Is Real Estate The Best Form Of Passive Income? – Answered Simply
At the end of every month, my phone goes off with the sound of tenants paying rent. It’s a beautiful sound that sends endorphins flowing through my body as I know I’ve just made some income. To me, this is passive income but is real estate the best form of passive income?
Is real estate the best form of passive income?
Real estate offers advantages that other options don’t. The choices you have whether that’s flipping, renting, or buying and holding gives you many options. From there you can choose to do things yourself or outsource them to make the income more passive. Lastly, my favorite reason is the tax advantages that come along with real estate. Mainly focused around deducting the mortgage interest expense and depreciation.
I bought my first rental property in 2014 and it has been one of the best, if not the best, investments of my time and money in my life. I consider the income to be passive but not truly passive and I’ll explain why a little later.
What Is Passive Income
When people hear the term passive income the first thing that comes to mind is the situation I described in the very first sentence of this article. You’re sitting on a beach and just cashing checks, right? Well sort of, but probably not.
Most likely this isn’t the case because the stream of income you’re talking about isn’t truly passive. For something to be 100% passive it would mean you don’t have to touch, talk or even think about it. When it comes to real estate this is possible but most likely for you, it just isn’t feasible.
In my mind real estate is the best form of passive income but it isn’t 100% truly passive income and I’ll explain why later on in this article.
Some examples of truly passive income are your interest return on a retirement account or the dividend payment you get for an investment in a company. You put your money in and don’t even think about it.
After you finish reading this article and want to learn more about other streams of potential passive income for yourself then you should check out my article: 5 Passive Income Examples You Can Start Tomorrow.
In that article, I go over some truly passive income options for the average person as well as some other examples that are mostly passive like real estate is.
Buy & Hold
I want to start this article out with the only form of real estate investing that I consider to be truly passive income. Buy and hold investing means just as it sounds. You buy a property and hold it for an extended period of time, usually over 5 years.
You then sell this property at an appreciated value. This is where you get your return on investment and the passive factor comes into play since you’ve done nothing since you bought the property many years ago.
This type of investing is out of the question for most because most don’t have the cash available to buy a property outright. It is possible to finance this but it becomes much more complicated and risky. Some people make hundreds of millions of dollars going this route but even more lose everything.
The risk here is that a property won’t appreciate in value. For the most part, it is safe’ish assumption that the value of a property will go up but there are certain things that are out of your control.
For example, when Amazon announced they were putting HQ2 in Queens, New York property values shot through the roof. Some people cashed in while others bought thinking it was a great long-term investment.
When Amazon backed out of HQ2 due to political pressure (they say this wasn’t the reason but come on) property values plummeted and people lost a ton of money. There is no such thing as a risk-free investment, remember that.
Buy & Hold With Farmland
One way to get around this need for excess cash is to buy farmland and lease it back. I wanted to include this in this section instead of rentals because you aren’t really collecting a monthly check.
Fertile farmland is expensive and only going up. The rate of which certain cities are expanding are only making this worse and I’ve seen tracts of land going for $20,000+ an acre, which is pure insanity to me.
The way this could be a form of passive income is that you buy some farmland and lease it out to a local farmer who actually uses the land. This is a contract that is usually negotiated every 3-5 years and can be anything from covering the property taxes to profit sharing.
You are then also betting on the land appreciating, which as we just learned doesn’t always happened, but the money you receive from the farmer leasing will lower your risk.
Flipping homes can also be a form of passive income and one that many people make a living through. I’ve talked about it many times but I believe that HGTV has romanticized the idea of buying an old home, updating it, and making thousands of dollars.
Does it happen? Yes
Does it fail more times than it works? Yes
To make flipping real estate to be truly passive you would need to subcontract out all of the work done to your property. The people that do this for a living usually have a contractor that they work with on every project. They’ll take them to a property they are looking to buy and get a quote before they even make an offer on the home. This way they can have a rough idea of the profit they’ll make.
Most people don’t take this route. Instead, for most people, this will only be sort of passive income as they are going to do some of the work themselves and for good reason. Everything you do yourself puts more money in your pocket *potentially*. I say potentially because I don’t know the value of your time, which is something you need to figure out on your own.
If it’s worth it for you to go in and tear out all the old cabinets and carpet then why wouldn’t you?
Flipping isn’t risk free though. All too often remodeling a property goes over budget and unexpected things comes up when you start tearing into a home.
Of this list, buying and renting a property is the most popular and most accessible for people. I’ve done it twice now since 2014 and absolutely love it.
This isn’t an article on the benefits of owning rentals but I can’t help but mention some. I now feel comfortable fixing almost anything in my home. I understand better how the financials work, specifically taxes. Lastly, my people skills have improved a ton. Dealing with people I know and adding in the money aspect is a weird dynamic at first but overall rewarding.
Now of everything on this list, I think rentals are the top reason that real estate is the best form of passive income.
Rentals give you that monthly cash flow that buys & hold and flipping lack. Moreover, both of those options expose you more to market fluctuations and what’s happening in the economy overall. No matter how good or bad the economy is people are still going to need a place to live. Also, an unfortunate fact is the worst the economy is the more people rent.
Rentals for me and many others aren’t truly passive though as we spend a lot of our time managing a property. I’ll talk about a little later how I could outsource all of this but for now, I don’t. It’s worth my time and effort to go fix things, manage my tenants, and do the financials.
It’s important to note that this isn’t my full-time job. I probably spend 1-2 hours a week total managing two properties. For that reason, I would consider my situation as close to truly passive as you can get.
Using Property Managers For Rentals
If you want a rental to be truly passive income each and every month then you are going to need to use a property manager. A property manager is a person or company that does all the hard work for you.
They find renters, make repairs, and almost anything in between on your property. This comes at a cost of course usually in the area of 10% of gross monthly rental income.
Is this worth it? Well, that depends. To most people, it is because they don’t want to take the time to go out and vet potential renters and in bad cases evict others. It’s just not worth their time.
For people starting out, like me, it isn’t worth it. I’m set up so my properties are close to each other (right across the street) and I know all of my renters. This just isn’t possible at a large scale and the reason I’ll use a manager in the future.
The Bottom Line
Finding forms of truly passive income is hard. Doesn’t matter if you are just starting out or well on your way it is something that everyone struggles with.
To most, real estate seems like a lucrative venture they will never have the opportunity to get into but I don’t think that’s the case at all. As you just read there are many different options for how you go about it and to me that makes real estate the best form of passive income.
For many, myself included, you’ll never know what works until you try something. At first, I thought I wanted to own many single family homes or duplexes but I’ve slowly realized over the last 5 years that I want to get into something more commercial.
Whatever route you choose to take there is no right or wrong answer.
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