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Pros and Cons of Turnkey Rentals vs Private Money Lending

Episode 063

John Larson and the Real Estate Cowboys talk passive income real estate investing.

Hear new episodes every Sunday morning at 8 a.m. The Cowboys talk about the pros and cons of both turnkey rentals and private money lending.

Keep the #CowboyCoffee hot while listening to John, and the Cowboys talk about how to #BeACowboy and earn passive income in real estate.

Episode Transcript

Keith Weinhold: Hey, this is Keith Weinhold from the Get Rich Education podcast. You are listening to my friend John Larson and the Real Estate Cowboys. Don’t quit your daydream.

Robert Helms: Hey everybody, it’s Robert Helms, host of the Real Estate Guys radio show, and you are listening to the Real Estate Cowboys.

Announcer: Have you thought about becoming financially free through real estate investing, but don’t have the time or knowledge to get started? Welcome to the Real Estate Cowboys podcast. Each week we discuss passive income investment opportunities in the red hot Texas market. John Larson and the Real Estate Cowboys will show you how to leverage their team to build wealth in real estate through passive investment opportunities. And now here’s John.

John Larson: Hello and welcome back to the Real Estate Cowboys. This is your host, John Larson. This week I wanted to discuss, it’s a pretty good topic, some things that we have offered, uh, at our company, uh, over the years. We started off, as many of you may know as a turnkey rental provider, we’ve slowly kind of put the brakes on that right now just because of the way that the real estate market is. It’s just so, it’s really hot. Cap rates have really become compressed and we’ve always been firm believers on really only buying high B to A inventory, uh, in, you know, uh, some of the best Metros in America, which you know, would be Dallas-Fort Worth, Houston, San Antonio, you know, many other places. But what’s happened is, you know, in some of these markets the prices have just risen so high to where, you know, the property only runs for so much and now you’re not seeing the type of returns that you could back in 2010, 11, 12, 13.

Right? The cap rates are just starting to become more compressed. And so now we’ve kind of pivoted into doing more of private lending and things of that nature because it provides our clients with that consistent steady cash flow that they’re looking for. And it’s uh, it’s consistent, right? And it’s great for investors who are strictly just looking for a cash flow stream. And like I said, a consistent cash flow stream. And it’s also a really good model for the self-directed IRA or 401k clients because these dividends are getting paid back to you monthly in the form of double-digit returns and those returns are coming back to you tax-free or tax-deferred. So this week I wanted to discuss the pros and cons of turnkey rentals versus private money lending. And so there’s pros and cons of both. And so I was really wanting to go over that with you today so we can really familiarize the audience with what you’re getting with both types of investment options.

Because I think both of these options are some of the most popular out there right now. Aside from, you know, doing multifamily investing and things like that. You know, with multifamily you’re coming to the table with a lot more money. Whereas with private money lending, a minimum of 50,000 is kind of similar to a down payment on an A class property with what a turnkey property at 50,000. So it’s kinda the same amount of money that you’re bringing to the table. And so basically let’s just go over, you know, if you’re going to put $50,000 into an investment, what are the pros and cons of each? So, you know, once you’ve decided to invest in real estate, you have several different options where to put your money, obviously. And I would say, like I said, the two more most popular choices are turnkey rentals and private money lending, especially for the investor that’s looking to invest maybe around $50,000 right?

You’re not really going to get a multifamily property for 50,000 even if you leverage it. So each of these real estate investment opportunities has its own unique benefits, right? And they also have some drawbacks and it helps to compare them in order to make a decision about where to invest the money.

So we’ll start with turnkey rental investments. So what are the pros of a turnkey rental? There’s definitely tremendous benefits with both of these options, but one, with a turnkey rental, it will provide instant cash flow. As soon as you close the profits of the turnkey rental are yours. If you buy your turnkey rental with the tenant already residing in the property, you’ll see instant cash flow. So that’s one good thing about turnkey rentals.

Affordable entry levels, all you need is money for a down payment in order to invest in a turnkey rental, right? And with Fannie Mae finance, you’re only putting 20% down in most cases. So this makes it a lot more affordable for anyone with good credit to qualify for a conventional mortgage. Okay. You get a lot of diverse choices with turnkey rentals. They exist in every city across America, obviously. Whether you choose to invest in one your own backyard or across the country, you’ll have a broad diversity of options on where to invest, right? Where to invest, what type of property to invest in, so on and so forth. Turnkey rentals are also backed by a hard asset. A turnkey rental is a solid actual asset that backs your investment. You always have something that you have equity stake in when you invest in a turnkey rental. So that’s good. A lot of investors like that.

