Passive Real Estate Investing Strategies
There are ways to invest in real estate so you can create passive income. Here’s an in-depth look at seven strategies that may work for you.
Investing in real estate allows you to build wealth and, potentially, increase your income all at once. But with the time, money, and effort that’s often needed, it can be downright hard to get started. Luckily, there’s a way you can invest with a more hands-off approach, while still being able to reap the rewards.
Passive real estate investing lets you dip your feet in the market without taking the full plunge. There are several methods you can use to accomplish this. Below, we’ll explain how each one works, including the benefits and downsides that come with them. After reading, you’ll have a deeper understanding of how this type of investing works, and whether it’s a good fit for your financial goals.
1. Buy-and-Hold Rental Properties
This tried-and-true real estate investment strategy has been around as long as the concept of property. It involves buying residential or commercial properties to rent them out to tenants. It can be a smart way to create passive income as an investor.
Often, investors will buy a property to let the rent pay for the mortgage. In this case, a common strategy is to purchase a multi-family home, such as a duplex, then let the tenants essentially pay off the loan via their monthly rent. Many refer to this method as “house hacking.”
Keep in mind that while this strategy can be very effective, it has its challenges. First, buying property of this kind can be expensive and take research, so it’s not totally passive. Some people opt to “leverage” their portfolio by using a combination of loans and equity to expand quickly. However, be aware that market conditions are a consideration here. If housing prices go down, you could see potentially significant losses.
Another downside is that, unless you’re up for the challenge of performing maintenance yourself, you’ll need to hire a property manager to do it. Otherwise, you’ll likely be the one waking up at midnight to fix a toilet or a faucet that doesn’t work.
2. Turnkey Rental Properties
Another method for creating passive real estate income is through turnkey rental properties. This involves purchasing recently renovated property with newly completed large maintenance projects so that units are immediately available for rent or lease.
Typically, you’ll purchase these properties through a turnkey provider, which will guide you through every step of the process, including:
- Locating an opportunity
- Evaluating financing options
- Managing the property
However, no investment is without risk and this one is no exception. You’re still going to be at the mercy of constantly fluid market conditions that could cause losses. Even so, finance professionals think of turnkey rental properties as one of the safer ways to build wealth. That said, getting started requires significant assets because you’re purchasing a revenue-generating property that has a chance to appreciate over time.
3. Real Estate Notes
When you borrow money to buy a property, you’ll have to pay a mortgage. This arrangement comes with a document known as a “mortgage note,” which defines your relationship with the bank and the payments you must make. It also breaks down what happens if you don’t pay, i.e., the bank can take your house.
Financial institutions and individuals alike can buy and sell mortgage notes. Typically, when a bank no longer wants a note, it can sell it to investors. If you buy one, you become the lender. This entitles you to payments from the borrowers, resulting in passive income.
While this all may sound great, understand that there’s still plenty of risk. Banks only want to offload notes if there’s a reason to do so. In most cases, it’s because a homeowner stopped making payments. It may also be because they’re going out of business; however, this is less common.
To gain the highest returns, you’ll want the homeowner to make payments throughout the loan. If they default on the loan, you can take steps to foreclose the house. Or, if they prepay the amount they owe, they’ll have to pay penalties (the exact amounts depend on the state).
4. Property Tax Liens
When a homeowner, landowner, or business fails to pay taxes to the city or county, the municipality places a lien on the property until the funds are paid. A tax lien certificate is issued with the amount owed, interest, and any fees. Then, the local government auctions the certificates to the highest bidder. Whoever wins the auction must pay the full amount owed, including interest and fees.
After you buy a tax lien certificate, you still won’t have control of the property. However, you can attempt to foreclose the home or receive payment if the owner pays their taxes. In the case where they take care of their bill, you’ll receive your initial investment, plus any interest (this works much like a bond).
Like all opportunities, this one isn’t without risk and has its own, unique pitfalls. It can take plenty of work to be successful through this method. For instance, if you have to foreclose on a house, you’ll have to go through that process and ensure you do so promptly. Otherwise, you could lose your investment. You may also have to rehab properties you seize, which reduces your overall returns.
