We’ve always been fascinated by real estate investing. It is an asset class that offers the opportunity for diversification, appreciation, and cash flow generation. No wonder many in the community decide to pursue it to accelerate the path for achieving Financial Independence.

The math behind real estate investing (REI) is not difficult, the real challenge exists in identifying a property that generates positive cash flow. Not all markets are created equal therefore there are areas in the country where real estate investing works and others where it just doesn’t. As an investor, one must set goals, run the numbers, and not let emotions affect your investment strategy. That way you’ll be able to set up a system that allows you to filter good deals from bad deals.

Analysis paralysis is real. You can do all the math and spend hours building the most sophisticated spreadsheets (yep, we did that); however, at some point, you’re going to have to take action to realize the benefits of real estate investing. The idea is then, minimize risk and increase the chance of success from the get-go.

If you want to invest in real estate there are many options at your disposal. There are Real Estate Investment Trusts (REITs), real estate crowdsourcing platforms like Fundrise, traditional REI where you buy a property, place a tenant, collect rent, and generate cash flow. In our case, we were interested in the latter.

At first, we debated following a DIY approach where we would build a team to find properties, potentially rehab, place a tenant, and collect rent. That option had the potential of higher returns but we quickly realized it would require significant time and effort on our part.

The next item on the agenda was the location. Investing in your local market is usually recommended; however, REI in Denver just doesn’t work. House prices are really high and rents have not increased at the same pace. For REI to work in this area, you either need to get far away from the city, do short-term rentals, rent rooms in a big house, and have roommates (house-hack) or get creative with financing. Neither of these options appealed to us.

We had a clear goal: buy-and-hold single family homes that generate positive cash flow. Given the reality of our local market, we explored investing out of state by partnering with a turnkey provider.

What is Turnkey Real Estate?

Turnkey real estate is a form of passive investing in which you buy a piece of real estate from a company, and that company manages the property for you. The team you work with finds renovates and maintains the house you invest in, rather than you doing it all yourself.

You don’t even need to visit the house before you buy it. You can purchase it sight unseen from a company you trust and let them handle the rest.

One of the big benefits of turnkey real estate investing, at least for us, is that you are a landlord in theory but you’re not in practice. When you partner with a solid turnkey provider there are no late-night phone calls. Those issues are all eliminated when you buy turnkey real estate investments.

All you have to do is proper vetting to make sure you partner with a provider that earns your trust and provides a great experience long term. This is by far the most important decision you’ll ever make as an out-of-state investor.

But How Does Turnkey Investing Work?

The concept of turnkey real estate investing is pretty straightforward. The business model is the following:

1. Acquire distressed properties in cash flow positive markets,
2. Complete renovations to make a property rent-ready,
3. Market and sell the property to an investor (at a profit),
4. Screen and place tenants,
5. Collect rent and manage all aspects of the property.

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I’ve heard the main argument against turnkey investing is that the only people really making money are the people selling the houses to the investor. Listen, if they make money and so do you then what is the problem with that. Why not think of it as a win-win? Aren’t all successful partnerships supposed to be like that?

When you partner with a reliable turnkey provider, you should expect to make a return on your investment, if you don’t then what is the point? It al comes down to these two simple yet powerful words.

Goals & Expectations

Do you want to generate a 30, 60, 90% return on your investment? if the answer is yes then turnkey investing is probably not for you.

Look, most of the people who say you’re a fool if you’re investing via a turnkey provider tend to be active real estate investors. They believe that in order to maximize returns you need to do everything yourself: find the property, fix it up, and then maintain it on your own. I think this process makes intuitive sense and in theory, should lead to higher returns; however, you need to decide the type of investor you want to be.

Do you want to be hands-on or do you want to partner with a company that handles everything for you?

Only you know the answer to this question. For us, it was easy: turnkey investing.

When you buy a property from a turnkey provider you’ll pay more than if you bought and handled it yourself. But in our experience, when you partner with a good company, you’re buying a relatively safe, high-quality investment that will pay off year after year. Furthermore, you’re minimizing the chance of rookie mistakes that come with a lack of experience (us!).

The way we see it, you’re giving your hard-earned dollars a chance to getting it right the first time which hopefully leads to saving money in the long run.

Is Turnkey Right For You?

Buying a house is not like buying shoes. It is a big purchase and as such, you should take the process seriously. When we started we asked ourselves these questions:

Do we want to be hands-on with our investments?

Note, turnkey investing is not 100% hands-off, you still need to manage your portfolio.

Do we want to maximize real estate investment returns?

Yes, but not at the expense of unnecessary risk or adopting a DIY approach.

Do we need to be close to our investments or can we handle investing out-of-state?

Living in a high COL area like Colorado, we were ok with investing out of state.

Do we have the funds to get started?

We saved and built a real estate investment fund and used conventional financing.

