I want to address some common misconceptions I’m hearing in my conversations recently. There are a lot of investors who believe passive and active investors should take the same approach to due diligence.
After 23 years buying and selling real estate, 18 years owning and operating a passive, turnkey investment company with my family, and having personally made or witnessed every mistake an investor can make, I believe it’s my duty to share my insight.
If you read this and take away nothing else, please take this: There is a fundamental difference in the approach a passive investor should take in doing due diligence as compared to an active investor.
Before I dive into this further, let’s make sure we’re aligned on our understanding of a few commonly used terms that often mean very different things depending on who you ask.
- Passive Investor: An investor who truly takes no active role in identifying, renovating, marketing (for sale or lease), or managing an investment property.
- Active Investor: An investor who does take an active role in all, or at least some of, identifying, renovating, marketing (for sale or lease), and managing an investment property.
- Turnkey: An approach to real estate investing that pairs a passive investor with a company or individual who owns the property and has recently completed a full renovation. In my opinion, that means no deferred maintenance. Additionally, there is property management in place which is provided by the same company who did the renovation. Both of these opinions are based more on standards than definition. In short, the company or individual owns the property, has recently completed a full renovation, and the property is under management when purchased. Anything short of these three standards is not a true turnkey property.
Why Due Diligence Is Different for Active vs. Passive Investors
An active investor is responsible for the purchase price, the negotiation of that purchase price, understanding neighborhood dynamics, and knowing how certain renovations can have a positive impact on the mindset of residents. They are responsible for every facet of their investment and ultimately if that investment is a success.
Passive turnkey investors have zero input in each of those areas. They don’t pick the neighborhood that a turnkey company works in. They do not pick the renovations that a turnkey company does or how well they complete them. They don’t decide the standards of how a turnkey company operates their management company. They get to pick the turnkey company they work with, and that about sums up the decisions they get to make outside of saying “yes” or “no” to a property.
Too often passive investors are focusing on details that they have no control over. Those details are controlled by the company they are buying from. I’ve actually talked a lot of investors OUT OF doing business with my family’s company because I recognize in them the traits of active investors. Perhaps they start with one or two passive investments, but I know they really want to be active. They are asking the right questions and digging in and doing research that will have no effect on the success of their passive investments.
In reality, investors who have the patience and stamina to put in the extra work it requires to be really good at active investing are never going to have their expectations met with a passive investment. They will always have questions and quite often have regrets because they believe they can do better. It literally takes two completely different mindsets and approaches depending on if you're going to be active or passive.
A passive investors number one job is to do their due diligence on the turnkey companies they’re considering doing business with!
Now, don’t misread anything here. Every investor gets to decide when they say yes to an investment. You can still decide which neighborhoods you want to avoid or which types of homes, prices, and rental prices you want to focus on from a turnkey company. You can still say “no” to any properties that don’t fit your needs, but the fact of the matter is, no amount of due diligence a passive investor does on an individual property can make up for a failure to do proper due diligence on a company.
Bad companies with poor business standards and practices can ruin a fantastic investment property in a very short period of time. And unfortunately, history tells us that there are more poorly run companies than there are good ones.
The 6 Things
A passive investor is not only looking to limit their role in property related oversight, but also their oversight of the people or companies they are relying on for their success. This means, first and foremost, the most important thing a passive investor can do to ensure their success is to do their due diligence on the person or company they are considering as their turnkey solution.
If you get everything else right, but choose the wrong turnkey provider, your results are very likely to fall short of your expectations. Here’s how you can set yourself up for success:
1. Define the exact results you expect in order to call your investment a success.
I talk a lot about expectations because too often commentators judge other investors’ properties by their own expectations. After talking to countless investors through the years, every investor has to set their own expectations. I have met many active investors who are able to let go of certain pieces of the process for passive investments and their expectations of those passive investments are dramatically different than their active investments.
They are a great example of how to approach these investments because they are able to show how a total portfolio performs. They don’t expect low returns, but in a majority of the cases, they expect a lower return with much lower risk and a higher probability of a return of their investments. In order to hit those expectations, their due diligence focuses on the companies they work with, not on the property they own. If their due diligence is done right, the companies will make those properties perform to the investors expectations.
2. Identify markets that you believe align with your expectations and have the highest probability of your success.
3. Identify existing turnkey companies or teams in those markets who give you the highest probability of success.
4. Interview those companies and referrals of those companies to determine if what they offer and how they offer it give you the highest probability of hitting your expectations.
5. Visit the market, but go with your eyes wide open. Remember: you’re doing your due diligence on the company. Keep in mind that while seeing the market may be helpful, the biggest factor in visiting the market is to meet the turnkey company you are considering.
If you have already built trust, then you are simply verifying that everything you have been told — if the very reason you believe they will give you the highest probability of success — matches what you are seeing and experiencing with them in-person. Here’s what to look for in that regard:
- Are they all smoke and mirrors or do they actually match up with the story they told you on the phone?
- How big is their team?
- What systems are they using?
- Do you feel safe looking at the example houses?
- Are they pushing you to sign on the dotted line right there on the spot?
- Are they requiring you to put down a deposit to come visit or to get on a list to see houses?
All of these questions should factor into your due diligence on their professionalism and if you truly believe that they will actually meet your expectations. It is easy to use paper returns and great marketing messages to be convincing, which is why looking people in the eye and talking to referrals of the company are your best ways to do your due diligence.
6. Begin considering properties. If you’ve completed 1-5, then — and only then — should you consider a property.
It all comes down to trust. Ultimately, a passive investor has to be able to reach the conclusion that they have done the proper due diligence on the company they are working with to trust that the investment they make will meet their expectations.
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