For the reasons above, investing in tax liens may not be right for you unless you have experience. It requires significant research and has a variety of ongoing tasks that could be more effort than what most people are looking for. Another option if you’re still interested is to buy tax liens through institutional investors and let their experts do all of the heavy lifting.
5. Real Estate Investment Trusts (REITs)
Some of the most common (and popular) passive real estate investments are REITs. These are companies you can purchase shares of that buy, operate, and sell income-generating properties. As a mutual fund does with stocks, a REIT combines funds from multiple investors to build a large portfolio of properties.
A REIT buys properties, typically commercial, to create regular income for its investors. If you own shares of one, you’ll receive consistent dividends. For this reason, these are a great way to add passive income to your portfolio.
As with any other investment, there are some negatives to REITs that you should consider. First, dividends are taxable as ordinary income or capital gains. You’re also at the mercy of the constantly changing real estate market, which makes it easier to buy at the wrong time if you’re not careful.
A popular way to invest in real estate passively today is by crowdfunding. With this strategy, a group of people contribute to a fund which is then put toward buying properties. It can be a smart way to get into the industry without needing to put forth much capital.
Keep in mind that this method doesn’t necessarily create huge returns. It acts more as a way to diversify your investment portfolio. It also creates passive income by paying out dividends.
But, much like other real estate investments, you should be aware of the downsides. Typically, you’ll need to pay management or advisory fees to those who buy the properties. And like with REITs, dividends are taxable. Crowdfunded projects also don’t provide much liquidity.
Much like crowdfunding, participating in a syndicate is another way to join another group of investors to buy real estate. This method allows you to pool your money and receive equity in a large commercial property.
Investing using syndication has a much higher barrier to entry than other strategies in this article. The U.S. Securities and Exchange Commission (SEC) requires you to be an “accredited investor” to participate. As an individual, you must have made at least $200,000 annually over the last two years, as well as have a $1M net worth, not including your primary residence. Couples must meet the same net worth requirement, plus make at least $300,000 total in the last two years.
Of course, there are some downsides to think about. In general, real estate is an illiquid investment, with this type being no different. And, if you’re just the sponsor (person putting up the capital) on the deal, you don’t have much control over how it turns out. Finally, it can be hard to predict when or if you’ll receive regular passive income from a property.
Frequently Asked Questions
How do I get started in passive property investment?
Before you invest in any type of real estate, you’ll want to make sure you have a plan in place. It’s important to pick the right strategy, as committing to the wrong one can get you nowhere at best or lose you a ton of money at worst. Because of this, we recommend speaking with a financial advisor before spending any money to build your portfolio. This way, you’ll have a better idea of which assets fit into your portfolio.
You can find an advisor near you by taking a short matching quiz. After filling it out, it’ll connect you with up to three professionals near you. Then, you can set up a meeting and get started on building a comprehensive investing strategy.
Which passive strategy is the best?
Because there are many factors at play, it’s hard to pin down a straightforward answer here. Before selecting a strategy, you’ll want to consider your experience level, capital available, and risk tolerance. For instance, if you’re looking for a lower-risk investment that doesn’t require much money upfront, a REIT might be smart. But if you’re working with a high budget, buying rental properties allows you to create more income at a faster rate.
Can I live off of passive income from real estate?
It’s possible to accomplish this if you’re making enough to cover your monthly and annual expenses. However, it’s not necessarily the best idea to try and live off of one asset class because if it goes down significantly, you could be in trouble. A well-rounded portfolio should feature plenty of diversification so that you’re protected from changing market conditions.
Do I have to pay taxes on income from real estate investments?
Yes, you must pay taxes if you receive payments from real estate investments. Typically, dividends from securities like REITs or crowdfunded properties count as ordinary or capital gains income. However, if you own shares of a REIT in a Roth IRA, earnings won’t be subject to taxes.
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