OOS Turnkey Rentals Vs. Stock Market

[Mrs. Healthywealth]

Hi all,

I have about $100k to invest. Was thinking about purchasing rental property, but not sure if that's the wisest option.  Here are the contenders:

(Option 1) I live in Los Angeles, so with a $100k I can get a Condo/Townhouse, or perhaps nicer homes in Corona, Chino Hills, Temecula, Eastvale, etc. The closer the home is, the lower the chance I need a property manager, since I gotta guy who takes care of these things. They would be newer homes, and easy to manage. Plus I'm comfortable with these areas.  Con: I can only afford one property, then maybe another in 5yrs.

(Option 2) Another option is to go with a Out of State (OOS) Turnkey company named Memphis Invest--I've researched the crap out of them (folks have had very positive experiences with them).  You end up buying a home for full retail value with no anticipated maintenance for at least 8yrs b/c they over rehab the properties to decrease initial stress. They also help with selling the home, and will tell you which areas are more likely to appreciate.

The rental's are roughly $150k each, I can purchase up to 5 or more (over 4yrs) throughout Little Rock Arkansas, Oklahoma City Ok, Dallas Tx, and St Louis MO.  It is definitely not the 1% rule, more like .8%.  Vacancy rate for them is 4%, 5% maintenance, 10% property management, CapEx 5%. I get a whooping $100-$40/month after mortgage (25% down, 5%APR).  But, if I pay them down, the net Cashflow is $6000-$8000/yr per property.  I'm pretty sure I can pay off 3 of them in 10yrs.  BUT, the homes are older 1960's to 1990's, and they are in another state; so I wonder what the issues will be in 15-20yrs (Although my primary property is from 1960 and I'm not worried about it since it was also rehabbed quite a bit, but I also have a great location).   Memphis Invest has stellar property management component, so that gives me faith.

(Option 3) Just put the money in Vanguard across VTSAX, VTIAX, and VNQ (REIT). If we invest continue to invest, I predict 1.1-1.3million in 10yrs. Con: can potentially make more in rentals, possible only 3-4% (after inflation returns), maybe worse--being conservative since it's only a 10yr horizon.

My goal is to go part time in 5 1/2 yrs, my spouse would work full-time for 5 more years after that.  I can go PT regardless of which option I choose. It's just that Option 2, when properties are slowly paid off, can potentially give me a lot more "stable" income--$10k or $15k versus investing in Stocks.  We have a savings rate of 50% with all currently going to stocks/bonds, if we did rentals, then we would do half towards stock/bonds and the other half towards rental properties.  But, rentals is sorta new territory for me, although I've been reading a lot about them, and had one unintentional rental in the past for 5yrs, For me rental property is more unpredictable in terms of costs down the line than stock market since I like to be conservative with my stock returns.

Retirement Expenses: $75k (would like $90k before tax spending to account for taxes; medical insurance will be covered by my pension).  My spouse and I will never stop working part-time until we no longer can--too much work out there in which we can help folks. So I figure we will bring home $40-50k on lowest end, after taxes. In 15yrs, my pension will cover 40k.  Plus $40k from stocks/bonds. (So like $80-90k from investments/pension and then $40-$50k from PT work). The mortgage will be paid off in 25yrs, which will decrease expenses to $55k before taxes).

I run the numbers through Cfiresim and FireCalc and usually get 100% outcome if I were to just stay the course. But, the rentals have the potential to give me extra income security. But, now we have an increase in income and decrease in expenses, so I want to know what you guys think is the better option with this extra boost of income ($12k/month and $100k).

Let me know if you need more info.
 

[BicycleB]

Stock.

[Dare2Dream]

I wouldn't jump into the rental game as a newbie.  The first step in the business would probably be with someone more experienced as a partner or partial equity only investor.

My vote would be mostly index funds and if you really want to dip your toe into real estate try out a REIT or RE crowd sourcing with a few thousand dollars.

[Mrs. Healthywealth]

Thank you for the reply’s, I’m sensing become a real estate mogul may not be in my future. The lower potential return also comes with lower stress. Thank you for your thoughts.

