In broad strokes, there are 6 kinds of investment properties. There are subtleties, tips, tricks, pros, and cons to each. This article is meant as a primer to help the beginner investor understand the variations so they can know how to spot opportunities and what to look for.
The 6 categories are as follows:
- Flip or Rehab
- Flip to self (BRRRR)
Most often, a property will be predominantly one type but have some of the characteristics or opportunities of another. For example, a property could be “almost” turnkey but need a few renovations which may make it a good candidate for Underperforming as well.
The following explains each category in its purest form and highlights the most obvious cross-category opportunities.
THE SIX TYPES
By definition, a Turnkey property is one that needs almost no work. The landscaping is good, the roof and windows are solid. The mechanicals (heating, electric, water) are up to date. The floors, kitchens, bathrooms don’t need any updating; pretty much a property that would be listed as “move in ready”.
It’s normal, and even expected, that even a turnkey property will need some minor work like painting, minor repairs or upgrades. A rule of thumb is that if the costs are under a few thousand dollars, the property could be considered a true turnkey.
Opportunities with Turnkey properties:
Of all the property types, a Turnkey property will provide the fewest challenges. It requires little effort and time commitment; just a little lipstick and it’s ready for a new tenant.
Because of the low effort, a Turnkey property has a huge potential for immediate rental returns.
Also, given the initial condition, a Turnkey property would generally be easier to manage than other property types, especially over the short term.
Challenges with Turnkey properties:
Almost always, properties that are presented as Turnkey are not what they claim to be. That can be challenging as you “work the numbers” only to visit the property and understand it’s listed improperly so it’s back to the drawing board to re-work the numbers as either a short-term or long-term flip (more on that later).
It’s difficult to find true Turnkey properties at a price that will produce good rental returns. Unless you are a speculator willing to risk rental ROI for potential market appreciation, your properties need to cash flow. That is, the rent needs to exceed the costs. You’ll need to purchase the property at a discount for this to happen. It’s possible but this is much rarer than with any of the other property options; especially in a strong seller’s market.
2) Underperforming Properties
Again, speaking in the purest of definitions, an Underperforming property is one where for a variety of reasons, the rents are lower than they should be. The three main reasons for this are:
- The rental unit is in a state of disrepair,
- The finishes are well below average for the area, or
- There are long-term tenants and rents have not been increased at the same rate as the market has increased.
Opportunities with Underperforming properties:
Underperforming properties present the best of both worlds between Turnkey and Flips.
By fixing the cause of the issue, there are increased profit opportunities through: cash flow, mortgage paydown, market appreciation and renovation appreciation. If you are working with a Joint Venture (JV) cash partner this is the easiest property to demonstrate long term profit potential.
By improving the units (a or b above), you will most likely also improve the quality of the tenants and as a result incur fewer property management issues.
Challenges with Underperforming properties:
Unlike a Flip, you are limited to making repairs or renovations when the unit is vacant. As a result, this generally means working on one unit at a time until the existing tenants vacate.
In the case of long-term tenants that have no incentive to move, it is important to follow the letter of the law. You can’t force someone to move out because they are paying low rent. There are ways of creating win-win incentives for these tenants. It will be important to seek legal counsel before taking attempting any strategies that can be seen as a violation. Unfortunately, in the case of some long-term tenants, the decision for you to just walk away from the deal may be the best choice.
If you are working with a financial JV partner, these deals can be a little tougher to explain due to the unknowns in the timing of the renovations or repairs.
3) Flip or Rehab
A Flip or Rehab is what has brought real estate investing to the forefront in many television series. Buy a house that needs some work, sometimes a lot of work, then sell it at enormous profits.
Opportunities with Flip or Rehab properties:
Flipping a property can be a great way to create some short term cash reserves for your real estate investing business. If you can make $10,000 or $20,000 in a couple of months it’s a good way to put some money in the bank to re-invest in your business.
Properties in need of rehab are generally easier to find than other property types. You can find them by searching listings for words like: handyman, TLC, repairs, investor opportunity.
Challenges with Flip or Rehab properties:
It’s important to understand that most of the money on a Flip is made on the purchase price. Many rehabs are listed at only $30,000 or $40,000 below the value of the home after the repairs are done (typically called the ARV for After Repair Value). If you spend $20K on repairs and you only sell the house for $40K more than you paid for it, you are likely to lose money.
To the point above, you need to build in your closing costs (real estate, legal), carrying costs (what you paid in interest, taxes and utilities) into the equation. If you wind up “breaking even” you have essentially spent a month of two working for nothing. A general rule of thumb is that you need to show, on paper, that you will make at least $10K a month on a Flip or it’s too close and it doesn’t leave any room for unforeseen issues.
Joint Venture partners are a little more challenging to find for a Flip since most JV partners are looking for long term cash flow and long term appreciation.
Financing for a Flip can be more expensive.
You’ll need to get great at estimating repair costs – or have a good contractor on your power team.