The big, big one would be the numerous tax deductions. So when you actually own real estate, you get to take advantage of all these tax deductions. And so owning a piece of real estate provides you with a tremendous tax deduction that you can use to offset other income sources. No matter how much your turnkey rental cash flows, those tax deductions are yours to take. So that’s really, really big. And there’s so many deductions with turnkey rentals. You can write off your maintenance for the year, you can write off your interest payments if you have a loan on it, you can write off travel to go see the property. You know, if the property is not in your own backyard. If you travel to Dallas to go look at your turnkey rental, that’s tax-deductible. So there’s a lot of tax benefits with owning rental properties and there’s really more than, I believe, ten write-offs that are available to you. And so definitely consult with your CPA or tax professional when it comes to doing your taxes on your rental properties each year and make sure that they’re taking advantage of all the deductions that are available to you. Even your property management fee is tax-deductible. So lot of tax-deductible options with turnkey rentals.

Now let’s get into some of the cons of turnkey rental investments. And trust me, there are some cons. I own turnkey rentals myself and I can tell you that they’re not always the most passive investment. I have had some heartache with some of my turnkey rentals, but you know, let’s go into some of this. You know, like I said, all of all investment options are going to have pros and cons and some drawbacks. So, um, it’s definitely a challenge. Number one, it would be a challenge to market or, I mean, I’m sorry to manage out of state. So if your turnkey rental is located out of state from where you live, it’s really nearly impossible to successfully manage it.

That means hiring a property manager, you know, will then add on an extra expense. Like I said, that management fee becomes tax deductible at the end of the year, but you know it will have an effect on the cash flow initially by hiring a property manager out of state. It’s hard to find cash flowing turnkey rentals right now. In certain economies, it can take a long time to find a track attractive cash flow in turnkey rentals. Even when buying from a company like us, often the inventory is simply very low and your choices are limited and it’s, you know, it’s also, like I said, it’s tough in today’s market to really find attractive cash flowing turnkey rentals. It just is. Really, if you’re buying turnkey rentals and you want something that’s going to be as passive as possible, you really do kind of have to buy in that kind of middle class type of neighborhood that’s going to consistently attract the middle-class at the tenant because that will actually provide you with as much of a passive experience as you can. I’ve said this before on the show many times, don’t go chase a paper yield or a paper return. Because a lot of times, and especially in the market today, if you’re seeing high rate return on income from, uh, from, from, from the rental income, it’s generally because you’re buying a C or D class property, which means you’re buying way below the median home value in that market. And that just means that you’re going to run into more trouble. Those are higher crime neighborhoods. They’re not going to attract the most responsible tenants. So you’ll probably see a lot of turnover, a lot of damage to the property, possible theft of the property, vandalism, things like that when it goes vacant.

So that can cause a real negative impact on your investment experience. Right? So I just think right now in today’s market, because there’s not much appreciation upside, because I believe that the prices are back up to where they were before the last recession. I don’t see them going much higher than where they are right now. If anything, I’m going to say I believe that the market is going to start to cool a little bit and that’s just not going to give you that appreciation upside. That actually really is the main benefit I think of buying and holding real estate. The cash flow is really, it’s unpredictable with rentals. Vacancy can happen, maintenance can happen. So you really can never count on that, that cash flow being an exact number from month to month. So that’s why I really don’t look at rentals as being such a big cash-flow producer.

Once you get to a large, larger portfolio, you know, some vacancy can be offset by other performing properties. And generally, a portfolio of ten homes should run pretty well. And then you’re getting obviously that uh, the tax benefits and you know, all the other things associated with, with owning real estate, but not having that appreciation upside. Like, just a quick story. My grandmother, you know, she bought a couple of properties in the Metro Detroit area, uh, years ago. I want to say it was probably close to ten years ago. Um, so it was kind of during the recession, right. Uh, just coming out of the recession. So she got the property is very cheap. She told me, you know, her experience, it was probably in like a C plus type of neighborhood. Her experience of actually owning the rental wasn’t the best. She did have a lot of turnover. She did have a lot of instances where tenants were paying late. Um, she did have a lot of repairs and maintenance. But, the properties did go up in value quite a bit because she bought them at the right time. And she bought them through her IRA, so she has quite a bit of a, of money coming back to her in the form of equity. Right. Not necessarily cash flow. They weren’t the greatest cash flow investments for her, but by buying that the right time, she’s cashing in on them now. They’re worth more than they were when she first purchased them. So in actuality ended up being a really, really good investment for her because she, because of the timing of the purchase. Another thing is expenses are still up to you to cover with turnkey rentals. So owning a turnkey rental means you’re responsible for covering the needed repairs and other expenses related to maintaining the property.

