Three Ways to Earn Passive Income From Real Estate
March 21, 2022
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If you're wondering how to earn passive income from real estate, you're in luck. There are three great ways to earn passive income from real estate investing. Whether you want to own real estate properties outright or you'd prefer an indirect method to create passive income, there is a method for every type of investor.
What Is Passive Income
Passive income is money you earn without having to work for it actively. For some forms of passive income, you'll put in the work upfront or have to do 'some work' to earn money, but not like working a 9 to 5 job, for example.
Ideally, passive income streams should pay you dividends or interest, and if it's real estate, appreciate over time without you doing much of anything. Passive real estate investments are a great way to diversify your portfolio and make more money to reach your goals, whether they be financial independence, growing retirement accounts, or just saving more money for other financial goals.
What's better than a rental property that creates cash flow? With monthly cash flow, you can reach your financial goals faster, or if you want to expand your real estate investing portfolio, you can save the money to buy more properties. It's a great form of passive income that pays you often and regularly.
You might think that investing in real estate properties isn't exactly passive income. After all, you are a landlord and responsible for everything to do with the home. But, there is a passive income component to it.
Not only do you earn the monthly cash flow, but you also earn appreciation in the home. Even though you aren't living in the property, you are the owner. As the home appreciates in value, you are the one earning the capital gains. In addition, when you sell the property, you get to keep the difference between the purchase price and the home's current value minus your outstanding home loan if you have one. Think of home appreciation as the 'bonus' you earn when you sell the property and as an addition to the passive income you already earned.
You can invest in just about any type of property, including commercial properties. However, investors just starting out typically stick to single-family homes, townhomes, or condos. You can even invest in foreclosures or short sales to save money on the purchase and have more significant capital gains.
- Real estate normally appreciates, which provides you with passive income. When you sell the property, you can sell it for more than you paid for it if the real estate market is in good standing at the time.
- You can earn a decent cash flow if you collect rent payments regularly, charge enough to cover your expenses, and still earn a profit. While you have to do some work to make the passive income, it's not a lot.
- You can leverage real estate to invest in a property that's worth more than the cash you have to put down on it. You can make a small down payment and borrow the rest to get yourself started in real estate investing.
- Your tenants help you earn equity by making rent payments each month. They essentially pay the mortgage down and help you earn more equity in the property each month. It doesn't get much easier to create passive income when someone does it for you.
- Real estate investing usually hedges against inflation. Unlike most investments, real estate properties keep pace with inflation. As the prices of other goods increase, so does real estate value.
- Real estate investing can take up a lot of time and energy, depending on where you invest and what you invest in. If you don't do your research and ensure that the property is in good condition, in an area with high rental demand, and an area with regular appreciation, you could end up spending more time and energy on it than you hoped for this passive income stream.
- Real estate investments aren't very liquid. While you can sell a property if you can't afford it or don't want it, you won't sell it overnight. It could take months to get your money back.
- You need to be willing to take some risks. Investing in passive income real estate can be a gamble, especially if you don't do your research. Areas often change over time, and what was once a great place to invest in rental property might not be as good any longer.
Real Estate Mutual Funds
Real estate mutual funds are shares of companies that invest in real estate funds. They are similar to REITs (real estate investment trusts), but they aren't the same thing. Instead, mutual funds invest in the companies that run the REITs and are a great form of passive income.
Investing in a real estate mutual fund is one of the most passive ways to invest in real estate. You invest with many other investors, and a fund manager handles the entire fund. You do nothing except decide how much you want to invest and how often you wish to contribute.
Real estate mutual funds are directly tied to the real estate market. When the real estate market does well, so do real estate mutual funds and vice versa. Unlike investing in physical real estate, you can buy and sell real estate mutual funds whenever you want.
- You don't have to purchase physical properties, but you still invest in real estate. So you can earn money when the real estate market does well, but you don't have to worry about carrying physical real estate when the market does poorly.
- You can reinvest your profits. For example, if your mutual fund pays dividends, you can have the dividends reinvested in the mutual fund, further growing your real estate investments.
- You don't pay taxes on any mutual funds in your investment portfolios until you sell the funds.
- You can sell mutual funds quickly if necessary. So you don't have to wait months to get your money back if you suddenly don't have enough cash flow or the stock market is crashing, and you're worried about your investments.
- There are many options to invest in real estate mutual funds, many of which have a low minimum investment, opening up the possibility of real estate investing to just about anyone.
- You are at the mercy of what the fund manager decides to do with the funds. You might or might not agree with the decisions, and oftentimes you won't even know what they are doing if you're using an online brokerage.
