Five Passive Income ideas From Real Estate
By Floyd Saunders, The Author of Five Paths To Wealth, Family Financial Freedom and Figuring Out Wall Street.
Really Simple Investing make this information available for informational and educational purposes only. Really Simple Investing does not warrant the accuracy or completeness of the materials provided, either expressly or impliedly, and expressly disclaims any warranties for a particular purpose.
Decisions based on information contained on this site are the sole responsibility of the reader.
Every successful investor I know has learned that wages are not sufficient to achieve financial independence. A common trait of people who are financially secure is they have multiple sources of income, much of it passive income (investments you don’t actively manage). Once you have enough before normal retirement age. This is often referred to as Financial Independence, Retire Early (FIRE) and the concept has sparked an entire financial movement.
Financial independence can simply be defined as the ability to cover your living expenses with passive income from investments. Those investments can include stocks, bonds, real estate, mutual funds, exchange traded funds even self employment can be considered an investment.
Many of your investments are potential sources of passive income, for example dividends from stocks, interest paid from money market funds and bank accounts or from real estate.
I often discuss investing in the stock market in my blog articles, but real estate can offer at least five different sources of passive income. If you are like most people, you might first think of rental properties as a source of income and away to achieve financial independence. But there are several other ways that may be even simpler and require less of your time.
1. Rental Properties
Rental properties generate typical generate income, for as long as you own the property and rent it others for their use. Your goal of course is to create a positive cash flow each month, after accounting for expenses like a mortgage payment, taxes, insurance, and repairs. Just be a smart investors and adjust your rental income annually to account for inflation.
Over time your rental income will rise while your mortgage payment remain fixed. This means your cash flow improves every year. With your rental properties, your tenants actually pay off your mortgage while your cash flow increases each year.
The best part with rental properties is the tax advantages. You can depreciate the value of your properties for taxes purposes, while the actual value rises. You can also deduct most of your expenses, from mortgage interest to repairs to travel to and from your properties.
Of course when it’s time to sell you will pay capital gains taxes on the adjust basis of each property. You can reduce or avoid your capital gains taxes, using a 1031 exchange. This is a provision of the tax code you will want to ask your accountant or tax preparer about.
2. Seller Financing
When you sell a property, you can offer to finance it for the buyer. They pay you any up-front lender fees, rather than the bank (You can make this attractive for a buyer by charging less in fees). The property buyer then pays you monthly interest and principle payments for the duration of the loan. This only works if you are not carrying a mortgage on the property or the mortgage payments are low compared to income to receive from financing.
If the borrower defaults on the monthly mortgage payments, you can foreclose to retake possession of the property.
3. Private Notes to Other Investors
You can also lend money to other real estate investors, who typically need money to finance a purchase for a short term until they can either sell a house they are flipping or arrange long-term financing. You are lending them money as flexible funds to use in their real estate investing.
Because you have a bit more risk with this type of lending, you will also charge a higher interest rates, and only consider lending to real estate investors you know well, and who have a history of profitable deals. Most real estate agents know who these investors are and can help arrange for you to be a lender.
But what if you don’t want to do all the work that’s required to be successful as a real estate investor? Is there a more passive way, where you can invest your money (even small amounts) and leave it to professionals to select and manage rental properties for you, while you receive regular monthly income in return? Well it is possible with something called a real estate investment trust.
A real estate investment trust (REIT) works a bit like a mutual fund. It is a company that owns, operates, or finances income-generating real estate, using money pooled from numerous investors. There are several different types of REITs, including apartment, factory outlet, health care, hotel, industrial, mortgage, commercial, office, storage units and shopping center REITs. As with any investment, some sectors of the real estate market will underperform other sectors, so you may have the be selective and be prepared to get out of REIT that is holding shopping centers and move to a REIT that holds storage units, depending on the economic and market conditions. A REIT makes it possible for individual investors to earn dividends from real estate investments—without having to buy, manage, or finance any properties themselves.
You simply create a real estate portfolio by investing primarily in real estate investment trusts (REITs) of various types. By law, REITs have to disburse at least 90 percent of their taxable income every year to shareholders by paying them dividends. The U.S. Securities and Exchange Commission regulates REITs in the U.S.
