If you are following my FIRE Journey, you would have noticed the last few months have been around setting up passive income from real estate investments for me. I have given one property on rent and am getting another property which can generate a decent rental income, whilst appreciating in value. Let’s look at why it is worthwhile to focus on real estate investments for passive income.
Most of us make a living based on our everyday work. Our earning gets halted when we stop doing so. Passive income, here, acts as a rescuer where you don’t have to work actively to make an earning. Passive income is a great way to supplement your current income. This is where the money works for you and that is the best way to achieve financial freedom. And among diverse passive income options, real estate has proven to be a great investment opportunity for investors to increase their earning streams.
Real Estate Investment
In real estate, investors can directly invest by purchasing a home, rental property, or other property, or indirectly through REITS. It gives you four distinct benefits:
- It can help you to diversify your existing portfolio
- It helps build an additional income stream
- Helps you safeguard your portfolio against inflation
- Capture the steep appreciation in value that is unique to real estate
Handling paperwork and legal documentation, maintaining the property and the tenants require you to be directly involved all the time. If you don’t want to actively manage properties, there are multiple ways to do so and still create an income source.
Let’s first look at the newer and non-traditional real estate investment options that generate passive income, before looking at rental properties.
Real Estate Investment Trusts(REITs)
Real estate investment trusts are the companies that own, manage, and operate the portfolios of high-valued real estate properties and mortgages to generate incomes.
One advantage is, both big and small investors can park their funds into the investment option and reap benefits accordingly. REITs brings on the opportunity for the investors to own high-priced real estate along with dividend incomes that boost their capital.
To qualify as a REITs, a company must fulfil certain provisions in the (IRC) :
- The company needs to have income-generating real estate for the long term and distribute income-generating real estate for the long term and distribute income to shareholders.
- Derive at least 75% of gross income from rents, interest on mortgages that finance the real property, or real estate sales
- Payment of a minimum of 90% of taxable income in the form of shareholder dividends every year is required.
- Be an entity that’s taxable as a corporation.
- Be managed by a board of trustees.
- Have no more than 50% of its shares held by five or fewer individuals
Types of REITs
The following is a list of different types of REITs.
This is the most common type of REITs known as equity REITs, which own and manage income-producing real estate. Primarily revenue is generated through rent rather than reselling properties.
Mortgage REITs give financial support to real estates by giving mortgages and mortgage-backed securities (MBS). These fetch them income from the interest generated.
mREITs rely on a variety of funding source that includes common and preferential equity, repurchase agreements, structured financing, debts and other credit facilities. REITs raise both debt and equity in the public capital markets.
Hybrid REITs own properties and mortgage loans, i.e. a mix of both types of REITs. Such REITs intend to get the benefits of both with less risk than if it invested in one or the other. Hence, diversification pays.
Publicly Traded REITs
Publicly traded REITs are traded on an exchange like stocks and ETFs and hence they are easily available to investors. You can purchase them using an ordinary brokerage account.
Investors can easily access the performance of shares of publicly-traded REITs. The information is given by the company and independent firm that owns, deals or actively analyze REITs. Recent success of Embassy REIT is an example of this.
Publicly Non-traded REITs
Non-traded REITs are not listed on public exchanges, hence they can provide the investors access to an unavailable list of real estate investment. They are mainly designed to reduce or eliminate tax implementation along with real estate benefits. These REITs doesn’t trade on securities, and hence they are quite illiquid for a long period of time.
Real Estate Syndication
Real estate syndication is the formation of partnerships between several investors to combine their capital and resources for investment. This aids in purchasing a property that wouldn’t be possible without collaboration. Previously, only the richest and well-connected investors could get into real estate syndications.
How to invest in real estate syndication
Real estate syndication involves a syndicator and investor. The syndicator has the responsibility to find, acquire and manage the real estate. They have a history of real estate experience and the ability to underwrite and do due diligence on real estate. The other party is the investors. They get all the benefits of property ownership, but they are not involved with acquiring the property, arranging to finance (if there is a loan on the property), and doing day-to-day management.
The investors are limited partners or simply members. The real job is for the real estate licensee who can convert the trade into a profitable return for both the licensee and the investors.
By pooling limited financial resources with other investors, small scale investors get the chance to won or operate a property that otherwise would be very difficult to deal with. It also offers expert management which is usually very expensive in other cases.
Real Estate Crowdfunding
Real estate crowdfunding is a way of raising money for real estate investment. Crowdfunding is done in order to raise a high volume of investment by bringing in multiple investors. This method helps in rising a large sum of money in a short period of time.
Crowdfunding pools money together so that small and mid-sized could use the funds to invest in the company. Equity crowdfunding was only open to accredited investors that included banks, pension plans, insurance companies as well as affluent investors.
Benefits of investing in crowdfunding
A sponsor usually doesn’t have a large amount of money to invest in big real estates. Hence, they allow individuals to invest in the project for execution. Profit earned are given to investors based on terms. It allows investors to invest in specific projects and maintains transparency. It eliminates the hassle of maintaining and managing the assets for the investors.
Evaluating crowdfunding investments is important as they are highly illiquid. Unlike when you own a property by yourself you can’t sell whenever you want.
Rental property are the most traditional source of passive income. It does require effort from the owner’s side to manage and run the rental property. It will take some effort in the beginning, so it is not completely passive. But it will provide a monthly income without you having to participate in any sort of daily work.
How to invest in rental property?
In order to invest in rental property, always look for the right location. Every location has some requirement. Based on that choose your option of renting. Homes in areas with good school and reputation and locality get better appreciation than low-priced properties. Rentals that have close transportation facilities and markets are very popular among renters.
Get a property that is visually attractive and ready to move-in. This will allow you to start earning income from the property ASAP. You should generally avoid properties that require huge redesigning or fixing when you are renting out.
If you are unable to manage the property by yourself then assign a property agent who will manage everything and will deal with tenants day-to-day complaints. This might come at a price but it will at least take the stress off your shoulder.
Things to keep in mind when invest in rental property?
Never buy a property having previous debts. Also, keep a fully-funded emergency fund. This will be helpful in case of any unpredictable events like repairs, missed rents, or vacancies.
When purchasing the property, employ a credible law firm to validate the documents and verify ownership. This might cost anywhere between Rs.3000 to Rs.25,000. But it is well worth the money as it prevents a lot of hassle in the future.
Be a great landlord
When you have your tenants moved in, the only thing you have left is to be a great landlord. Make clear about the rent and timely payment. Also, respond to maintenance requests quickly. Keep a friendly relationship with your tenant that will also help your reputation and future availability of tenants.
Real estate can be a huge source of income stream. Some of these passive incomes can also turn into full-time job depending on the interest and management skills of the investors. If done righlty, you can easily get financial freedom at an early stage.