Fundrise was also something on my radar, but would like to wait for a few years to see how their numbers change with the slowing economy.  I don’t feel a need to rush into something new, and always value mustachian advise. 😊😊

[Bobberth]

I don't have any specifics on Memphis Direct. I know they have been around for several years so that makes me think they are legit but from what I have seen in St. Louis (a market similar to Memphis) and other turnkey operators, I'm highly suspicious of that segment of the market. Make sure you verify EVERYTHING a turnkey operator says. Take nothing for granted. Run comps. At least check realtor.com for the zip code to make sure you're not overpaying. Make note of what end of the market the house is priced at and days on market for similar houses. I've been approached by several OOS investors looking to buy in St. Louis where they are telling me what a good deal they are buying when it's priced well above MLS. I replied earlier this week on a BiggerPockets post where an OOS investor didn't understand that sewer and water bills are separate here and believed the turnkey seller that the tenant paid for the sewer bill to make the numbers look better. It's customary for landlords to pay sewer and water here. Now the investor is in collections for the unpaid sewer bill and is learning why most landlords here pay for sewer to avoid those risks. He didn't do his homework.

If you do decide to pursue OOS investing, let me give you a tip from a local in a location with many OOS investors: We're not rubes. Just because you live in California (seems like most are from there, not specifically you), doesn't mean you're smarter than us when it comes to our local real estate. We know our market. We know what's overpriced. There's a reason why locals let a "deal" sit on the market for 10 months. There's a reason why locals cater to OOS investors and not other locals. There's a reason why someone with 100 rentals is passing a "deal" on to someone else.

I'm not saying it can't be done and it can't be done profitably, just keep a healthy dose of skepticism, stay alert and be smart.

And as a final reminder after all of this: Real Estate is not an investment. It's a Business.

[mathlete]

You don't have to put all of the money into turkeys. Maybe buy one turnkey, and put the rest in stocks. If you fall in love with the turnkey experience, you can liquidate more stock later on and buy up more turnkeys. If you have a bad experience, you can sell it and take solace in the fact that most of your money was in stocks.

I also like Dare2Dream's idea of a partnership or equity only investment. Finding such a setup will take a little networking on your part, but there are a lot of real estate investors who are looking for more money to chase more deals with.

One thing to consider is why you want to be in rentals in the first place. You spoke about aggressively paying down the mortgages on the rentals (within 10 years), but this mutes a lot of the potential benefit of real estate investing in the first place: leveraging with low interest loans. The potential of $6-$8K a year in cash flows is exciting, but if you have $150K tied up in the asset, this is really just a ~4.5% yield.

And speaking of yields, just looking at the ballpark numbers, if you netted $100 a month on a a $37.5K investment ($150K * .25 down), your cash-on-cash return is only 3.2%. I encourage you to bust out some spreadsheets. Make sure that any potential investment meets your IRR objectives.

[Mrs. Healthywealth]

One thing to consider is why you want to be in rentals in the first place. You spoke about aggressively paying down the mortgages on the rentals (within 10 years), but this mutes a lot of the potential benefit of real estate investing in the first place: leveraging with low interest loans. The potential of $6-$8K a year in cash flows is exciting, but if you have $150K tied up in the asset, this is really just a ~4.5% yield.

And speaking of yields, just looking at the ballpark numbers, if you netted $100 a month on a a $37.5K investment ($150K * .25 down), your cash-on-cash return is only 3.2%. I encourage you to bust out some spreadsheets. Make sure that any potential investment meets your IRR objectives.

Yes, good point. The IRR drops dramatically if I pay it down early, and the idea of it being tied up in a house that may not sell for what I bought it, even 20yrs later (thinking of Memphis), is a bit scary. Worse case scenario, I have a house from 1970’s 20yrs from now that has need a lot of maintenance, and I can’t sell to anyone other than a TK that would buy for less.

What’s a good IRR that would make it worth rentals over stocks?  Most of these, when I run the numbers on various calculators and spreadsheets come out as 13%, as long as I don’t pay them off early.

[Mrs. Healthywealth]

If you do decide to pursue OOS investing, let me give you a tip from a local in a location with many OOS investors: We're not rubes. Just because you live in California (seems like most are from there, not specifically you), doesn't mean you're smarter than us when it comes to our local real estate. We know our market. We know what's overpriced. There's a reason why locals let a "deal" sit on the market for 10 months. There's a reason why locals cater to OOS investors and not other locals. There's a reason why someone with 100 rentals is passing a "deal" on to someone else.

I'm not saying it can't be done and it can't be done profitably, just keep a healthy dose of skepticism, stay alert and be smart.

And as a final reminder after all of this: Real Estate is not an investment. It's a Business.

It really is a business, so much work and I haven’t even purchased anything. With Memphis Invest, I’m noticing they are selling for whatever amount is higher on Zillow, Trulia, Realtor.com. This is what gave me a major red flag, and when I wrote on here to get thoughts.  I agree and have read on Biggerpockets that TKs love  OOS investors from California cause we are comparing our market to theirs vs just looking at the area. So I look at the surrounding homes, which I’m sure haven’t been as rehabbed and their usually $10-30k less, in Cali that’s no big deal, but when the house is $150k, that’s a lot of discrepancy.

