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3 Key Lessons for Avoiding The Dark Side of Passive Income

by Michael Blank on February 24, 2014 · 17 comments

  
Lessons in Passive Income

When I first read the book “Rich Dad Poor Dad,” it changed my financial goals drastically.  I went from trying to build up a nest egg for retirement to pursuing passive income. To this day, I believe that it is a worth while effort, and I continue to make that my financial goal.

We know that once passive income equals our living expenses, we are financially independent. At that point, we can quit our J.O.B. and do the things we really want. Even if it takes ten years to achieve, it’s worth it.

Passive Income. It’s what we want. It’s good.

But no one ever told me there is a dark side to passive income.

Here are some lessons learned over the years.

Related: The Flywheel Effect: Building Your Business into a Passive Income Machine

Lesson # 1: Don’t Become Complacent

I got into the restaurant business as a way to launch my passive income career. After opening several pizza restaurants and hiring someone to run the restaurants for me, things stabilized. I met with my operator over lunch once per week to review the numbers and discuss opportunities and challenges.

Weeks went by, then months and, eventually, several years.

If you’re familiar with the short story “Who Moved My Cheese,” then I’d say I had grown quite accustomed to my daily cheese and came to expect it. I didn’t realize that the cheese was getting old and smelly, and that it was slowly dwindling.

The income of the businesses slowly declined year over year. I didn’t realize it until one day we bounced two checks in two weeks. We were having cash flow issues.

This rattled my cage pretty significantly and forced me to get more involved in the restaurants.

The lesson here is: don’t get complacent with your passive income investment!

There is a parallel lesson in the apartment investing world… While you should always strive to have a property manager run your properties, don’t become that absentee landlord. Make sure you interact with your property manager regularly, ask for reports, ask questions, and keep him accountable.

In other words, stay involved.

Lesson # 2: Don’t invest in anything you’re afraid to run yourself

The other dark side of passive income is that you shouldn’t invest in anything you’re not willing to run if necessary.

In my case with the restaurants, I eventually parted ways with my operator. I knew it was the right thing to do, but I also knew I would have a full-time job running the restaurants.

I was depressed for weeks. I DIDN’T SIGN UP FOR THIS!!! It was supposed to be a passive income investment!

I have another investor friend of mine who funded an enthusiastic entrepreneur’s vision of a coffee house. When the entrepreneur defaulted on the note, my friend was suddenly the proud owner of a flailing coffee house. He did what he had to do to liquidate the business. It was certainly not what he signed up for either!

One of my mentors funded an e-commerce business which was highly profitable. But when the owner defaulted on his payments, my mentor took over the site and now runs it himself. My mentor was smarter, though, because he knew this rule of passive income: he wasn’t afraid of running the investment if he had to. In fact, he’s actually having some fun with it.

Don’t invest in anything you’re afraid to run one day.

Related: The Truth About Active Income vs. Passive Income

Lesson # 3: There is no such thing as TRUE Passive Income

Unless you’re investing in savings bonds and CDs, there is no such thing as passive income. Or, at least, you should not treat anything as true passive income because that means you’re becoming complacent.

And complacency is the down fall of every successful entrepreneur. It is to success as good is to great.

I think it’s all about setting the proper expectations. Expect to be active enough with your investments and they will take care of you for a very long time.

I would LOVE to hear your stories about your experience with passive income! Comment below and let’s discuss…

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{ 17 comments… read them below or add one }

kris February 24, 2014 at 10:04 am

NNN Passive income, such as Walgreens can last 75 yrs!!!

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Michael Blank February 25, 2014 at 2:49 pm

That’s the kind of passive income I dream about for sure!

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kris February 25, 2014 at 6:02 pm

Bad news is income is same for 75 yrs??!!! They guarantee first 25 yrs.

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Simon A. February 27, 2014 at 11:33 am

My clients have had much success in other types of Single Tenant NNN properties (not Walgreens, but mostly restaurants). These are pretty much truly passive income, and typically have built in rent increases to hedge against inflation.

Kevin Yeats February 24, 2014 at 10:19 am

Complacency and lack of understanding are first cousins.

People invest in bank CDs because there is not much to understand. I deposit $10,000 with Big Bank and Big Bank promises to pay it back with a predetermined amount of interest in one year. I really don’t care about how the bank uses the money that I just deposited because of those four letters on the front door to the bank – FDIC. Beyond bank CDs and investor needs to know how the borrower will use the money in order to engage the risk of making the investment.

