You know those moments in life when you’ve been dead set in one direction and then all of a sudden something crazy happens that changes everything?
It just happened to me.
I’ll spare you the nitty-gitty details but long story short, I had a pretty big disappointment happen recently that led me to take some time off to reevaluate everything in my life and the direction of my future.
Out of that personal reflection came the inspiration for this post, so I hope it serves you well.
What is Passive Income, Really?
I want to start off by asking some questions:
What does it mean to be a real estate “investor”?
Does it mean you are a millionaire?
Does it mean you are the owner of expensive things?
Does it mean you are powerful?
What does that word actually mean to you?
For me, I never really thought of that word until recently. I called myself a real estate “investor” but come to think of it, I haven’t really done any real investing in my life yet.
You see, my interest in real estate investing started out with a conversation I had with one of my best friends. He had jumped into full-time real estate about 6 months prior and insisted that in one transaction it was possible to make over $50,000 and at the time, that was more than I could make in a year.
I really hated my day-jobback then (I loved my employers though, I just hated the actual work itself) and I had just discovered Pat Flynn over at the SmartPassiveIncome blog and was well versed in the philosophy of the “4 Hour Workweek” and the power of passive income streams. I really wanted to figure out a way to be financially free so that I could pursue my heart in life and at the time I was depressed because I couldn’t find a means to get me there.
Then this conversation happened and it was as if I was struck by lighting! I got so full of hope and excitement -real estate was my way out! It was my way to my freedom and to my destiny!
So I quit my day job on blind-faith, leaving behind both income and benefits, believing this real estate thing was going to pan-out no matter what happened.
My wife wasn’t working at the time.
We went from income to no-income at the snap of a finger.
9 months later as I am writing this post, I am finally about to make my first check from real estate in about a week from now (Luckily my wife found a job 3 months in).
I’m living the dream right?
Not really. To be honest my day-job was way better in a lot of ways.
I’ve worked 10-15 hour days, day-in-and-day-out, sometimes going for literal weeks without a day off.
I have a ton of results out of the hard work I’ve put in, with a lot of money now pending because of it (our acquisition strategy was only going after under water properties so everything I’ve brought in for the company I work for just so happens to be in the short sale process) but was this what I signed up for in the beginning?
You see, what was described to me by my friend was the lifestyle and benefits of what I consider a true investor:
someone who makes money without having to do anything for it beyond the initial set up and who makes enough of it to pretty much do whatever they want.
Though the technical definition from Investopedia defines an investor as any person who commits capital with the expectation of financial returns in terms of the investor concept described in the Rich Dad’s Cashflow Quadrant, I have come to see a huge difference between active income investors and passive income investors and I would go on to argue that active income isn’t really investing.
Let me explain.
Is a 4-Hour Workweek Possible?
Active Income is defined as income for which services have been performed. For simplicity, if you need to be constantly working in order for your investment to turn out well, than its considered active income.
Passive Income, on the other hand, is defined as earnings an individual derives from a rental property, limited partnership or other enterprises in which he or she is not actively involved. In short, you did something with your money that now pays you returns for doing little-to-nothing.
For me, lifestyle is the ultimate measurement of success. It doesn’t boil down to numbers in a bank account or the square footage of your primary residence. It boils down to freedom and how much control you have of your time.
Now I want to be clear about what I’m saying and what I’m not saying. With the popularity of Tim Ferriss’s 4 Hour Work Week there has been a lot of confusion as to what lifestyle design is and what it isn’t. I’ve seen a lot of that confusion actually here in our community at BiggerPockets and I want to clarify somethings for you.
Tim Ferriss typically works more than 4 hours a week.
He has actually said it multiple times in countless interviews. The 4 Hour concept isn’t to eliminate work entirely.
The point of it is to free you so that you can put the majority of your work hours into things that you are passionate about and that make you come alive inside.
The “4 hour” in the title is the sum total of the dreadful labor -the stuff you couldn’t care less about doing, that is ultimately necessary to have the income to support a life of your dreams.
Does this mean traveling the world, winning tango competitions and defeating wrestling foes in exotic Asian countries?
Sure, if that’s your passion.
But it can also look like being a stay-at-home family where both mom and dad’s primary focus is the kids.
It can look like you running a summer camp for the underprivileged or you starting a small bookstore downtown.
It can look like anything you want it to because ultimately your passion is what governs it.
Lifestyle Design is Freedom, Not Laziness.
It actually takes a crap-ton of work to be able to it set up so don’t think I’m saying otherwise.
How Do I Engage In Real Passive Real Estate Investing?
Bringing it back to real estate investing and my personal experience, if lifestyle and freedom to pursue your passion is the hallmark of success then certain components of the real estate industry cannot be looked at as a good long-term strategies.
I have categorized the components of active income investing to include the following:
- 1. Wholesaling
- 2. Fixing and Flipping
- 3. Traditional Buyer/Seller Agent or Broker
- 4. Developing
In every one of these sub-niches of real estate, in order to be successful in them you have to be constantly on the move. You can’t really ever let your foot off the gas peddle because if you do, both your deal flow and cash flow will stop.
All of these strategies have great upsides but in terms of lifestyle, you can pretty much throw it out the window. You have to work and work and work to make things happen.
