The Passive Income Deception

"Trump"ing the Competition
Image by Ferdinand_M via Flickr

I was at an investor’s meeting not too long ago talking with a young, idealistic, newbie investor who brushed off one of my real estate suggestions and told me he was looking for passive income. He wanted -in short order- to work only 4 hours per week. Ahh, yes, the fabled four-hour workweek, I’ve heard of it so many times yet I’ve never actually known anybody who had one, not anybody making any money at least. I think it must be next to the pot of gold at the end of the rainbow.

I admit, I’m going a little overboard with the pot of gold bit, but it’s for a much-needed theatrical effect. To be fair, real estate is like any business and there are some investors out there who have worked hard, became successful and were able to build a system that they could back away from a little and turn more operations responsibilities over to others. Make no mistake, however, it took a lot of work to build that system.

When they say passive income they are usually talking about rental properties. They tell you to go buy a property. Rent out said property to a tenant who pays the mortgage and expenses and you keep the difference. Easy right? Maybe if your Donald Trump and you start out with a million dollars to put down and pay management.

Lets analyze a more realistic scenario. The consumers of these passive income systems are most likely newbie investors looking for a way to build wealth. They often have very little money to throw at deals so they are looking for high leverage, possibly no money down properties. It is very difficult to get a significant amount of cash flow out of property that is financed to the brim. But, don’t even worry about cash flow yet. Good high leverage deals are not easy to come across. Our newbie investor is probably going to bust his hump for the first few years just trying to find properties. There’s nothing passive about that.

Here’s the anatomy of a real good investment property. Our newbie investor finds this deal. The purchase price is $100,000 and it will rent for $1,000 per month. Better yet, with the seller’s cooperation the home can be purchased with no money out of our newbie’s pocket. We won’t even complicate the deal by talking about closing costs but be assured you will have to deal with closing costs in your purchases. They close the deal. The blended interest rate on the home is 7% for thirty years. Trust me, that’s a good rate for a no money down deal. The principle and interest payment on the mortgage is $665.30 plus taxes of say $75 per month and insurance of $50 per month. That’s a grand total of $790.30. But wait there’s more. I always figure that a rental home is going to be empty or vacant for at least 1 month out of every 13 months. That’s because I have a one-year lease and I expect the tenant will move out at the end of the lease. Just count on it taking a month to get a new tenant in the home. So I figure vacancy expenses at about 7% of the rent or in this case $70 per month. And, lets not forget maintenance. If you can get through the year without having maintenance costs then congratulations, you’re a slum landlord. In my case I figure about 5% of the months rent should be squirreled away for future maintenance expenses. That’s another $50 per month. Believe me that is a minimal amount. If the fridge goes out you’re there. You can save money if you do the work yourself rather than hire a handyman but then you’re another step further away from passive income. Pipes don’t often break between the hours of 9am to 5pm. So with vacancy and maintenance you’re now up to $910.30. If you were really looking to have passive income you’d hire a property manager. That will cost you another 10% or 100 dollars per month and that would bring your total up to $1010.30 per month. Now you’re loosing money.

Nah, it’s no problem. You’ll manage it yourself. So start by running adds and taking phone calls for prospective tenants. Make yourself available to run over to the property on a call from a prospective tenant that is so excited about the house they just can’t wait and then stand there for an hour because they don’t show up. I’m not kidding. In my experience, I say maybe 1 out of every 3 people who make an appointment to view a property will actually show up. Finally you find a candidate who has the deposit and the first months rent in their hand. Don’t you dare jump on it yet. You had better do a background check first. You won’t want to. You’ll be eager to be done showing the home and start collecting your passive income but you’ll have a whole lot more work to do in a couple months if you have to evict this person.

