Passive income is the holy grail of personal finance and investing.
With enough passive income, working becomes optional because you can pay your bills with the income from your investments. It’s a state called financial independence, and most people don’t reach it until they retire.
The classic sources of passive income are bonds and dividends from stocks. And sure enough, as workers get closer to retirement, most financial advisors recommend they shift their asset allocation to emphasize income-oriented investments like bonds and dividend-paying stocks and funds.
But too many investors ignore real estate as a potent asset class for passive income.
Sources of Income From Real Estate
Real estate is not only an income-oriented investment, it’s also a less volatile asset class than stocks. So even as investors create multiple streams of passive income from real estate, they can also reduce risk in their portfolio without sacrificing returns.
Here are 10 ways you can invest in real estate to start diversifying your passive income immediately.
When most investors think of diversifying into real estate, they jump straight to real estate investing trusts (REITs) — and for good reason.
You can buy REITs easily through your regular brokerage account, IRA, 401(k), or other retirement account. Because they’re publicly traded, they’re regulated by the SEC and required to provide a wealth of information to help you make informed investing decisions. They offer high liquidity, allowing you to buy and sell instantly. And they make diversification easy, as you can spread your investments among hundreds or even thousands of properties and real estate projects across the world.
Real estate investing trusts typically come in two varieties: equity REITs and mortgage REITs (mREITs). Equity REITs invest directly in properties, while mREITs lend money secured by real estate.
One unique characteristic of REITs is that under SEC rules, they must pay out at least 90% of their profits in the form of dividends. So investors can expect particularly high dividend yields from REITs compared with typical stocks or funds.
The downside of this rule is that REITs have difficulty growing their portfolios when so much of their revenue must go to shareholders. It means REITs often don’t see the same growth in share prices that many stock indexes do.
2. Real Estate Crowdfunding
A more recent entry into the world of real estate investments, crowdfunding offers another way to indirectly invest in real estate.
While many crowdfunding websites still only accept money from accredited investors, these services have increasingly opened their doors to middle-class investors. That means investors can get started with less than $1,000 and invest like their wealthier counterparts.
These websites’ investing models differ. Some buy properties directly and allow investors to invest money in pooled funds similar to publicly traded REITs. Others lend money against real estate like mREITs. Some, like Fundrise, do both and allow investments as low as $500.
Among those that lend money, crowdfunding websites take two distinct approaches to accepting investments. One is the classic pooled fund model, where you invest whatever you like toward the fund and get the same return as everyone else. The other allows you to pick the individual loans you want to fund, which adds a more personal and participatory dimension to your real estate investment.
Check out Groundfloor as a good example of a crowdfunding website that lets you pick your property investments. It allows investments as low as $10, making it easy for anyone to invest and diversify their investments among many properties.
As a final thought, keep in mind that these crowdfunding websites pay out returns differently. Many pooled funds, like Fundrise, pay quarterly dividends. But when you pick and choose investments, you typically earn your return only when the loan reaches maturity (usually a one-year term).
3. Rental Properties
Owning rental properties directly comes with its own unique advantages and disadvantages.
When you buy a rental property, you can predict the cash flow, or ROI, with great accuracy. You know the price you’re paying, you know the market rent, and you can forecast the long-term average of your expenses, such as annual repair costs, vacancy rates, property taxes, property management fees, and insurance.
Not many investments offer such predictable returns. When you can predict the return of any given property, you can buy nothing but good investments.
You also control the investment. You choose the property, the tenants, the management practices. You can invest money into property upgrades to raise revenues. When was the last time the CEO of a stock you owned called you up and offered you control over the company’s management?
Then there are the tax benefits of owning real estate. You can write off everything from mortgage interest to property management costs to insurance. And you can keep going by writing off paper expenses like depreciation that you never spent a dime on.
For all those perks, rental properties come with several downsides. They’re notoriously illiquid. Like any direct real estate purchase, they cost a great deal of money and time to sell.
They also require a hefty chunk of change to buy, even if you finance them. When it costs tens of thousands of dollars in closing costs and a down payment to buy one single asset, it makes it difficult to diversify.
And then there are the issues that come with landlording. Unless you hire a property manager, get ready for the 3am phone calls from tenants complaining about the neighbors or asking you to change a lightbulb for them.
Pro tip: If you’re interested in purchasing a turnkey rental property, look no further than Roofstock. Not only has Roofstock completed over $2 billion worth of transactions, but they also provide you with a guarantee that you’ll have a signed lease with tenants within 45 days or they will cover 75% of the market rent value for up to 12 months. Sign up for Roofstock today.
4. House Hacking
No one says you can’t live in your own rental property.
The idea behind house hacking is simple: You bring in other people to pay your mortgage for you. In the classic model, you buy a multifamily property, move into one unit, and rent out the neighboring unit or units. You neighbor-tenants pay your mortgage for you, and you live there for free.
But if multifamily housing doesn’t appeal to you, there are plenty of strategies to house hack single-family homes as well. From roommates to accessory dwelling units to foreign exchange students and beyond, you have plenty of ways to turn your home into a source of income.
You can even use Airbnb to house hack by periodically using your home as a vacation rental for guests (more on that below).
5. Airbnb/Vacation Rentals
While you can use a rental property as either a long-term rental or a short-term vacation rental through Airbnb, the business model for each varies significantly.
Short-term rental properties require much more work, from cleaning units between guests to marketing to coordinating entry and ongoing communication with guests. In essence, you’re running a hospitality business.
For your trouble, you can earn strong profits and get a vacation property you can periodically use yourself. But you have to have the right mindset for it.
Where so many new investors run into trouble is accurately forecasting expenses and returns. Many underestimate vacancy rates, the impact of seasonality, and the costs (in both time and money) of management.