Even if you have a property manager, you’re the one that’s paying for things. So you know, I’ve had instances where storms came through and um, wrecked something on the home, a roof or whatever, and have the insurance company come back and say, well, we don’t cover named storms, you know, and so now the owner’s on the hook for a larger repair like that or you know, a plumbing issue, the tenant just neglects it and it becomes a larger issue over time. You’re responsible for that. Things of that nature, you know, it just leaves you open to a lot more exposure as far as expenses go with the actual investment. Okay.

The next thing is, it’s not a purely passive way to earn income like I said. A turnkey rental owner, you know, your participation is needed in order to help ensure that the investment is economically viable. It’s not a completely passive income experience. You’re going to have conversations with your property manager, you’re going to get some bills in the mail sometimes that you’re like, what is this for? You’re going to have to review your property management statements each month. You’re just going to have to sit down with your tax professional each year and hash some things out and make sure that you’re getting all the tax savings that are available to you. And so I think there’s a lot more accounting that goes with it and you know, just the general repairs and maintenance and like your property manager calling you and saying you have a vacant property and now you know your loan still do every month, even though your property is vacant. So it just becomes a little bit more cumbersome. And you know, it doesn’t really provide you with a truly passive way to earn income.

Now let’s go into the pros of private money lending as an investment. So with private money lending, it’s one of the less known types of investments. Uh, but those who do know about the, the benefits of private lending there, they love it and they’re usually repeat investors. And so let’s go over some of the benefits of private money lending that you should be aware of. And the first thing is dependable income. It comes in like clockwork in the form of a dividend. The same way that you would pay a bank, right? That’s how you are paid, right? You are getting that loan payment every month, a mortgage payment every month. So as long as you work with good quality, trustworthy private money lending sponsor, uh, which we offer these type of investments in good markets like DFW, uh, you can count on regular dividends coming in like clockwork each month.

You’ll always know how much to expect to the penny, right? It’s the same payment every month. There is no vacancy, there is no maintenance, there is nothing associated, uh, with private money lending where you would not receive your full dividend. Okay? And unless the project went south for whatever reason, or we weren’t able to exit out of the, out of the property like we planned or at the price that we planned, maybe your principle that would be returned to you wouldn’t be as much as what you put in. But it’s really tough to see loss on a private money lending opportunity, especially if when you hold first lien position because these assets don’t go to zero. And for some of you that have been listening to us and follow us, you know that we’re also in the CBD space, we are borrowing money and also loaning money to other partners to purchase equipment to do extraction and refinement because this hemp that is being grown needs to go through an extraction process and then a refinement process to then be put into these retail products that just seem to be popping up everywhere now.

And they’re starting to be popping up in Walmart and Walgreens and CVS and the stores that we find on every corner, right? They’re even being found in gas stations. So it’s just becoming more and more just relevant I guess in, in today’s consumers’ eyes. So I believe that the benefits of CBD are real and I believe that more and more people are finding out that the benefits are real and all that’s going to do is cause this industry to turn into a multibillion-dollar industry, which it’s already on pace for. And so I believe that you know, real estate backed investments on the private lending side are great, but I’m an investor, loyal person and so I want to be able to provide my investors with opportunities that I know will pay them back. And I know we’ll cash flow and I know we’ll get them the double-digit returns that they’re looking for.

And with the real estate market where it is right now, a lot of the deals are super, super tight and they’re very, very hard to come by. So your margin for error on, you know, purchasing a commercial building and rehabbing it and pushing rents up and things like that, there’s a lot of moving parts that go into that to make sure that the investment pays off. Whereas with this equipment, it spins off such predictable cash flow and reliable cash flow, that and so much of it, right? A million-dollar machine through one harvest could make multimillions of dollars, you know, probably even close to $10 million. And if your loan on that machine is 1 million, well than investors should feel pretty secure that they’re going to get their money back on that investment. And also you can hold first lien in the form of a UCC-1 on the equipment that you’re loaning on.

