

It is important to have the pre-approval in place from the bank. If you don’t, they aren’t going to hold up and wait for you.

You also have to be on the radar of these providers. They should know what you are looking for so they can let you know when something is coming through the pipeline. Investors aren’t waiting for the rehab to be 100% finished before putting the property under contract. If you are, the deal is going to someone else.

Prices are a little bit higher than a few years ago, but the 1% rule is still achievable so the numbers make sense. If I couldn’t get right around 1% of the purchase price in rent per month, I would look at other markets.

I’ll be picky with my property, but ready to move on a moments notice.

It’s Exciting to Be Back!

I’m jazzed to be adding to my portfolio again.

Hopefully it will be a more regular occurrence from here.

What do you think? Is now a good time to buy in a low-cost cash flow market like Memphis? What else should I consider?

What would be valuable to hear about my process?

Cash Out Refinance on a Rental Property – My Actual Numbers

May 12, 2017

If my rental portfolio is a game, I just leveled up.

I’m now on the compound returns level. Cue the music:

I did a cash out refinance and will soon invest the proceeds into another rental property. One of my properties cloned itself!

See: Let’s Double Down! Cash Out Refinance on a Rental Property

Let’s take a look at why do it, my process, and the actual numbers.

Compound Returns

We all know compound interest is powerful – it is important to start early and all that. But when owning 100 shares of stock, it is a bit hard to see how that compounds.

If the stock goes up 50% in 7 years, you still own 100 shares. Is the company now 50% better at making money, accelerating the returns? Doubt it.

When a stock pays a dividend, you can save up those pennies to buy more shares. That makes the compounding a lot more understandable. Unfortunately not all stocks have dividends.

Compounding is much easier to understand with real estate investing. It is also manual – you have to actively do it.

You wait patiently for several years while the equity builds up, then you have a couple options for accessing that money. One is a cash out refinance. The other is a 1031 exchange, where you sell the property tax-free and reinvest the money into another property or two. If you are looking to a refinance mortgage for your property it might be worth looking into a company similar to SoFi for more information.

See: A Cash Out Refinance is Tax Free Money

You are in control. You get to decide when and how to go about it.

Why Now?

In How Do You Know When to Refinance Your Investment Properties? I went through the calculations in-depth. Let’s do a quick look.

I have had my Atlanta area property for almost 6 years. I bought it for $81.5k and estimated it was worth $116k back in my January portfolio update.

See: Rental Property Portfolio Update – Chowing Down on Appreciation

In the meantime, the mortgage balance dropped below $60k. Thank you to the tenant for paying that down for me!

According to my estimate, I have roughly $56k in equity ($116k value minus $60k mortgage balance). The bank owns approximately 52% and I own 48%.

That equity doesn’t earn a return. I want to put it to work, but it costs money to do a refinance. You are signing up for a new mortgage that replaces your old one. Closing costs, title, taxes, appraisal, etc.

It is a matter of balancing the benefits of compounding vs. the cost. From a pure numbers standpoint, it is better to put that equity to work as early as possible. Since my property was closing in on 50% equity, it was time.

How it Works

Refinancing is very similar to getting a mortgage in the first place. You have to submit a whole bunch of documents to satisfy debt-to-income requirements, credit score, cash reserves. It takes 30+ days to close. If you already know your cash reserves and credit score are low, you can look at Credit Cards for No Credit and build up your credit. This way, you look more trustworthy and responsible to lenders and then they’re more likely to lend to you. Speaking of credit score, having a good credit history can be beneficial for a lot of things that you are going to want to buy later on in life, such as a house or a car. If you are looking to rent a property, most landlords will do a tenant credit check before they go any further with renting the property. With this being said, if you are only just applying for a credit card, making sure you check if your eligible for a credit card, as this will save you time before applying.

See: Rental Property Loans – What The First Time Real Estate Investor Should Know

On a cash-out refinance, you are currently allowed up to a 75% loan-to-value ratio. That means, your new mortgage balance will be 75% of the value.

How do you know the value? You have to get an independent appraisal. A lot is riding on it, let’s look at an example.

