Learn the Benefits of Passive Investing

There are lots of types of real estate investment; “turnkey” is one.

 

In our last article, we addressed becoming an investor in a traditional fashion. You buy a property, fix up what’s needed, and then rent it out to gain an income stream that boosts your bottom line. Eventually, you sell it, reaping, hopefully, a healthy profit. Sometimes this sale occurs soon after you started, what’s known as flipping. The traditional approach of being actively involved appeals to many who like to be hands-on. They also find the financial prospects quite heady stuff.

 

Passive Turnkey Real Estate Investing

Chris Clothier of Memphis Invest

And so do others. “We devour stories about people who went from rags to riches flipping houses. We watch episode after episode of renovation reality shows on TV: a quick half hour from wreck to rental property,” writes Christopher D. Clothier, who helps potential investors define their purpose in real estate investing at the company Memphis Invest. The 15-year-old business purchases, renovates, sells, and manages more than 800 homes in five cities every year. His company manages close to 5,000 single-family homes with a total of $650 million in asset value. With his expertise, Clothier has found that some don’t want to be as actively involved throughout the process. They prefer a more passive role, known as “turnkey real estate,” the subject of his book, The Turnkey Revolution (McGraw Hill Education, 2018).

 

What does this strategy involve and how hard is it to master? We recently chatted by phone with Clothier who is also a contributing columnist for BiggerPockets, the largest online real estate forum based in Denver. Clothier, based in Memphis, provided his 10 essential tips to become a successful turnkey investor:

 

What turnkey investing means. With this strategy, a buyer purchases a property from a turnkey company that previously bought, renovated, and placed a resident in a home or apartment. Of course, sometimes the property is empty and needs to be marketed for rent. The company selling the property is looking to turn over ownership to someone else. In some cases, it will still manage it in exchange for financial remuneration, often 10 percent of the collected monthly rent.

 

Dallas and Houston represent two of the three best rental markets at this time.

The best investor candidates. Who’s the best candidate? According to Clothier, an investor who wants to take advantage of top rental markets—those where the medium home and rent prices give the investor the highest yield. Three of the top current markets in the country are Memphis, Dallas, and Houston, Clothier says. Three that he would consider poor choices because of their high cost of housing are San Francisco, Los Angeles, and Miami. To get in on the best deals, the savviest investors leverage the advice of top experts who guide them in building a portfolio of affordable, quality rental properties in desirable areas. The investors come from a diverse background. Some are busy professionals with extra cash. Some are entrepreneurs looking to diversify their holdings. Some are stay-at-home parents and still others, retired boomers looking for additional income. Many are open to purchasing properties far from home that they can’t inspect in person, but which they’ve researched. In other words, they don’t have to quit their day jobs to take on this new role.

 

The right members for the team. It’s critical that a turnkey investor hire the right team members or company to work with them because they’re depending on someone else’s advice for so much—from purchasing the right properties, to fixing them up and managing them. “With whom and where you do business is way more important than any home itself,” Clothier says. Furthermore, it can reflect a long-term investment rather than a quick flip. “Many who get involved think of it as a generational wealth-building strategy. They go in with the mindset that they may never sell and may pass down their portfolio to children or grandchildren,” Clothier says.

 

Buy properties that are in the “path of progress” where roads, schools, and shopping centers are being built or redeveloped.

Best property prospects. As with other real estate holdings, location is key. A dying city is never a good place to start, says Clothier. Migration and net growth of an MSA is an important factor. A second key is the location of a property within a specific city or town. Ideally, it should be in the “path of progress” where roads, schools, and shopping centers are being built or redeveloped. The specific property should also reflect quality housing that two-income earning families would find desirable. “The fewer the headaches the better; you don’t want a property with a high turnover since you want renters who come and stay. The passive investor traditionally has higher expectations,” Clothier says. In contrast, active investors are more willing to take on greater challenges such as less expensive housing with deferred maintenance because they often pay less.

 

How to get started. Clothier believes that an investor should begin with a portfolio of two to three homes to guard against the rollercoaster that comes with owning just one. “With one property, you tend to be either happy or sad,” he says. “But with several, you should always have some positive income.” While a dollar figure is hard to peg, since so much depends on the area and type of house purchased, he thinks a good number to be willing to spend for the first two to three homes ranges between a total of $80,000 to $150,000. And it’s best to buy them from a company that operates in the area and is selling houses they bought and renovated themselves. Securing an appraisal and third-party inspection before closing to be certain the house is what the sellers claim it to be is essential.

 

Start with a portfolio of two or three houses.

 

The importance of patience. Turnkey investment is not a get-rich quick strategy but requires patience and a long-haul view, Clothier says. Yet, it can be a good hedge against inflation and usually a secure investment. By being able to leverage funds and secure a home loan, an investor can acquire assets in a passive way and let the income coming in help pay down their mortgage. A typical return on a high quality turnkey investment should be between 5.5 percent and 7.5 percent in an all-cash purchase. When an investor uses a bank loan to leverage a property, they should expect a higher 10 percent to 14 percent return on their down payment.

 

How to locate potential partners. The easiest way to find a trusted partner is to use Google and look locally. Enter the name of the city along with the phrase “turnkey real estate” and see what pops up. Know that not every city will have a quality company focused on this category. Good questions to ask when you find some are—Do you personally own the properties you are selling? And Do you own the management company that will manage my investment going forward? With a list of prospects in hand, interview them one at a time. After you’ve bought your initial investments, and your turnkey company partner has proven his ability to choose wisely and meet your expectations, you may be ready to add to your portfolio.

 

When to unload properties. This decision is best made in consult with the turnkey company. If the market is experiencing strong appreciation, it may be time to capture some of the money by selling and purchasing more property through a 1031 exchange. Or perhaps, it may be time to trade up to better single-family homes. Or you may even want to go the commercial route. The bottom line, Clothier says, is don’t sit on the sidelines and see the market pass you by.

 

Roadblocks to watch out for. Many can be mitigated with tax strategies such as a 1031 exchange when selling and reinvesting in new properties. A CPA or other financial adviser who understands real estate is an essential partner for anyone looking to sell—or buy—investment property. Many courses and webinars from firms such as Global Real Estate Education Network can provide additional information and even suggest ideas for finding a mentor or coach. When Clothier started out in 2003, he attended seminars and received coaching from those who were investing in real estate.

 

It does NOT need to be an either/or decision being active and passive investing.

Other scenarios. Passive and active investing don’t have to be mutually exclusive. Clothier has worked with several investors who place a portion of their profits from every active deal into a passive fund and purchase as often as they can. “Neither is necessarily better, but investors need to be honest with themselves about whether they like the approach of passive investment since the turnkey company does all the heavy lifting,” Clothier says. For him, passive investing has provided welcome income thanks to experts doing most of the work.

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