And so trust me, that borrower does not want to lose his equipment because he didn’t pay his loan off. That’s gonna make him multimillions of dollars for years to come. Right? So you’ve got to think about that as the investor. I mean, it would not make any sense to the borrower to not pay off that small loan for a machine that can make 10 times what that loan amount is. And so that’s why we’ve kind of geared over to that space as well, because of the fact that it’s just really dependable, reliable, cash flow, predictable cash flow. Okay. And so just I know that we’re the Real Estate Cowboys and everybody associates us to real estate and American Real Estate Investments, but there are other options out there that I’m just letting you know and I’m uncovering to our audience that you can loan on and see really solid returns and also feel the comfort that you’re going to get that money paid back to you.

You’re going to get that loan paid back, and guess what? If that person does not pay it back, then we go in and we take that equipment and that’s equipment that is highly, highly profitable. Okay.

All right, so the next thing is it’s a hundred percent passive income. The true beauty of private money lending as an investment is that it’s completely passive. Once you submit your funds, there’s nothing else you need to do. No one will ever pester you with an issue or a question. The only communication you’ll see is when your dividends come in, and that’s just when my controller sends out your payment each month. That’s all it is. You can also see higher returns with private money lending. A lot of cases, you’re seeing double-digit returns on your money. You’re seeing 10%. Some of our CBD raises that we’ve done have paid 12%. Where else are you going to get 12% in today’s market, fixed? It’s, it’s going to be really, really hard to come by and especially on assets that are backed in markets like DFW or on assets that, like I said, are a key, they play a key integral role in the burgeoning CBD market that we’re seeing out there right now. Right. And CBD, it’s not marijuana. It’s legal. Hemp is now legal everywhere. The sale of hemp is legal everywhere. The sale of CBD products is legal everywhere in every state. So there’s no reason to be alarmed like you’re investing in something that’s, you know, not status quo. Like it’s not legal. No, this is a legal thing. The government has made it completely legal and so it is more than safe to invest in these opportunities. Okay. And I’ll just tell you, it’s is very, very tough to see double-digit returns in today’s economy, especially on turnkey rentals.

You know when you factor in all the ways that rentals pay you, you will see double-digit returns and sometimes triple-digit returns, but it’s all about timing with those. And like I said, right now I don’t believe that we can necessarily get triple-digit returns or sometimes in some cases even double-digit returns in today’s market buying properties today. It’s just a very, very hot market and very low inventory and the cap rates have really become compressed and you’re definitely not going to see double-digit returns in the form of rental income cash flow. Okay. Unless like I said, you’re buying a very risky property, risky investment that in most cases never pans out the way it does on paper. So just be careful of that. In today’s economy, you know, you, you may never see that level of returns in the form of double digits in any of the other type of investment and that’s certainly not in CDs or mutual funds which are safe but are only going to yield you, you know, a 5% return or something like that. When you factor in inflation and all that, really what are you making? Okay.

And so also with private money lending, you have recourse. Your private money lending investment is backed by firstly lien position. And those are the only opportunities I do. There’s other opportunities out there where we could go put, um, you know, we can do larger deals and we can raise money for the down payment and then put a bank loan on it, you know, go get a larger bank loan for the investment. But then at that point the investors are only taking second position and I’m completely fine with just doing smaller deals where my investors can hold first lien because I believe that that’s really, really valuable and also provides my investors with that sense of security, uh, to go into one of these investment opportunities. Right? With recourse, if the borrower defaults, you and the rest of the pool of lenders have recourse to take possession of that property. It’s really like having insurance on your investment dollars. So how can you really go wrong there at that point?

That’s all I have on the pros. Let’s jump into the cons. Cons of private money lending. Um, there are cons with everything. And so in, in most cases with private money lending, since you’re putting a group of many different lenders on one note, I believe it’s over six if money’s crossing state lines if you are being publicly solicited. Like right now I’m talking about private lending opportunities and I talk about private lending opportunities on my show quite often. So in that case, I’m pretty much publicly soliciting these offerings. So that means that we have to fly under the 506c rule of the Regulation D, uh, with the SEC, which means that all investors who participate in our private money lending opportunities must be accredited investors.