Let’s say you have a $50k mortgage you are refinancing and believe the property is worth around $100k. A 5% swing in appraisal price can have a pretty big affect on how much money you get back:

$95k appraisal: $71,250 on the new mortgage = $21,250 cash (minus closing costs)
$100k appraisal: $75,000 on the new mortgage = $25,000 cash (minus closing costs)
$105k appraisal: $78,750 on the new mortgage = $28,750 cash (minus closing costs)

See how big a difference the appraisal makes? It has a great deal of influence on how much money you get to reinvest into another property.

My Process

I have a mortgage guy. Doesn’t that sound so baller?

Photo: Tyson Cecka

Really though, I have a guy who I used on both my investment properties. He was chill and more than willing to spend some serious time on the phone explaining things to a beginner.

I wanted to see what he can do on a refinance, but also get quotes from elsewhere.

There was one bank that works with investors I heard about on a podcast. Rather than package the loans and sell them to someone else to service them, they keep them. It sounded to me like they were able to remove a middleman and give some pretty competitive rates.

Then I was also going to see what I could get through the current mortgage holder. My mortgage got sold to Wells Fargo for servicing, so a huge national bank actually owns it. I briefly tried to get ahold of someone there who wasn’t an idiot, but it proved impossible. Plus being self-employed adds another layer of complexity, so I wasn’t confident they would be able to get it done.

Ok, so I had two different mortgage providers to compare. What comes next?

Get Numbers on Paper

I actually just start the process with both of them. Why? I think it is hard to get an apples-to-apples quote you can compare to someone else. There are just too many variables.

There are little hits to the rate for it being an investment, for cash out, for 75% LTV, and probably more. You aren’t going to get the 3% mortgage rate you see on a banner ad.

If you get a quick quote, you are likely to find out later in the process – oh we didn’t include the .1% increase for X. The bottom line quote to get you in the door, then it goes up from there.

The downside of this approach is you have to later tell one of the companies you aren’t going to go through with it. It’s kind of like breaking up with someone – awkward but you know it has to be done. Hopefully you can tell them before they put the complete documents together which takes some effort.

One came in at least $500 cheaper and they were also more responsive. Let’s move forward!

My Actual Numbers

It started with a $525 appraisal that was billed directly to my credit card.

After getting the appraisal back, you get to decide if you want to move forward with the refinance. So while there is a lot riding on it, you do have a rip cord you can pull if it no longer makes sense. I would have been out the $525 though.

Luckily my appraisal came back at $130k! I was conservatively expecting $115k, which means I was able to get pull out an extra $11k in cash!

My new loan will be at $97.5k. With those proceeds I have to pay off the old mortgage and the closing costs.

What did it cost to access this money?

All the Fees

The fee from the mortgage provider is called many different things and sometimes broken into smaller line items. Add them all up and you have the origination charges. Mine were $825.

Title is a huge expense. It isn’t finalized, but I expect it to be $1300 to $1400.

You have a few small things like credit report, flood certification, recording fees, transfer taxes, and prepaid interest. Those all came to around $400.

The Prepaids

I had an escrow account before, but I have to start a new one with the new mortgage.

They want $2580 in the escrow account at the time of closing to cover 13 months of homeowners insurance and 10 months of property taxes.

The good news – once the old mortgage provider receives the funds to close out your loan, you are sent a check for everything in your previous escrow account. Mine is currently $2284.

Since it comes out essentially to a wash after a short delay and is still my money in a forced savings account, I’m going to exclude escrow from my analysis.

My Interest Rate

Before my rate was 5.5%. So even though interest rates are currently going up, my rate for this property will go down.

The exact rate depends upon a number of factors and changes daily. Mine was just over 4.75%. I could get a 4.75% loan for +$122 in closing costs.

Then you have the option of moving up or down. You can pay more for a lower rate (mortgage points), or accept a higher rate with lower closing costs (lender credits).

I opted to take a 5% loan with $975 back in lender credits. More cash, more flexibility.

Adding it All Up

$525 appraisal
$825 origination
$1350 title
$400 taxes / other
-$975 lender credit
= $2125

It would have been $3100 without lender credits, $2125 by accepting a rate increase to 5%. Not bad!

The End Result

How much cash do I get?