There are probably other questions that may help you decide if turnkey investing is right for you. Just know there are lots of people that started their journey by partnering with a turnkey provider and later decided to switch to a DIY approach.

In other words, they have transitioned to being active real estate investors or embraced a hybrid model where they manage an out of state portfolio with one or more turnkey providers while self-managing their local portfolio.

Getting Started

There are great turnkey providers but unfortunately, there are others that have given the turnkey name a bad reputation. We spent significant time (months) evaluating multiple turnkey providers in different markets following a systematic approach that consisted of internet research, using the biggerpockets forum, phone interviews, and discussions with existing investors.

In general, these were the main themes in our selection criteria:

1. Customer service: critical for us and a big piece in building trust.
2. KPIs: # of active investors, AUM, lease structure, avg length of stay, and % vacancy.
3. Reputation: how long have they been in business.
4. Quality of their product: scope of work of renovations.
5. Return on Investment: cash flow, cash-on-cash returns, etc.
6. Market: where do they operate and plans for expansion.

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Ultimately, we decided to partner with this company and have been in business with them since 2017.

In addition to ranking high in our selection criteria, they also interviewed US to see If we would be a good fit for them. They asked us questions about our vision, long-term goals, and expectations. This conversation was somewhat unexpected but definitely facilitated our decision to entering a partnership with them.

We were assigned a portfolio advisor who asked questions to filter properties that met our investment criteria. Once completed, we started to receive properties (one at a time) and provide feedback to tweak future offerings. When we found one we liked we locked it down.

We’ve bought two properties from them and are now in the process of closing on a third one.

Create a Plan and Set Your Goals

If I remember correctly, we looked at 5 properties before pulling the trigger on the first one. The company provided an analysis that detailed all of the assumptions supporting the pro-forma monthly cash flow and annualized cash-on-cash returns.

This is information every investor should have before making a decision, but it is equally important to understand the math so that you can run your own numbers.

Our goal was to realize a monthly cash flow of $250 or more, and cash-on-cash equal to or greater than 10%. Other metrics included checking the 1% rule, cap-rate, payout, $/sq.ft; however, cash-on-cash (equation 7) remained our top priority. The math we use is the following (annualized):

1. Gross Income (GI) = Rental Income
2. Total Expenses (TE) = Property Taxes + Insurance + Property Management + Maintenance & Repairs (4%) + Vacancy (4%)
3. Net Operating Income (NOI) = GI – TE
4. Cash Flow After Financing (CFAF) = NOI – Mortgage
5. Cash Flow After Taxes (CFAT) = CFAF – Tax liability (personal situation)
6. Total upfront cost = Down payment + closing cost
7. Cash on Cash (%) = CFAT / Total upfront cost

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Numbers On Our First Property

• Type = single family home
• Purchase price = $119,900
• Monthly rent = $1,050 (first year) and $1,100 (second year)
• Sq.ft = 1,600
• Annual property Taxes = $1,735
• Annual homeowner’s insurance = $500
• Annual management fee = $1,260

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The provider quoted an estimated $268 monthly cash flow and 19.62% cash on cash. Numbers looked good on paper but they were likely to deviate from actuals based on down payment amount, interest rate, and whether or not we included closing cost, appreciation, and equity paydown.

We don’t like to include appreciation and equity pay down. As a result, we estimated an 10% cash-on-cash return based on the following:

• Down payment = 22% (due to slightly lower appraisal)
• Closing cost = $4,466 (actual)
• Interest rate = 4.875% (actual in 2017)
• Vacancy = $0 they placed a tenant prior to closing
• Maintenance & repairs =$0 based on the scope of work of renovation

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• NOI = ~ $758.46
• CFAF = CFAT = ~$263.12
• Total upfront cost = $30,766
• Cash on cash = 10.26%

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Note the difference between the Pro-forma and personal cash-on-cash numbers. I cannot stress enough the importance of understanding inputs and assumptions. The 19.62% is not necessarily wrong, the assumptions are just different.

Be careful with optics. You might think the turnkey provider is inflating estimated returns but it is just a matter of understanding the methodology and acknowledging the assumptions.

The other thing to note is that when you look at comps you will quickly realize the acquisition cost is likely to land on the high end of the range. If you are using traditional financing, then you’ll know when you get the appraisal. Our two properties were below purchase price by $3K on average. That said, our third came $2K above asking. The home appraisal is certainly a wild card.

As far as property #1, we’ve had it for ~4 years (Feb 2017) and our turnkey provider has been able to keep the same tenants while gradually increasing the monthly rent to $1,110. Our 12-month trailing cash-on-cash is sitting at ~ 12%.

In terms, of tracking performance, we’ve navigated from using multiple spreadsheets to now using Stessa. They use similar math so no need to keep up with spreadsheets when you can automate tracking with the app. I highly recommend tracking your portfolio performance with Stessa.