Okay. And in a lot of cases, you must be an accredited investor to participate in a debt syndication. It’s not impossible to get to that point, but you know, it’s a hurdle that you wouldn’t have to face with a turnkey investment. Anybody can buy a turnkey rental. That entry point can sometimes be higher. So in most cases, you know, you’re seeing a minimum of 50k usually to invest in a private money lending opportunity or that syndication. Whereas with a rental property, you could buy a property as low as $80,000. Although I don’t necessarily recommend it. Um, but you know, at that point with your closing costs and everything, you’re only kind of coming out of pocket $20,000 to purchase a home like that. Or purchase an investment like that. Right. But with private money lending, you will see minimums that could be higher, especially when the sponsors are targeting only accredited investors who usually have more money to play with.

Right. And also with private money lending, you don’t technically own anything. Private money lending is strictly hands-off investing. Okay. Although you’re investing in real estate or you’re investing in a piece of equipment or in a business or whatever it may be, you don’t technically own that, right? You just hold first lien to it. So, therefore, you can’t take advantage of any of the tax deductions that are available to turn-key rental owners. Or if you were to do an equity syndication, you actually own that property. Okay? You don’t hold lien on it. You don’t receive instant income or instant returns on your money because it’s equity and in most cases, equity positions or equity syndications may have longer terms. And also the guarantee that the equity that’s promised, there’s not really a guarantee that that’s what you’re going to see. So if the equity sponsor is promising a 30% return or whatever it may be, and then something happens with the market or whatever it is and you’re not able to sell the property or exit out of the property for as much as you planned will, then now your return would diminish. So you have to think about it. Well, I was in that project for three years and I only made a 10% return over three years. That’s something that you have to consider with an equity syndication.

But that’s all we have for this week. I hope that you found this episode very informative and I hope it kind of gave you more insight on the different things that we do at American Real Estate Investments and the Real Estate Cowboys and what the pros and cons are of each. Okay. So it’s something to noodle over and kind of figure out, you know, what investment option may be best for you.

And you can always go to our website, We have a quiz on the website. Uh, you can take that quiz. It’s basically what type of investor are you quiz, um, where you just answer ten short questions and it kind of spits out a generic type of answer. Are you a private money lending investor? Are you a turnkey rental investor? Are you a vacation rental property investor? Those are the kind of the three options that we look for. And those are the three options that I talk about in my book, The Passive Income Guide. If you’re interested in getting your hands on that book, you can just go on Amazon and either get the paperback book sent to you or you could download the e-book. Um, both are very affordable options, but you just, the Passive Income Guide: What’s Your Return on life by John Larson, foreword written by Keith Weinhold of Get Rich Educations podcasts, which is another great, great podcast to listen to. If you don’t listen to that one, uh, it should definitely be on your radar. Um, and if you’re interested in learning more about the private money lending opportunities that we have today or the debts indications, private money lending, whatever you may call it, it’s pretty much the same thing. Uh, you can go to put in your information in and you can get our free passive income starter kit, which talks more about our opportunities here at American Real Estate Investments. And the Real Estate Cowboys and a member of our team will reach out with more info on what we’re offering right now, what the returns are, what the project is, if you’re an accredited investor, you’ll get access to the PPM and you can make an informed decision if you’d like to move forward. But we always have videos on the opportunities. I go out and shoot videos with our borrowers or at the projects that we’re planning to invest in and raising money for.

So, but the first step would just be to putting your information out, or to get more info on the great opportunities that we have, which are spinning off double-digit returns to our investors fixed every month. So if you’re interested in that, like I said, go to our websites and put your info in. Uh, but that’s all for this week. I’m, like I said, hope you found all the information informative and is getting you one step further, uh, to starting to take action in earning passive income in real estate or in private lending in general. And so with that, I’ll let you go and always remember what’s your return on life and have a great week everybody. We’ll see you again next week.

Announcer: All opinions expressed by the host of the show are the opinions of American Real Estate Investments LLC and do not reflect the opinions of guests or sponsors. No personal or professional advice on this program should be considered an endorsement to follow a real estate financing or investment strategy. Before acting on any information, seek advice from your financial tax, mortgage or real estate advisor, as the information is not guaranteed and investment strategies have the potential for profit or loss.