There is a big difference between a borrower who will take the money and buy inventory or equipment versus someone who wants to invest in lottery tickets.

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Adam Roberts February 24, 2014 at 11:13 am

I enjoyed the article, Michael -

A lot of folks are favoring owner-financed deals (on the sell side) in lieu of renting their properties as there is just a bit less management involved. It’s not totally hands-off as you may end up foreclosing on the buyer, etc, however there does seem to be less management involved.

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Michael Blank February 25, 2014 at 2:53 pm

Owner financing is great … MOST of the time, if things go as planned. With anything you owner finance – it’s pretty much hands off until there’s a default situation, and then the fun begins. A good compromise might be to stay in touch periodically with the borrower to see how they’re doing so that a bad situation doesn’t catch you by surprise. Again, another example where complacency could rear its ugly head and could be averted with a little bit of pro-activity.

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Alison February 24, 2014 at 11:36 am

Hi Michael, good article and I agree 100%. As you know I invested in a self storage facility in 2012 with 3 partners. I actually did run the business remotely – I’m in DC and it’s in Atlanta – for 2 months before we got a property management company in place. Whew! I thought, back to my regular residential rehab business which had taken quite a hit during the acquisition and early days of the self storage deal.

Fast forward to May 2013 and suddenly our management company is sucking air, so we have to cut and run. Back to the drawing board – interviewing and hiring a new management company, which came on board in September 2013.

The last 5 months have been much smoother but I learned on the front end of my passive income career that no matter what your guru, mentor, or partner tell you you MUST stay engaged and keep your eye on these passive investments.

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Michael Blank February 25, 2014 at 2:54 pm

The quality of your property manager is key. I just replaced mine in November. The transition was quite a bit of work, but my experience with this apartment building is LIKE NIGHT AND DAY. I think I’ve reduced my work load from 6 hours per week before to like 1 hour with the new property manager.

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Sara Cunningham February 25, 2014 at 2:42 am

Hi Michael good article to make us remember we can never just sit back and do nothing. When we started investing we ran everything ourselves and it was really hard work with full time jobs. However we now live in Europe so were forced to hire 2 property management companies to take care of all the every day stuff. It’s still requires work though. I am constantly having to call email asking for reports and updates and to make sure they are taking care of any maintenance issues, filling vacancies etc. that alone keeps me on my toes.

To comment on what Adam said about owner finance deals we also have 4 of these which we deal with directly. Yes they require less work since the lessee do maintenance etc but there are sometimes problems with city violations or them not paying on time so they too can’t be totally ignored.

I like to feel connected to my investments so I know exactly what is going on. I would never leave it all to a third party it’s my money not theirs. If I did then I can only blame myself when things start going wrong. I know it’s easier when you don’t have hundreds of properties but that’s what keeps me focused knowing that I won’t ever take on more than I handle personally if I have too.

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Michael Blank February 25, 2014 at 2:55 pm

That is an excellent mindset right from the start! Sometimes I need to learn stuff the hard way -;)

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Walt Payne February 25, 2014 at 11:37 am

Good article, thanks for the reminders.

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Dayna February 25, 2014 at 2:46 pm

“Once passive income equals our living expenses, we are financially independent” — this is the dream, right? But you are right, just as with most things in life, we must pay attention and not make assumptions. Make sure, periodically, that what we believe to be true about our investment is still true. :)

thanks for the post!
Dayna – http://www.flipt.co

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Chuck February 27, 2014 at 9:17 am

Good article. For some reason I thought this was going to be about taxes.

I’m still very depressed that ZERO of my passive losses (since 2009?) are deductible because my wife and I are “rich.” Our combined AGI is literally $3K above the $150K threshold. Very much middle class in the Los Angeles area. :(

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luis February 27, 2014 at 9:48 am

Great article. I’ve had the experience of becoming complacent and taking a long layoff. I had to whip myself back into shape.

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Michael Bushey March 1, 2014 at 1:26 pm

This was really helpful for me to hear as a beginner looking to build passive income. I need to keep in mind that passive income isn’t truly passive and I need to work at it. Thanks for helping me set my expectations accurately.

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IJ March 4, 2014 at 9:37 am

Thanks for sharing your wisdom. It will help me stay active.

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