$97.5k new loan balance
-$59.3k old loan balance
-$2.1k closing costs
= $36.1k

Wow! Excluding the small escrow changes and delay, I will get $36.1k back in this refinance. That is a huge chunk of change!

The best part about it? I only paid $20k out of pocket 6 years ago!

So not only am I in for $0 on this property, it also provided an extra $16k that I get to invest in another rental! That is incredible!

The downside?

My monthly payments go up, meaning cash flow goes down.

Right now my principle plus interest payments are $370. On the new mortgage it will go all the way up to $523. An increase of $153 a month.

That is most of the cash flow. Each month there is $207 of taxes and insurance, and $90 a month to the property manager.

With the rent currently at $1000, that leaves just $180 of “cash flow”. But that has to cover repairs and vacancies. If I’m honest, $180 a month won’t cover it, considering you have to save for big ticket items like a new roof someday.

The rent will increase though. It should be at $1100 to $1150 within 2 years, as that is more in line with the market rate for the area. We are increasing it $50 a year as long as the current tenant stays. If they move out, it will jump up (but there will be turnover costs, so I’m not hoping for this).

That will get me back to my pre-refi cash flow numbers. In the meantime, I’ll hold onto more reserves – some of that $36.1k will sit in a savings account.

In Closing

The cash out refinance is powerful stuff!

I am all about the long-term mindset. I know calculations show rental property investing is a homerun over one to two decades, thanks in large part to the power of compounding.

Now for the first time I’m actually experiencing it. If I thought it was cool before, I now consider it Miles Davis.

Those without rentals: do you see how crazy powerful this compounding is with rental property investing? See why getting started now is so important?

Those with rentals: how did I do on the rate and cost of the refi?

3 Reasons Your Rental Shouldn’t EXCEED the 1% Rule

April 27, 2017

The 1% rule is common advice for cash flow rental properties.

It states that the monthly rent should be AT LEAST 1% of the purchase price of the property.

$80k home, you’ll want $800+ in monthly rent
$100k home, you’ll want $1000+ in monthly rent
$120k home, you’ll want $1200+ in monthly rent

I’m going to tell you something counter-intuitive.

Your rental shouldn’t exceed the 1% rule either.

Why the 1% Rule Exists

You want to make sure your property cash flows. But keep in mind, the ultimate goal is to maximize your total return.

Every month you will collect the rent and pay expenses. The expenses include things you pay every month: mortgage, taxes, insurance, property management. It also includes putting aside money for things that happen frequently, but not every month: minor repairs, tenant turnover. And even expensive items that come up once a decade: new roof, HVAC, water heater, and bathroom remodeling. The latter 3 can easily be sorted by a single company such as the highly recommended plumbers in Port St. Lucie. Getting a new roof installed can’t be sorted by a plumbing-type service, unfortunately they can’t do everything. You would need to look into a seperate tiling/roofing service the likes of a roofing Colorado Springs company would offer.

If you have money left over after all those actual and projected expenses, you have cash flow!

Ok back to the 1% rule… it is a quick way to determine if the property is going to cash flow.

But how much cash flow? That is a more complex calculation with a ton of variables:

How much tenant turnover is there in the neighborhood?
What interest rate is your mortgage?
What are the property taxes in the area?
How much life is left on the major expenses like the roof?

Obviously it will be good to dig into those questions and calculate with more accuracy if you are thinking about purchasing the property.

But at first glance, is the rental even capable of cash flow? Just use the 1% rule.

If the monthly rent is 1% of the purchase price, you can keep investigating. But make sure the rent isn’t much more than that!

Wait… Isn’t More Rent Good?

Yes, absolutely. But what are you giving up to get more rent?

For this analysis we are considering properties that are at market price or just below.

If you put in the work to find an incredible deal, like sending out mailers that say “I want to buy your ugly house” or going to foreclosure auctions as seen on sites like Auction.com, that changes things. You are trading your effort for a lower purchase price. In that case you should exceed the 1% rule. Some people might even want 2% to make it worthwhile.

I am currently purchasing properties through turnkey providers – they do the purchase and rehab, then sell the finished product to an investor. They might claim the property is worth more than the purchase price, but it really isn’t. If they could sell it for more, they would. Maybe they price it 5% lower to sell it quickly, but that is still pretty much market price.