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We bought our second property just a few months after property #1 (May 2017). Similar to #1, our provider has been able to keep the same tenants while gradually increasing the monthly rent to $1,170. As far as performance, we are hovering at the 13% cash-on-cash mark. At a portfolio level (yet another reason we love Stessa) we are coming in at a 12.4% cash-on-cash.

As I said, we don’t include appreciation in our numbers but both properties have increased in market value by an average of ~ 14% in 3 years (per Zillow). As a result, we are in the process of exploring a cash-out refinance to take advantage of lower interest rates and use some of the equity to continue growing our portfolio.

Real Estate Portfolio Returns vs Stock Market

Hindsight is always 20-20. No one has a crystal ball to predict the future. We never debated investing in real estate or the stock market. We like and do both. Having said that, I thought it would be interesting to perform a what-if scenario to see how our investment would have done had it been 100% placed on an S&P 500 index fund.

I like using the S&P 500 dividends reinvested price calculator adjusted for inflation to check the index annualized return for a given period. The screenshot below has the details of my assumptions.

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As you can see, the annualized S&P 500 return (with dividends reinvested) has delivered 12.7%, a touch higher than our 12.4% cash-on-cash return.

Look, I mentioned we do not like to include appreciation when calculating cash-on-cash returns; however, once you acquire a property, it is important to know your equity position.

As it turns out, the market where we invest has appreciated more than we had anticipated. If we take the current market value (potential) of both properties and subtract our loan balances we get $110K in unrealized equity! Not bad in my opinion.

Our residents have paid our mortgage, delivered positive monthly cash flow, all while allowing us to build equity.

Please don’t get me wrong. I’m not suggesting you should invest in real estate and ditch the stock market. This is simply an exercise to compare how we’ve done. Our numbers probably won’t blow your mind but we are happy with our returns these last 3 years. Our experience has been outstanding and as passive as we thought it’d be.

Things to Consider

Funds FOR Real Estate Investing

There are many options to acquire properties. You can pay cash, use traditional financing, FHA loans, hard money lending, seller financing, and others. Each option has pros and cons but in the end, it is up to the investor to choose the option that best fits their particular situation.

In our case, we use traditional financing where we try to save enough cash to put a ~20-25% down payment to balance leverage, minimize fees and loan costs (PMI).

Look, it is certainly possible to start investing in real estate with $0; however, those who do it tend to be active real estate investors who benefit from the experience and having the right connections. I’m not here to tell you what to do. Evaluate your options and do what is right for you.

Funds FROM Real Estate Investing

I’ll start by saying that if you need monthly cash flow from a real estate property to cover your bills, you are not ready to invest in real estate.

If you don’t have the funds to take care of problems, you’re going to be in a terrible spot. We’ve never counted on the returns coming from our portfolio for any particular expense, instead, we use them to grow and build our real estate acquisition fund.

Taxes

For real estate investors, the tax benefits are plentiful. If you know how to navigate the tax landscape, you can find considerable tax savings opportunities.

There are many tax breaks you could potentially be taking advantage of, but there are also traps and mistakes you could make.

My recommendation is to consult with a CPA who is experienced in dealing with real estate investors. We partnered with one and are extremely happy with the decision.

Diversification

Real estate investing, when done right, can be a solid investment. Moreover, it can be a lucrative asset class along with paper assets and any type of business.

Real estate investing currently represents a very small part of our portfolio (~5%). The majority is still concentrated in paper assets in both tax-deferred and brokerage accounts.

We like the idea of acquiring more properties. If we do, it will be while continuing to max out tax-deferred accounts and contributing to our brokerage accounts. This may influence the number of properties we acquire in a given year but that is ok.

Long Term Goal

Our goal is to passively build and grow a real estate portfolio that provides a reliable and sustainable income stream. There are many options to invest in real estate but turnkey investing is our preferred choice.

In terms of the number of properties, we don’t really know. Ideally, we would like to have as many as we can responsibly acquire. The number we have in mind is hovering ~ 10 which happens to be the max number of traditional financing you can do.

I’m not sure if we’ll be able to get there but if we can generate enough cash flow to cover the mortgage of our primary residence that will be a big win. That may lead to a total of 5 properties which we think is doable. Time will tell.

Final Thoughts

• Turnkey investing done right has the potential to deliver a reliable and passive income stream.
• I can’t stress enough the importance of properly vetting a turnkey provider. You want to find a company that is going to be your partner.
• Creative financing is probably not a good idea when you buy turnkey real estate. Be patient and try to build your real estate investment fund enough for a 20%+ downpayment.
• Set a vision and take steady and patient action.
• Understand the math and the importance of positive cash flow and cash-on-cash returns.
• Turnkey investing is not entirely hands-off. You still need to track the performance of your portfolio and make sure you stay on target.

Until next time … JJ