Real estate investment is one of the best ways to avoid the Wall Street scam and take charge of your own future and finances. But when you start investing in real estate, one of your first choices will be whether to buy a fixer-upper or a turnkey property. Turnkey properties for sale have a lot to commend them, but there are a few things to know before you invest.
The 7 Things to Know Before Buying Turnkey Properties for Sale
It’s Hard to Find Deals
Precisely because turnkey properties are ready to make you money straight out of the gate, it can be much more difficult to find a good deal here than you could with a property that needs a bit of attention. In most cases, turnkey properties have already been bought by someone who’s done all the work to bring the property up to code and make it attractive to renters. What you’re buying is the finished product.
The person who bought and updated the property has improved its equity and is anxious to cash in on it by selling to you. For you, a turnkey property is rarely a deal at the moment. It’s only valuable as you keep it and continue collecting rents over time. Remember that the ongoing earning potential is the most important thing to consider, so understanding your CAP rate is key.
Net Operating Income
To estimate CAP, you first need to know your net operating income. In other words, after you pay taxes, homeowners association fees, city sewer fees, utilities, landscaping, or anything else, how much income is left to you?
Calculating Your CAP Rate
Your capitalization rate, or CAP rate, gives you a good idea of the earning potential on a property. To find this, divide your net operating income by the purchase price. The higher the CAP rate, the better, all other things being equal.
Not All Lenders Are Equal
If you need financing for turnkey properties for sale that you’re interested in buying, it’s important to check what’s available and compare lenders carefully. Some lenders are not willing to lend for out-of-state purchases, even if you live in the area.
It’s usually better to go with a local lender in the area where you plan to purchase, even if you live on the other side of the country. For a turnkey property, you’re going to need long-term financing rather than a hard money loan, so local community banks and portfolio lenders are always a good bet.
ROI Requires Careful Calculation
Your return on investment is different from your capitalization rate, but it’s no less important in determining whether a turnkey property for sale is the right one for you. You can make a better calculation of your return on investment through cash-on-cash return measurements rather than simple CAP rate.
What the CAP rate doesn’t take into consideration are your mortgage payments. Unless you’re buying the property outright, you’re going to have to pay off the mortgage, and that’s going to cut into your net operating income. Of course, when you go with the lender, you are investing less of your cash into the project.
How to Calculate Cash-On-Cash
The cash-on-cash measurement reveals what return you’re getting for the money you’ve laid out. To calculate it, first find your annual net income. Then subtract from that income your annual mortgage payment. Now divide this number by the total amount of cash investment you would put into the property. The resulting number is your ROI percentage.
Tread Carefully With Existing Tenants
If there are any tenants in the property that you’re buying, this could be a good thing. After all, it means you start collecting rent the moment you sign the papers and get them finalized. However, an existing renter could also end up to be an albatross around your neck.
Check the Lease
Make sure you carefully look at the lease before you buy. What agreement is in place? In some cases, you may be obligated to continue renting to them for the same amount of money as the previous owner, at least for a period of time.
Check the Tenants
If you don’t have an obligation to continue renting to the tenant, then check them out carefully to see if you want to continue the relationship. Vet them in the same way you would a brand-new tenant by doing a complete screening and reviewing their payment history, income, and original rental application.
Check the Laws
If you are buying a property in the city (or these days even in whole states, like California) where rent control is in effect, you must be very careful about existing tenants. Rent control makes it difficult to get a fair market price for your unit if you’re dealing with an existing tenant, and in areas with rent control, tenants are incentivized to stay in place as long as possible.
Carefully Check the Infrastructure
Just because a property is advertised as in livable condition or ready for tenants doesn’t mean that all the systems are in good shape. Even if there is an existing tenant, the HVAC system could still die next summer when they turn on the air conditioning.
Just remember that livable is not the same category as newly renovated and that even an updated property needs to be carefully checked. The seller may not have necessarily updated every part of the property. There are a few significant areas to check out:
- Furnaces and HVAC systems
- Electrical wiring
- Major appliances
- Plumbing and sewer connections
Even if a few things need to be updated, this doesn’t necessarily mean that the property isn’t a good deal. But you should go into it with your eyes open. If you identify some infrastructure issues that need to be addressed, this gives you a good platform to negotiate with the seller.
Not All Renovations Are Equal
If your mother didn’t warn you that you can’t always trust everyone with a bridge to sell, then she should have. Just because a property has been renovated doesn’t mean it’s been renovated well. There are some flippers who buy properties, make a few cheap cosmetic changes, and then tried to get the most money they possibly can out of the sale.
They choose second-rate contractors and use substandard materials, leaving you to pick up the pieces a year from now. Always do a very careful check of the renovations. If you see anything that seems shoddy, even if it’s a small thing, be suspicious. If you’ve noticed something on the surface that looks poorly done, what might be underneath?
Property Management Is Everything
Before you consider buying, you have to decide who is going to manage the property. This is especially important when dealing with a turnkey property because the whole point is to be able to get the property rented out and bringing in income as soon as possible.
Of course, you might be the one to manage the property, and that’s fine. This is especially a good choice if you’re relatively new to the industry and want to understand better all the ins and outs of property management. Just remember that your labor has value. You might not be paying out money to a manager, but you’ll be paying in labor all the same.
If you live too far away, or you have too many properties to manage, you’re going to need a property manager. The more time and effort you invest in choosing a good property manager, the more angst and difficulty you’ll save yourself in the coming years.
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