So if the purchase price is fairly fixed (when you pay someone else to do the work and take on the risk of rehab), that leaves rent as the variable to look for in the 1% rule.

This is where people get in trouble. There are three reasons this can be an issue:

1. Expenses Aren’t Always What They Seem

Let’s look at a snapshot of a city right now. Here are some ballpark numbers you can get in Memphis:

A neighborhood

$120k price
$1100 rent
0.92% ratio

B+ neighborhood

$100k price
$1000 rent
1% ratio

B- neighborhood

$80k price
$875 rent
1.1% ratio

C neighborhood

$60k price
$800 rent
1.3% ratio

The quick 1% rule analysis shows ratios improve on cheaper properties. What do you think? Go with the best ratio?

What would actually happen if you owned all 4 of those properties for the next 15 to 20 years? Would the cash flow match that pattern? Keep in mind the cash flow is rent minus expenses…

I bet there would be a tightening effect when you consider actual expenses.

Worse neighborhoods are going to have more vacancies. The tenant moves around every year and doesn’t treat the property as well.

Better neighborhoods? You are more likely to get a tenant for multiple years, who treat the property well, leading to minimal repairs.

The quick 1% rule is misleading even for cash flow.

2. Appreciation Potential

You’ll often hear from cash flow investors that appreciation is the “icing on the cake”. Meaning it isn’t the main reason they invest.

I don’t quite agree. You need cash flow to keep the investment sustainable, but the biggest part of the return over the 15 or 20 years you own the rental? Without a doubt, appreciation. Especially if you understand the power of smart leverage.

Let’s not chase appreciation in a stupid Miami high-rise condo sort of way, but let’s keep it in mind as a cash flow investor.

We just looked at the numbers today for different classes of neighborhoods in a city like Memphis. Would you expect different appreciation potential for a C property and an A property?

I would, mainly due to the selling options. With class C properties, often the tenant can’t qualify to buy a home. They are stuck renting without a choice. If you sell, it likely will have to be to another investor, so the properties are less liquid. As you get into nicer neighborhoods, you’ll find tenants who can to qualify for a mortgage, and the potential to sell to an owner-occupant.

More interesting – what if the city and time isn’t held constant?

Let’s look at some potential numbers for a city like Dallas 4 years ago:

A neighborhood

$140k price
$1200 rent
0.86% ratio

B+ neighborhood

$120k price
$1100 rent
0.92% ratio

B- neighborhood

$100k price
$1000 rent
1% ratio

C neighborhood

$80k price
$875 rent
1.1% ratio

The deals in Memphis would have been better too. The A class properties might have been around $100k with a $1000 rent, right at the 1% ratio.

So the A property in Memphis would be the same as the B- property in Dallas. Same cash flow numbers, which one do you think has greater appreciation potential?

When prices are down, you have the option to chase appreciation while still getting cash flow.

Where we are right now in the real estate cycle? In Dallas you might get a C or C- property at the 1% rule. Not something I’m interested in.

More: How to Visualize the Real Estate Cycle

3. Your Mental Health

I hope you aren’t approaching rental property investing as a get rich quick scheme.

If you can make over a 20% return a year (like I think you can), you will eventually have a pile of money, but it is going to take a decade or two.

The biggest predictor of success in rental property investing is how long you hold the properties.

What is it going to take to keep you in the game that long?

Fewer headaches. Pay a property manager and let them do most the work.

But also keep in mind the neighborhood and class of property play a role. If you try to beat the 1% ratio by sacrificing in this area, expect to deal with more ish.

Don’t try to be a superhero, you might burn out. Trade a little bit on the ratios to improve your mental health and stay in the game.

Your Rental Shouldn’t Exceed the 1% Rule!

Does it make sense to sacrifice on cash flow to gain in other areas?

With the strategy of paying close to market rate and waiting for 1-2 decades, do you agree your rental shouldn’t exceed the 1% rule?

How about each of the individual points. Do you agree:

Expenses aren’t always what they seem
Greater appreciation potential can be smartly chased
Your mental health is worth supporting