Be sure to triple-check your numbers before investing in a short-term rental property and to thoroughly understand the business obligations involved. Make no mistake: You are starting a hospitality business, even if you only have one vacation rental property.
Wholesaling properties is often misunderstood by people new to the world of real estate investing.
It involves finding a great deal, putting it under contract, and then selling that contract to another investor with a profit margin. You never take title to the property; you merely connect an eager seller with a willing real estate investor.
For example, say you find a property worth $150,000 and you get it under contract for $110,000. You reach out to your network of investors and offer them the property for $125,000. When you find a taker, you assign the contract to them.
The investor gets an $150,000 property for $125,000, and you get a $15,000 fee — all without having to hassle with financing, closing costs, renovations, tenants, or real estate agents.
Sound too good to be true? It’s not. Finding deals this good takes a lot of work, and so does building a network of real estate investors who trust you not to sell them bad deals. And then there’s the risk of failing to find a buyer, which leaves you stuck between breaking your contract or buying the property yourself.
Still, it offers a great side gig to earn money while you learn some of the fundamentals of real estate investing before you’re ready to start buying properties yourself.
7. Flipping Houses
Most of the options on this list involve creating passive income streams from real estate. Wholesaling and flipping houses are the exceptions.
Flipping properties requires a ton of work on your part, but in return, you can expect extraordinarily high cash-on-cash returns. And as with rental returns, experienced investors can predict these returns accurately.
While the calculation is different, the fundamental challenge is the same: accurately forecast your costs and revenue. In this case, the revenue number is simply the after-repair value (ARV), or the price you can get for the property after renovating it. This is simple but easy to overestimate, as real estate values fall within a range of market values.
The costs aren’t much more complicated. You know your purchase price and closing costs, so all you need to forecast are your renovation and carrying costs. Where new flippers get into trouble is underestimating these costs and failing to budget a buffer for unexpected repairs.
Still, it makes for an easy calculation if you know what you’re doing. Consider a quick example: You buy a property for $100,000 and put $40,000 into renovating it. Between both rounds of closing costs and your carrying costs, you spend another $25,000. You sell the property for $200,000, earning a $35,000 profit.
That’s if you pay cash. If you finance 80% of the purchase and 100% of the repairs, you only need to come up with a $20,000 down payment, plus closing and carrying costs. Even if you add an extra $5,000 to those closing and carrying costs to account for lender fees and interest, you still earn a $30,000 profit on a $50,000 investment.
That’s a 60% cash-on-cash return on investment. That may sound unbelievable until you take into account the headaches and work it takes to oversee the deal.
8. Syndications and Silent Partnerships
In real estate syndications and silent partnerships, you put up money but don’t actually do any of the work of finding deals or managing properties. Instead, the principal partner or “sponsor” does the work and gets an extra cut of the profits for their trouble.
Syndications typically involve large commercial properties. The sponsor finds a good deal, then raises money from investors to fund it. As part of the deal, the investors surrender all decision-making power and oversight to the sponsor.
For that reason, syndications would fall under SEC scrutiny — if they opened investment to the public. So they almost never do, instead only allowing accredited investors to participate.
The rest of us non-accredited investors can instead invest money as silent partners with friends, family members, and other people we know personally. If your brother-in-law flips properties on the side of his full-time job, you can form your own LLC with him with whatever rules you like.
But entering a silent partnership does require you to know and trust the real estate investor. Otherwise, don’t expect to sleep soundly at night with few safeguards in place to protect your money.
9. Private Notes
Instead of going in as a silent partner with a real estate-minded friend or family member, you could just lend them money.
It offers you even fewer protections, since your name isn’t on the deed with them. But it also means no liability and no obligations whatsoever.
Besides, many real estate investors don’t want a partner to split the profits with; they just want financing.
Once again, it requires you to actually know and trust the real estate investor you’re bankrolling. If you don’t happen to have a real estate prodigy in the family, don’t despair. You can always start networking with real estate investors to build those relationships and find investors with a strong track record of success. Being shy is no excuse. Brush up on networking tips for introverts.
I invest money with real estate investors I know and earn between 10% to 12% on my money. But if they default, my only recourse would be to sue them, win a judgment, then try to collect it.
Once again, it all comes down to trust.
10. Opportunity Zone Funds
At the obscure end of the real estate investing spectrum lie Opportunity Zone Funds.
These funds were introduced by the Tax Cuts and Jobs Act of 2017, which specified roughly 8,700 Qualified Opportunity Zones to target for economic stimulation. The idea is simple: encourage investment in struggling areas by offering tax breaks to invest money in them.
Opportunity Zone Funds are private equity funds. An experienced commercial real estate investor raises money from accredited investors, then uses the money to buy real estate in Qualified Opportunity Zones. Because these zones are impoverished, it raises the risk of investing in them. In return for that heightened risk, investors get preferential tax treatment, including deferral of some or all capital gains tax through 2026.
Only accredited investors qualify, and besides, the tax breaks only really justify the higher risk for wealthy investors with higher tax liability. Mom-and-pop investors need not apply.
There are plenty of ways to create income streams with real estate. Some are completely passive, such as REITs and crowdfunding investments. Others require minor labor on your part, such as rental properties. And a few, like flipping houses, are labor-intensive but lucrative.
Anyone who hopes to live a long life needs a plan to replace the income from their job. You can’t work forever, and even if you could, you probably don’t want to. If you design your perfect life, it may not involve work at all.
If you want to reach financial independence and retire early, you need multiple sources of income. And real estate offers a range of options, regardless of your current wealth, to create passive income streams and gradually replace the income from your 9-to-5 job.
Have you ever invested in real estate, whether directly or indirectly? How do you plan to create multiple income streams from real estate moving forward?