No way in hell will I think I’m smarter than local investors. I rather just look in areas with friends who are in real estate and know more about the surrounding area.

I agree it can be done, but I think the amount of due diligence and my inherent skepticism makes it nerve wracking. Which is why Memphis Invest seemed more practical. They are super up front about the premium you pay to go with them.

[BicycleB]

One thing to consider is why you want to be in rentals in the first place. You spoke about aggressively paying down the mortgages on the rentals (within 10 years), but this mutes a lot of the potential benefit of real estate investing in the first place: leveraging with low interest loans. The potential of $6-$8K a year in cash flows is exciting, but if you have $150K tied up in the asset, this is really just a ~4.5% yield.

And speaking of yields, just looking at the ballpark numbers, if you netted $100 a month on a a $37.5K investment ($150K * .25 down), your cash-on-cash return is only 3.2%. I encourage you to bust out some spreadsheets. Make sure that any potential investment meets your IRR objectives.

Yes, good point. The IRR drops dramatically if I pay it down early, and the idea of it being tied up in a house that may not sell for what I bought it, even 20yrs later (thinking of Memphis), is a bit scary. Worse case scenario, I have a house from 1970’s 20yrs from now that has need a lot of maintenance, and I can’t sell to anyone other than a TK that would buy for less.

What’s a good IRR that would make it worth rentals over stocks?  Most of these, when I run the numbers on various calculators and spreadsheets come out as 13%, as long as I don’t pay them off early.

I always wonder if people get numbers like the 13% by comparing the projected return over a long period (say 20 years) to their initial investment. It seems to me that the relevant capital at each moment is the capital accumulated to that date. I would think the return is much lower calculated that way.

For example, if you invest 20,000 in a 100,000 property and earn 2600/year at first, it starts out at 13%. If 10 years later, you are earning 2600/year on 50,000 of capital, you'd be getting 5.2%. More generally, it seems the rate should gradually approach the capitalization rate, the rate of return you get if you buy the whole property in cash.

Not meaning to assume OP's calculation is wrong, just wondering.

[NorCal]

I'm going to go against the trend and say to diversify.

Put some cash in a rental, and invest future cash flow in the stock market.

Maybe the house goes better, or maybe the stock market goes better.  Only time will tell.  Maybe you like being a landlord, maybe you don't.  You'll never know if you don't try it.  But if you do try it, do it with only the capital you're willing to lose.

I've found that it's almost always better to invest in something that's a learning experience, as long as it's a risk you can handle.  Heck, I'm still glad I invested that $20K in starting my own business that completely flopped.  The learning experience was worth way more than $20K.

Of course, I'm saying this as someone who has been sitting on the sidelines of real estate investing while keeping my money in the stock market.  So take it with a grain of salt.

[Dare2Dream]

I'm going to go against the trend and say to diversify.

Put some cash in a rental, and invest future cash flow in the stock market.

Maybe the house goes better, or maybe the stock market goes better.  Only time will tell.  Maybe you like being a landlord, maybe you don't.  You'll never know if you don't try it.  But if you do try it, do it with only the capital you're willing to lose.

I've found that it's almost always better to invest in something that's a learning experience, as long as it's a risk you can handle.  Heck, I'm still glad I invested that $20K in starting my own business that completely flopped.  The learning experience was worth way more than $20K.

Of course, I'm saying this as someone who has been sitting on the sidelines of real estate investing while keeping my money in the stock market.  So take it with a grain of salt.

+1 diversification is the key

[kite]

Why do you think the rentals give you extra income security?  There are vacancies, bad tenants, natural disasters...(my state was hit by Hurricane Sandy)...and a million little things that could derail your best laid plan.  Ask yourself, if it's a slam dunk, why hasn't someone else with more resources already beaten you to it? 
I own real estate and believe in it as a part of a diverse portfolio.  I'm also a landlord.  There are good reasons to do it.  But a belief that you can be successful remotely using a property manager and have income security is not accounting for the actual risk involved. 

[Mrs. Healthywealth]

After much thought, I decided it's a good time to pull in a CFP (fee based/fiduciary) who also has a realtor/broker on his team, together they will look over the numbers, not just for rental property, but my entire portfolio. I've worked with him for years because of my parent's investments, so I appreciate the family discount.  What was cool was that he gave me and my spouse a very lengthy financial education and some much appreciated advise back 6 years ago for $100, this was before i discovered MMM.

It's a fortunate position to be in, having the ability save and invest. I appreciate the individual who suggested I need a team of folks to help out, this will be my team for now.