So be aware (did you notice that the top two are the things most talked about by the gurus?)
On the other hand, real estate has some of the most incredible passive income vehicles available and I’m going to take the time to go over them with you.
Buy and hold investing is probably the most popular form of passive income in real estate. The concept is pretty straight forward, you purchase a property that you can rent out at a large enough amount that there is a profit after paying for financing fees and expenses. There are two types of buy and hold properties: residential (1 -4 units) and commercial (5 or more unites).
Something you can do to truly automate your buy and hold investments and completely remove yourself from the management process is to outsource the headache to a property management company. In an ideal situation, they will handle all the dirty work while you collect your check. If you go this route, make sure to really do your due diligence on the property management company you’re looking to hire because they have a reputation of not really having your best interest in mind.
I’ve heard a lot of horror stories regarding property management companies but it’s not to say there aren’t good ones out there. You just need to be intentional on the front end to make sure that you are working with good people and creating good systems.
You see on the passive income side of investing, the work is 99% in actually setting things up, i.e. finding and buying your property, finding good tenants, finding a good property management company and maintenance man etc.
Once these things are set up you pretty much can sit back and enjoy the fruits of your labor and what’s awesome is that the checks will be there month-to-month, whether or not you do any additional work.
Now you could argue that multifamily investing is not 100% passive because even if you outsourced the day-to-day work to a property management company you would still need to be in touch with and “manage” the management company, so-to-speak.
I would agree if this is the case it’s not 100% passive but again, going back to the “4 Hour” concept of Tim Ferriss, this is the minimal pain needed to reap the freedom and lifestyle one can enjoy as a full-time landlord. So it’s worth it!
2. Triple Net
Triple Net investing is probably my favorite type of investing in all of real estate. This is a true step up in automation from multifamily because instead of outsourcing everything to a property management company that you ultimately still have to manage, you actually end up outsourcing all responsibility to your tenant!
You read correctly.
You see essentially a Triple Net investment is a free standing property that is leased to credit-worthy tenants such a Walgreens, Walmart, Bank of America, Starbucks, McDonald’s etc.
Once these tenants move in, they are responsible for all maintenance, property expenses -everything. Once you get everything set up, the tenants are usually on 10-25 year leases, so all you really need to do is cash in your checks!
Now the downside on this type of investment is the fact that they’re typically expensive. These are commercial buildings so naturally they cost more and because of that you really want to be careful at purchase, or you could loose a lot of money. If you get stuck with a Triple Net in a terrible location no tenant will want to lease from you and the month-to-month vacancy cost can be pretty crazy on some of these properties.
Another passive income stream in real estate are in owning and selling promissory notes. These are “proofs” of debt borrowed from party to another. To put it simply, when you invest in notes you actually buy the loan that the property owner owes to the bank or individual who lent him the loan.
This is a great passive income stream because you essentially get to function as the bank! The principle and the interest goes to your pocket!
4. REIT Investing
Though I don’t know a ton about these, a Real Estate Investment Trust (REIT) is a real estate holding company that offers public shares that pretty much act like stock in a company, but instead of investing in ownership of a business your investing in ownership of a piece of property and/or mortgage.
REITs are given some pretty cool tax advantages and their shares can be purchased and traded straight from your computer screen… so that means your office could be a coffee shop off of Santana Row (Shout out to San Jose!)
From what I hear, there are pros and cons associated with this asset class being that the returns are typically higher in multifamily properties and other forms of investments, but with REITS you don’t have to deal with the headache of tenants and your cash has a lot more liquidity.
5. Tax Liens
Our final asset class of passive income real estate are tax liens. The easiest way I can describe a tax lien is to compare it to the bank foreclosure process. When a borrower is behind on their mortgage payments they begin to get severely penalized by the bank as an incentive for the borrower to get current. If the delinquency of the borrower continues to no avail, then the bank will end up selling the borrower’s property at a foreclosure auction.
Tax liens are a very similar process only its not with banks and loans, its with the government and property taxes and as a means to ease the tax loss, the municipalities have decided to sell the payment demand, or lien, to investors. The government gets their taxes, while the investor gets the right to collect the delinquent tax, an additional penalty charge and interest on the late payment that can go up to 12-36% a year, depending on your state.
This is a great passive income source because after your initial research, that’s all the work you have to do. And, if the delinquent homeowner ends up not paying you within the set given period of time, you can actually foreclose on the property. So you win either way!
Passive Income Through Real Estate Summary
As you can see, these type of investment strategies are more accustomed to life-style driven investor.
What came out of my life reflection is that if these types of investments are available, then obviously they are what I need to be studying for and striving for.
But how do I get there?
A lot of these asset classes have a higher learning curve and demand higher capital to get started.
That’s where a choice needs to be made and active income investing comes into consideration.
If you want to grow into the passive income supported, “4 Hour Work Week” lifestyle through real estate investing, what better place to start than with building capital and experience actually in real estate?
I mean yes, essentially your starting out as an entrepreneur and bootstrapping your way to the top (which sometimes looks like struggling in the beginning) and it maybe a little smoother to have a day job to support you, but in active real estate, you’re essentially killing two birds with one stone and there is no better education than hands on.