Originally Posted February 2017
Edited April 2024
Investing for Beginners: 5 Reasons to Consider Passive Income Investing
Many people conflate the concepts of real estate investing and passive income. Real estate can be a form of passive investing, but often not in the ways that investors think. Passive real estate investing can be one of the most powerful ways to make your money work for you. But before we discuss the specific benefits of passive real estate investing, we need to clarify what this type of investing is — and, just as important, to explain how and why it is different from active real estate investing.
Many people envision buying and renting out a piece of residential property — a single-family home, condominium unit or apartment complex, for example — as passive real estate investing. They view this as passive income because, as they imagine the investment playing out, they will simply buy a piece of property, rent it out, and then collect checks every month from the tenants. But this is not passive real estate investing.
At a minimum, the investor in this scenario must select the property to purchase, and then work with a property management company to make regular decisions about such matters as which tenants to accept, whether to fix or replace a broken water heater and when to re-carpet or paint the property. If the investor chooses not to outsource these operational tasks to a property management company, they will have to manage the day-to-day responsibilities of owning the property themselves. This is active real estate investing.
So, what does passive income mean, and what is passive real estate investing?
What is a Passive Income Investment?
Passive income typically refers to an income stream that is somewhat automated. You make an upfront capital investment — often in a stock or mutual fund or other equity-based vehicle — and then receive an ownership stake in that investment, from which you are paid dividends or other types of regular income.
What makes this form of income passive is that you are not directly managing the investment.
What is Passive Real Estate Investing?
Passive real estate investing, therefore, is a form of real estate investing in which you place your capital into a real estate venture that you will not have any direct responsibility for managing.
You can passively invest in real estate in several ways — such as by purchasing stock in real estate-related businesses that are publicly traded. These can include real estate development companies, large real estate brokers, or construction companies. You can also invest in Real Estate Investment Trusts (REITs), which are companies that pool investors’ capital to invest in large real estate deals.
And thanks to the advent of real estate crowdfunding, you can now also make direct investments in individual real estate deals — pooling your capital with other investors in equity or debt-based investments — while still enjoying all of the potential benefits of passive real estate investing.
When you invest in real estate through a crowdfunding platform, you have the option of finding deals, typically debt-based investments, which can pay you a fixed monthly payment over a predetermined time. You can also find investment opportunities on a crowdfunding platform that allow you to take an equity stake in the deal, where you can participate in the ongoing revenue and/or the ultimate profit of the property and reap these possible rewards when the income is distributed.
You can passively invest in real estate with several goals. For example, you can invest for the passive income — paid out to you as either regular dividends in an equity investment, or as fixed payments (with interest) in a debt-based investment. Or you can passively invest in real estate for growth — in other words, the appreciation on the properties in the investment and the profit when they are resold. You can also engage in passive real estate investing for both the ongoing income and the longer-term growth opportunity.
If you are looking for a passive income stream, real estate can be one of the best passive investment vehicles available, based on the opportunities we will explain below. For now, what is important to understand is that passive real estate investing can be a great way to add to your residual income.
What is Residual Income?
Residual income refers to the income — usually calculated monthly — that remains for an individual or a business after all debts and expenses have been paid.
How Can I Generate Additional Residual Income?
Establishing passive-income investments can be one effective way to generate additional residual income. You place your capital in a debt- or equity-structured investment — stocks, real estate, etc. — and enjoy a regular income stream from that investment. Because you make this capital investment only once, those regular payments are added directly to your residual income.
As we stated in the introduction, one powerful opportunity for creating additional residual income is through passive real estate investing. Here are five reasons this can be a powerful strategy for growing your wealth.
5 Reasons Passive Income Investing Might Be for You
You’ll Have Uncle Sam Working for You In an equity-structured investment, passive real estate allows tax-deferred cash returns that can let you keep more of your earnings.
This is one reason we stated earlier that real estate can be a more powerful passive investment than other forms of passive investing. Unlike interest payments or stock dividends, which can be taxed at your highest income bracket, the pass-through potential benefit of real estate ownership allows your share of the depreciation expense to offset your income.
You Won’t Have to Deal with Tenants, Toilets or Trash When you are a passive real estate investor, you do not deal directly with the hassles of day-to-day-management. Leaky faucet? You’re not getting a call at 2am. Broken gate? It’s not your responsibility to call the handyman.
You Won’t Have to Deal with a Bank Working with banks to obtain financing is difficult. Since the economy went south, banks have started to require even more documentation to get loans, and the process is both time-consuming and mind numbing.
When you are a passive real estate investor, your investment is tied to a professional private real estate investment company that already has relationships with select banks. They navigate the bank financing waters on your behalf so you don’t have to.
Your Passive Investment Lets You Leverage the Expertise and Experience of Others You always have the option in any investment to go it alone, whether that means investing in stocks through an online brokerage or buying your own investment property. But there is something to be said for leveraging the intelligence of the people around you.
Some real estate investors devote their lives to learning the in’s and out’s of the market, and passive real estate investing gives you the chance to benefit from their deep education.
You Can Make Money While You Sleep Passive real estate investing can be quicker than doing an active real estate investment. You do your due diligence, sign legal paperwork online and transfer funds almost immediately. And as soon as your investment is processed, you become an equity stakeholder in that real estate venture with the potential to realize passive income and/or a portion of that venture’s growth.
In other words, you have the potential to make money while you sleep. Primarily when investing in properties with existing tenants where there is existing cash-flow, your money is working for you 24/7.
What Are Some Additional Passive Income Ideas?
If you are looking for other ways to passively invest in real estate, you can research publicly traded real estate companies and public Real Estate Investment Trusts (REITs). You might also want to investigate private REITs, which are not publicly traded on any stock exchange. Be aware, however, that private REITs are also not subject to the same financial disclosure rules as public REITs or other businesses traded on public exchanges.
If you are interested in passive investment opportunities other than real estate, you can also research the many ways to invest in traditional equities such as stocks, bonds and mutual funds. With the ease of opening an online trading account, and the historically low costs now associated with buying and selling your issues, creating passive investments in the equities markets is faster and simpler than it has ever been.
It is important to keep in mind, however, that the interest you earn on stock dividends can be taxed at the highest bracket of your regular income. A passive real estate investment, however — such as an ownership stake in a series of properties that you acquire through a real estate crowdfunding company — provides you with the opportunity to realize tax benefits that work to offset your regular income.
What Are the Risks of Passive Income Investing?
Of course, real estate investing also carries risks, just as investing in any asset class does. When you invest in any passive income asset, you carry the ongoing risk of the loss of your principal, and there is no guarantee that the investment will result in any distributions of passive income in any projected amount or at all. In the case of both a stock or a REIT investment, this can result when the value of the investment goes down — either due to internal issues with the underlying asset (the company whose shares you’ve purchased or the real estate portfolio of the REIT), or due to a general downturn in the market. In either case, the value of your asset can decrease.
This is why it is so important that before you make any type of investment — whether in real estate or some other asset class, and whether active or passive — you must first do your own research. No investment can guarantee you either a return or even protection of all your principal. But your own due diligence can help you find safer and possibly more lucrative investments for your capital that are in alignment with your particular financial situation, investment experience and financial goals.