I'll share a few of the rental property info with you all.

[Mrs. Healthywealth]

Attached a copy of one of the rentals. Other tabs let you modify the information.  In case anyone is curious what some of the numbers look like.

[Mrs. Healthywealth]

Why do you think the rentals give you extra income security?  There are vacancies, bad tenants, natural disasters...(my state was hit by Hurricane Sandy)...and a million little things that could derail your best laid plan.  Ask yourself, if it's a slam dunk, why hasn't someone else with more resources already beaten you to it? 
I own real estate and believe in it as a part of a diverse portfolio.  I'm also a landlord.  There are good reasons to do it.  But a belief that you can be successful remotely using a property manager and have income security is not accounting for the actual risk involved.

These are all the questions I've though about. I like the idea of trying something new and learning, but $35k might be a steep way to learn the lesson.  I think the security comes from the feedback with folks who have utilized this particular turnkey company, even with an eviction, they make sure the process is as "smooth" as it possibly can be. My gut is telling me that this turnkey company is what Edward Jones would be for stocks/bonds, not necessarily an awful option, but you pay a high price to allow someone else do most of the work.

"Income security"--in reality, i guess there is no such thing.  Stocks will go up and down, rentals will have issues, there is risk with everything.  The one thing i have noticed, is the amount of time and energy I have put into thinking about this. This is time that I could be spending with my kids. It's one of the bigger reasons i decided to consult a CFP, and to take a break.  Being goal oriented, can also be a bad thing...i was reminded this week of the importance of enjoying the moment and not focusing on the financial piece so much because it will work itself out, doesn't have to be right this second. ...so even though i didn't invest the 35k yet, i did utilize valuable time. Not sure that's really worth it.  Instead of exploring properties, I choose to push my kids around in a wagon instead, these mindful moments are waaayyy more important to me than reaching FIRE in 5yrs.

[kenmoremmm]

i looked into memphis invest. seemed very polished. but, pricey compared to other competitors. we invested with another TK company and plan to do so with many more purchases. i doubt it'll return as much in the long run as stocks, but it should facilitate early retirement just as well and will provide cash flow in the short term which is something we don't get with stocks since we don't have enough in post-tax accts and we live (currently) in a HCOL place.

[GoCubsGo]

I'm in the rentals as a diversification camp with a caveat.  During the great recession my rental homes held up extremely well, money lending tightened and tenants were fighting for good quality rentals ( I had one person show up with 6 months of rent cash).  I was able to significantly raise my rental rates because my homes were in solid (not perfect but solid ) neighborhoods.  My local knowledge allowed me to buy in solid performing neighborhoods that I knew well (I'll benefit from roughly $100K of appreciation when I sell but I go in assuming minor appreciation growth). 

It sounds like it'd be tough to make a rental work in your area (the numbers no longer work in my area either due to property taxes and appreciation of the market).  I don't think I'd be able to do a TK unless I was on the ground researching the area for myself and felt very comfortable with the area and the quality of the renovations.

[SyedAli]

I didn't seem to see any discussion of your current net worth and asset allocation. However, a few comments -

1) Needing a "team" to invest $100k seems like a bit of an overreaction, doesn't it? I get that an endowment fund, or a billionaire, or a professional athlete probably need a team to rely on in order to make the appropriate investment decisions. In the grand scheme of things, $100k isn't very much. You're going to need ~10x that in order to retire - given that you're partially retiring in 5.5 years, accumulating the cash itself is much more critical than the investment gains that cash makes. Put more simply, let's say the turnkey rental is an insanely profitable investment and doubles in value over the next 5.5 years (13% net IRR) - you'll still need to figure out how to come up with the other $800k, won't you?

2) An investment property will make you less diversified, rather than more (unless your net worth ex-housing is significantly greater than the $100k). Your asset allocation will be extremely weighted toward your (presumably leveraged) investment in housing, such that your entire portfolio will live or die by the performance of the housing. The goal of diversification is to avoid this sort of thing. You will also have less financial flexibility given that a large portion of your net worth will be locked in an illiquid investment.

3) I'm not sure I understand why the "stable" income from the rentals is favorable to the stock market. Assuming the stock market appreciates faster than the rental service, why not just accumulate a larger pile of cash in the stock market and then invest in a dividend-focused mutual fund? That will likely produce a higher level of stable cash flows.

Just stepping back and thinking about this high level - why is the management company offering you the opportunity to make a 15% net IRR, when they will only be making 10% (before whatever fees they incur)? If the opportunity is so good, they should just cut you out of the picture and make 15% plus whatever they save by not needing to pay a management company.