- You don't get depreciation tax benefits or earn any dividend income from real estate. Instead, you simply own a share of the investment companies that get these benefits.
- You don't own physical real estate, which means you won't have a monthly income from rent like you would if you owned investment properties yourself.
REITs — Real Estate Investment Trusts
If you've always wanted to own real estate but don't have enough money to start investing in physical properties yourself, a real estate investment trust is the next best thing. An REIT is a company that owns a handful of real estate properties. They are usually commercial properties, allowing you to earn a passive income without directly investing in them.
When you invest in an REIT, you indirectly invest in commercial properties. As a result, you can earn monthly cash flow and appreciation without managing rental properties or even being a property owner.
- You can invest in a large number of commercial properties without worrying about how you'll finance or manage them.
- REITs typically aren't directly tied to the stock market. So if the stock market does poorly, it doesn't mean the REITs will too, which can be a great way to diversify your portfolio while increasing your passive income.
- You don't have to figure out how to afford housing prices or have an investment strategy to invest in commercial properties.
- You can use your existing online brokerage account to buy REITs, and you don't have to be an accredited investor to start investing.
- REITs must return at least 90% of their profit to their investors.
- You don't have a say in which properties the REIT invests in, which can make you feel slightly out of control. Even though it provides passive income, many investors cannot handle feeling out of control.
- You don't get to take advantage of any of the tax benefits owners of physical real estate get to take, especially when they have a loss.
- You aren't the only owner in the REIT, so you must share the profits the fund makes.
Related Article: Real Estate Investing Amid COVID-19
Real Estate Funds vs. REITs: What's the Difference?
Real estate funds and REITs sound very familiar, and both provide passive income, but they have some key differences you should understand.
- REITs find properties to invest in and directly manage them. They usually have a handful of properties in their portfolio to diversify their real estate income streams. Real estate funds invest in the companies that buy properties.
- REITs pay monthly payments of dividends from the rent earned. REITs are required by law to pay at least 90% of their profits back to investors. However, real estate funds aren't required to pay dividends, and not all do.
- REITs trade on the market throughout the day and are very liquid. Real estate funds trade once a day and may or may not trade at the price you put in the order at because it depends on the price at the time of the sale.
How to Generate Passive Income From Real Estate: Tips and Tricks
Determine Your Timeline
Decide how long you can tie up your investments. For example, if you buy an investment property, you should keep it for 3 - 5 years to recoup your investment and make a profit. If you aren't sure if you can tie up your money for that long, you should consider more liquid investments, such as REITs, where you can buy and sell shares throughout the trading day.
Decide How Much You Can Invest
How much money you have to invest is important too. For example, if you're talking $500, you'll want to look at an REIT or real estate fund. Both have options with low minimum investment requirements.
If you have thousands of dollars to invest, you can consider buying a residential property other than your primary residence and renting it out. It's a great investment opportunity to earn income, even if you need financing like a conventional loan, and it provides you with a passive income stream.
Consider How Much Control You Want
Control is the key difference in the three passive income opportunities. Real estate investors that buy property are in complete control. Even if you hire a third-party property manager to help manage the property, you still have 100% say of what happens on the property, how much rent you charge, and anything else that goes on in the home or property.
If you don't care about control and want an investment that requires less work, investing in an REIT or mutual fund is a great alternative to diversify your investment portfolios.
Frequently Asked Questions
When Should You Consider Investing in a Rental Property?
If you're looking for a passive income stream, invest in rental property. If you have decent credit, enough money to put down on the home, and can manage the property or hire a property management company to do it for you, you're well on your way to enjoying passive income streams.
Why Is Real Estate a Good Form of Passive Income?
Real estate is a good form of passive income because it is separate from the stock market. If the stock market crashes or inflation goes crazy, real estate usually does okay. You don't have to worry about losing everything because you put all your money in one stock, or you didn't take advantage of passive real estate investing.
What Is Residual Income?
Residual income is money left over from your business or investments after paying your expenses. Creating passive income in real estate is easy when you have a strategic investment plan that ensures you will bring in more money than you spend.
How Much Should I Spend on a Property I Plan On Renting Out?
If you're ready to start investing in real estate, start small. Don't put all of your capital into the first home you invest in. Instead, get your feet wet with a cheaper house to get used to creating passive income.
Look for foreclosures, short sales, or homeowners in trouble who need to sell their house quickly and can sell to you for a great price.
Learning how to earn passive income from real estate can be fun. Whether you'll earn rental income, use real estate crowdfunding, or invest in mutual funds, there are many ways to invest in real estate directly and indirectly. Think about how much money you can invest, how liquid you need the investments to be, and how much passive income you want to earn. Click here to check out Concreit's website!
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