4) Flip to Self (BRRRR)
A Flip to Self, also often called a BRRRR, has most of the same opportunities and challenges as a short term Flip or Rehab. BRRRR sands for Buy, Renovate, Rent, Refinance and Repeat.
The process with a Flip to Self is to Refinance with a higher After Renovation Value (ARV) once the property is fully rented and recapture most of the renovation costs within the refinance.
The last “R” in BRRRR means that, because you have recaptured your renovation costs in the refinancing, you have the funds available to do it over again with a new property.
Opportunities with Flip to Self (BRRRR) properties:
Often, these properties are also “conversions” where an additional rental unit is created; for example, a basement apartment. If you can do this, you significantly increase the potential for great positive ongoing cash flow.
Where the Flip to Self differs from a short term Flip or Rehab is that rather that sell the property (and incur all the associated closing costs) you keep the property as a rental and enjoy the benefits of long term cash flow, mortgage paydown, and market appreciation.
Since you keep the property, you get some added credibility in the real estate investor circles because one definition of success is how many properties you have in your portfolio. It’s a longer term play and most real estate investors, and brokers appreciate that metric.
Challenges with Flip to Self (BRRRR) properties:
As you, or your JV partners, build a portfolio of properties, conventional lending opportunities may shut down and you will likely need to resort to more expensive private lending.
As with the short term Flip, you will need to have a way to accurately predict the renovation costs to ensure you build your profit in up front with the right purchase price.
Any list of the types of real estate investing would be incomplete without talking about Wholesaling. Wholesaling is the science and art of purchasing properties well below market value. The stereotypical wholesaler is the “We Buy Houses” entrepreneur.
The concept is to get the properties under contract and then charge a fee, generally to another real estate investor, as a broker on the deal. The original contract is then assigned to the new purchaser and the wholesaler collects a fee for putting the vendor and the purchaser together.
Opportunities with Wholesaling properties:
Wholesaling can either:
- Provide cash reserves to fund other parts of you real estate investing business, or
- Provide properties you can “hang on to” and deal with as one of the other property types. (i.e. turn it into a Flip or Rent-to-Own.)
Property owners that deal with a wholesaler generally do it with eyes wide open. They understand who they are dealing with, they just want out quickly, seamlessly and without a lot of hassle. Commonly, they are looking for a quick exit due to one of the 4 D’s – Death, Disaster, Divorce or Debt. Selling discretely and quickly, without for sale signs, inquisitive neighbours and open houses, is often a relief. The vendor generally understands they are dealing with a wholesaler and a few thousand dollars feels like a worthwhile price for the convenience and expediency.
Challenges with Wholesaling properties:
Wholesaling has a bit of a bum wrap because of some of the aggressive, low class marketing and strong-arm tactics of some of the less ethical wholesalers. Done ethically, wholesaling provides a valuable service but there is still a stigma attached to it.
Finding wholesale properties is tough. It demands time, attention and lots and lots of marketing. It’s a heavy lifting, cold-calling type of business that is not for the faint of heart.
Rent to own is a process whereby a prospective purchaser wants to buy a property and stop being a “renter” but they can’t save enough for a down payment or they don’t currently have the credit rating that allows them to get a mortgage.
To solve this problem, they rent a property with a contract to purchase it at the end of a given term, generally 3 or 4 years, for an agreed upon price.
Four things happen while they are renting that facilitates the purchase down the road:
- They provide you with a significant deposit as part of the agreement to purchase.
- There is a portion of the rent that goes towards a future down payment. This is in addition to the market rent.
- They enjoy the guarantee of a set price in the future so they can take advantage of any market appreciation while they are renting.
- They have the opportunity to clean up their credit rating so that they can qualify for the mortgage at the end of the term.
Opportunities with Rent-To-Own properties:
These properties can be easier to find as the Renter is often the one that finds the property. As an investor, you purchase it for them and enter into an agreement on the future sale.
Cash flow is great on these since as the owner you are collecting not only the market value rent but also the marked-up portion that will go towards the eventual down payment.
The renter pays for all regular maintenance and repairs and there is essentially no property management required.
The investor is protected should the future deal fall through since they have the initial deposit.
Challenges with Rent-To-Own properties:
Somewhat like Wholesaling, there can be a bit of a stigma with being a rent-to-own real estate investor. That is mainly because the opportunity exists to go into these deals with unqualified purchasers knowing that they will not be able to qualify for financing — where the worst case scenario is that the deal falls through and the investor gets to keep the deposit and still own the house. Legislation is in the early stages to prevent this type of abuse by investors but, until those protections are in place for renters, there will be unscrupulous investors giving the Rent-To-Own a bad name.
It’s important to find the Renters first, and then the properties. Once you find the renter, it is incumbent upon you to do all the due diligence you can to ensure they will likely qualify for the mortgage at the end of the term. This can be a time consuming process.
You need to ensure all the property evaluation metrics are in place for the property as well.
This article was not meant to be a comprehensive list of all the ins and outs of each investment opportunity. Entire books have been written about each property type. The purpose was to give you high-level insights to help you along your path towards understanding the business and making informed property purchase and investment decisions.
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