Passive Real Estate Investing: What It Is & How It Generates Income

Residential rental property investing is on the upward trend, driving people to purchase property to rent out and collect rent from their tenants, while others are buying and renovating homes to resell at a higher-than-purchased value. For many real estate investors, one of the main attractions to real estate investment is what’s known as passive income – i.e. money that you make without having to work. While there is no completely full-cycle source of passive income as even real estate investment takes some initial research and time put in, the long term resource and time allocation can be much less than a lot of other forms of investment.

If you yourself are interested in the concept of passive income through real estate investment, we came up with a list of how you can invest in real estate and the benefits and risks of passive income through them.

Investing Through the Stock Market

The easiest way to begin real estate investing is to buy shares in a publicly-traded Real Estate Investment Trust (REIT). The concept is similar to mutual funds, and it will pay dividends based on the earnings. By buying shares in a REIT, you are not directly investing in real estate. You are investing in a corporation that makes money from a variety of commercial real estate properties, as well as apartment buildings. They are also reasonably easy to sell out of, so in some ways, they offer more liquidity than the other options. 

While you can profit by selling higher than the price at which you bought, the only source of passive income is the dividends these investments pay. You aren’t able to collect rent or control the value of the investment properties the company buys.

This investment strategy can add diversity to your portfolio, but publicly-traded REITs are more affected by the stock market than the real estate market. One of the main reasons buying real estate is a good investment is that it has a low correlation to the stock market. Across the board, real estate tends to gain value in line with inflation, and if you buy in the right area, it can appreciate in value even faster than the rate of inflation.

Private REITS & Crowdfunding

A private REIT is a private group that owns and operates money-generating properties. Private REITs have the advantage of being immune to market trends, but they historically earn less in dividends than their stock market counterparts. They also have an entry barrier: only institutional or accredited investors can buy into REITs. In recent years, dividends have been declining as they buy up investments at record low caps. Still, they are considered a stable investment and relatively low maintenance. 

With a REIT, you don’t ever have to worry about the day-to-day operations of property you’re investing in. However, there are many fees associated with them. A publicly traded REIT doesn’t charge any commissions, while private ones can cost as much as 12%. Since they are private, there is virtually no transparency or oversight, which means you risk buying into a scam. Sometimes, even the legitimate ones don’t make it easy to get investment redemption when you’re ready to back out. So while this qualifies as a source of passive income, the only cash flow that’s readily available from them is through dividends.

A Crowdfunding platform is like a hybrid between a REIT and direct purchase. The JOBS act was signed into law in 2016, which allowed anyone to buy into a crowdfunding platform. It takes a lot less money to become an investor (as little as $500 sometimes), and it isn’t limited to accredited investors. While the field has proven lucrative for many people – who sometimes see gains of 10% or more – it is a new frontier with unforeseen risks. 

That being said, the investor often has more of a say in these risks than one would with a REIT. By managing your own portfolio, you choose where to buy and how much to invest, and can pay as little as 1% in fees. They also generally have thorough exit plans for investment redemption, so within a couple of months, you can buy out.

Direct Purchase

There are ways to directly own property without having to be active in the day-to-day management. You can act as a silent partner with an active real estate investor who will handle the day to day management. You can benefit from their experience and expertise and make a proportionate share of the profits. If you’re buying into residential real estate, you can start seeing rental income as soon as there are tenants. Additionally, with a well-informed purchase into thriving areas with lots of growth potential, the property value and rent amount collected will usually appreciate over time.

You could also take charge and become the sole owner. This will generally require a larger down payment than any of the other options. However, by becoming the direct owner of your investment properties, you will have much more control over what and where you buy, as well as when to sell if desired. On a side note, the opportunity to renovate at your convenience or desired timing can immediately increase the value of your investments. 

An added long term benefit is that directly owning property lets you leverage your assets to acquire new ones. With tenants, the debt you took out begins paying for itself steadily, and every month you have more and more equity in your property. By taking out loans with your equity as collateral, you are able to buy more property. Even if you stick to safe bets over areas with quick appreciation, you’re building your net worth from that first down payment. 

Over time, your investments will become passive in two ways—by appreciating in value (i.e. building equity that you can leverage) and by earning rent. This will require work and smart investing upfront, but eventually, this income alone can become a livable source of income.

Making Your Investment Truly Passive

As every new real estate owner eventually learns, being a landlord can feel like a full-time job. That means your work as an investor or your own responsibilities might be put on hold every time a tenant needs something.

If it’s your desire to just be an investor and collect monthly consistent rent, there are other options for management. The right property management company can take care of the day-to-day management which includes finding & placing high-quality tenants, collecting rent, handling maintenance, and dealing with evictions if needed. This means you can get the benefits of passive income without sacrificing control for a small monthly management fee.

Noah Jeong

Noah works on the Growth Team at Great Jones. He's just as frustrated as you are with the status quo in the property management industry and is passionate about making contributions towards raising the bar for property management.

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