3 Realistic Ways to Make Passive Income in Real Estate

3 Realistic Ways to Make Passive Income in Real Estate

Passive earnings have transformed into a significant trend. The attraction of receiving consistent earnings without direct involvement in active work holds greater appeal today.

One of the most prevalent methods to establish a stream of passive income is by engaging in real estate — at least theoretically.

The procedure follows a general pattern: You secure a loan from a bank, acquire a property, and the tenant covers not only your mortgage but also generates surplus. As your equity grows, you replicate the sequence, acquire additional properties, expand your endeavors … and just like that! You find yourself as a real estate magnate. But the reality is different.

What about a property manager?

If you aspire to become a landlord, your responsibilities would encompass locating dependable tenants, collecting rent, and addressing maintenance and repair needs (which might come out of your own finances).

While an adept property manager can simplify matters, financial authority Dave Ramsey highlights that the earnings aren’t genuinely as hands-off as they might appear.

“Even when you’re overseeing the management company, they’ll still reach out to you for approval on expenditures like the unexpected $8,400 HVAC system replacement or just the other day, we had a $26,000 issue with one of our commercial properties,” he mentions in an episode of The Ramsey Show. “It didn’t feel passive to me in the slightest.”

Ramsey still holds a favorable view of real estate as an investment category but cautions that potential investors should be fully aware of the commitments involved.

“I’m quite fond of real estate. It does offer a superior rate of return that other investments struggle to match, but when someone talks about passive income and real estate in the same breath, it typically means they’ve fallen for get-rich-quick schemes.”

So, what strategies can you adopt to invest in real estate while minimizing the associated hassles? Here are three approaches to contemplate.

REITs

REITs, an abbreviation for real estate investment trusts, are enterprises that possess income-generating real estate assets such as apartment complexes, shopping centers, and office skyscrapers.

Visualize a REIT as a colossal landlord: It holds a considerable portfolio of properties, collects rental income from lessees, and channels that income to shareholders in the shape of regular dividend disbursements.

To qualify as a REIT, a corporation must distribute a minimum of 90% of its taxable earnings to shareholders in the form of dividends each year. In return, REITs enjoy a reduced or even zero income tax liability at the corporate level.

Naturally, REITs can encounter challenging periods. During the recession spurred by the pandemic in early 2020, certain REITs trimmed their dividend payouts, and their stock values also plunged in the market downturn.

Conversely, a few REITs manage to sustain consistent dividends regardless of market conditions. Take Realty Income (O), for instance, which issues dividends monthly and has executed 118 dividend increments since its initial public offering in 1994.

Investing in REITs is straightforward due to their status as publicly traded entities.

In contrast to the protracted timelines involved in purchasing a house—where transactions could extend over weeks or even months—investors can buy or sell REIT shares at any point during the trading day. This liquidity renders REITs one of the most flexible alternatives for real estate investment.

Real estate ETFs

Selecting the appropriate REIT or crowdfunding opportunity necessitates thorough research on your end. If you’re seeking a more convenient and diversified method to invest in real estate, consider turning your attention to exchange-traded funds (ETFs).

Picture an ETF as a compilation of stocks. As the name implies, ETFs are traded on major stock exchanges, offering ease in buying and selling.

Investors utilize ETFs to access a diversified array of holdings. You’re relieved of the task of handpicking individual stocks for purchase and sale. Certain ETFs passively mirror an index, while others are actively managed. In exchange for their management services, all ETFs incur a fee known as the management expense ratio.

For instance, the Vanguard Real Estate ETF (VNQ) extends comprehensive exposure to U.S. REITs. This fund encompasses 167 stocks, boasting a total net asset value of $63.2 billion. Over the past decade, VNQ has yielded an average annual return of 6.41%. Its management expense ratio stands at 0.12%.

An alternative option is the Real Estate Select Sector SPDR Fund (XLRE), which seeks to replicate the real estate sector within the S&P 500 Index. Presently holding 30 assets, it bears an expense ratio of 0.10%. Since its inception in October 2015, this fund has achieved an average annual return of 6.56% before taxes.

Both of these ETFs distribute dividends on a quarterly basis.

Crowdfunding platforms

Crowdfunding involves the strategy of funding a project through gathering small sums of money from a large multitude of individuals.

In the present era, numerous crowdfunding investment platforms extend the opportunity to hold a portion of tangible real estate assets — spanning from rental residences to commercial edifices and parcels of land.

Certain alternatives are tailored for accredited investors, often involving higher minimum investments that could stretch into tens of thousands of dollars.

To qualify as an accredited investor, you must possess a net worth surpassing $1 million or have earned an income exceeding $200,000 (or $300,000 jointly with a spouse) over the past two years.

For non-accredited investors, several platforms permit investments even with modest amounts — as little as $100 in some cases.

These platforms enhance the accessibility of real estate investment to the general populace by simplifying procedures and minimizing entry barriers.

Certain crowdfunding platforms additionally aggregate funds from investors to sponsor development projects. Such ventures typically necessitate more extended commitments from investors and present distinct risk-reward profiles in comparison to purchasing shares in established, income-generating rental properties.

For instance, a development endeavor could experience delays, postponing expected rental income.

Sponsors of crowdfunded real estate initiatives commonly impose fees on investors, generally ranging from 0.5% to 2.5% of your invested amount.