In addition to individual REITs, investors can purchase shares of exchange-traded funds or mutual funds that hold one or more REITs in their portfolios. Some portfolios in this category also invest in real estate operating companies. Here are the things you want to know about a real estate investment trust:
REITs owns, operates, or finances income-producing properties.
REITs generate a steady income stream for investors but offer little in the way of capital appreciation.
REITs are generally publicly traded like stocks, which means you can buy and sell shares in REIT just like stocks and makes them more easily converted to cash (unlike physical real estate).
REITs can invest in most property types, including apartment buildings, cell towers, data centers, hotels, medical facilities, offices, retail centers, and warehouses.
You can invest in a publicly traded REIT, which is listed on a major stock exchange, by purchasing shares through a broker. You can purchase shares of a non-traded REIT through a broker that participates in the non-traded REIT's offering. You can also purchase shares in a REIT mutual fund or REIT exchange-traded fund.
You can also be invested in real estate by purchasing shares in an ETF focused on real estate. For an example, look at the Vanguard Real Estate ETF (VNQ). This ETF Invests in stocks issued by real estate investment trusts (REITs), companies that purchase office buildings, hotels, and other real property. Like most ETFs, it tracks to an index so it is easy to compare performance to the index, in this case the MSCI US Investable Market Real Estate 25/50 Index. This real estate ETF like the others in this category offers high potential for investment income with a dividend yield that is around four percent and some growth; share value rises and falls more sharply than that of funds holding bonds.
4. Real Estate Investment Trusts: Property Funds
Joining other investors in real estate investing can be considered a form or crowdfunding. This includes several options. One option includes private REITs that own properties directly, called equity REITs. Equity REITs own and operate income-producing real estate.
These REITs don’t trade on public stock exchanges. But they own a portfolio of income properties, and pay high dividends.
You can find and invest in these private funds that own residential properties, commercial office buildings, mixed-use properties, or other types of real estate such as industrial buildings. You can learn more about REITs and other investments in Five Paths to Wealth.
The SEC regulates these private equity REITS differently than publicly-traded REITs. A private equity REIT is not required to payout its profits in dividends, so an equity REIT is more of a long-term return on your money.
A real estate fund is a type of mutual fund that invests in securities offered by public real estate companies, including REITs. A real estate funds provide value through appreciation. You can buy and sell public REITs on public stock exchanges. Publicly-traded REITs tend to fluctuate right alongside stocks, even though the underlying value of the properties they own don’t swing as much.
Real estate exchange traded funds own the shares of real estate corporations and REITs. Like other ETFs, these trade like stocks on major exchanges.
book cover design by Ashley Dameron
5. Direct Loans
An alternative model for real estate crowdfunding involves putting money toward loans secured by real estate. You are working as a lender to real estate investors, usually offering hard money loans for short-term fix-and-flip loans. A real estate investor takes out a hard money loan to buy a fixer-upper, renovate it, and then sell it (or refinance it with a long-term rental property mortgage).
You can fund these loans, either individually or collectively, through crowdfunded lenders. You are just effectively lend money to the lender.
Alternatively, some crowdfunded lenders let you pick and choose individual loans to fund. The interest rate varies based on the risk inherent in each individual loan.
Private real estate investment funds are professionally managed funds that invest directly in real estate properties. These are available only to accredited, high-net-worth investors and typically require a large minimum investment.
Two choices to look include crowdstreet for commercial properties and Fundrise for residential properties, as both allow non-accredited investors. Another option is GroundFloor a lender who offers both options to investors. You can lend them money at a fixed interest rate, or you can pick and choose loans at varying interest rates.
As you build passive income and work toward financial independence, diversify your income investments as much as possible. That includes multiple asset classes (e.g. stocks and real estate), different types of investments within each asset class (e.g. rental properties and crowdfunded real estate investments), and diverse geography.
Really Simple Investing make the information i this available for informational and educational purposes only. Really Simple Investing does not warrant the accuracy or completeness of the materials provided, either expressly or impliedly, and expressly disclaims any warranties for a particular purpose.
Decisions based on information contained on this site are the sole responsibility of the reader.