The tenants in place and you’re done, right, not even close. First get a good lease signed and money exchanged. Open up a separate bank account for deposits (required in most states) and start your accounting system. You also better make sure the tenant changes over all of the utilities into their name. On one of my properties the water company makes me sign and fax in authorization to change over the service every time I get a new tenant. Of course we’ve already mentioned maintenance. Tenants are not known for taking care of a rental property but they demand their rich landlord (because all landlords are rich) keep the property in top-notch condition. So unless you want to pay a $50 service fee every time something is leaking, or squeaking you’ll be making trips over to the house and like I said things don’t break during normal business hours. I also highly recommend that you go personally pick up the rent every month.

Now, look back at our profit margin. You’re pulling down $90 per month for all of this effort. So if you’re going to make a living at this you’re going to need at least 20 of these properties. Believe me, the tasks I’ve listed above are very summarized there are many more things that can and will come up. Trust me, if you have 20 of these things you will have 2 full time jobs.

Despite all of this, have faith and know there is no better wealth builder. 15 years down the road these homes will likely rent for $1500/mon and the mortgage will be paid down 20-25%. If you bought right the home has probably also gone up in value. Then you’ll have some breathing room. Then you can hire a property manager and you can afford to pay that handyman the service charge. Believe me, there will still be things for you to do, but you’ll be well compensated each month and you’ll have a very large net worth (20 properties with say $50,000 equity each makes you a millionaire.)

If you want easy money, trust me, real estate is not the right place for you. If you’re not afraid to work your but off and just need a place where the playing field is a little more leveled then welcome home my friend.

About Author

Justin Pierce

Justin’s work ethics and values are based on his small town western upbringing and eight years of active duty in the United States Marine Corps. He currently resides in the D.C. area. He holds a BA in Management, a Masters in Business Administration and an active Virginia Real Estate Agent license.


  1. LOVE THIS!! A brilliant businessman (Keith Cunningham) said to me “The label becomes the experience”. In other words ‘passive’ makes you think you can do the least to get the most … and we tried that with real estate early on. Worked out pretty well for the first year until everything flew apart and we ended up in court defending fire code violations, trying to fight a property manager that had robbed rent money from us, and evict a tenant. Nightmare!! So now we would NEVER say we have passive income from real estate. We stay involved. We make tons of money and we have a pretty nice net worth for our age but it’s work … and we continue to work at it.

    Thanks for a great article and perspective!!

  2. You’re pulling down $90 per month for all of this effort. So if you’re going to make a living at this you’re going to need at least 20 of these properties. Believe me, the tasks I’ve listed above are very summarized there are many more

  3. This is a great article and speaks volumes about many of the hats that we wear. I have to say that through the creation of systems, checklists and a good support network, you can find ways to help allieviate some of the tasks. There is no such thing as easy money.

  4. Thanks for the comments. I couldn’t have said some of this stuff better myself. Julie, I wish I would have used that in the article. You sum up my entire post right there.

    I am really impressed with the caliber of investors here on biggerpockets. I’m really glad I agreed to contribute.

    Highest regards,
    Justin Pierce

  5. The only landlords that are making any passive income are the ones that have no mortgage payments… Simply trying to create a small spread between what is owed and what your getting is like the old… Do I dare say… Carlton Sheets method I believe… No doupt, landlording not fun… But you know what they say… There’s no such thing as a bad tenant, only bad landlords.

  6. Brian Frierson on

    It is too bad that in this economy so many people are looking for the easy way out. The other problem are all of the people selling these “turn key” systems. If it worked so well, why are they selling systems instead of doing the business? That should tell most newbies something. Most people go into these deals wishing it works out instead of looking to put in the work to make it work.

  7. Justin you paint a scenario that’s from the past. I have 11 rental houses, all occupied. One turned over this year, and one last year. My wife and I spend less than your four hours per week on all of the them combined. Except, obviously, when they do occasionally turn over.

    With this market and the prices that great homes are selling for, it’s now possible to buy homes that never before in history would cash flow as rental properties. I’m talking about brick homes with full basements, garages, hardwood floors, and central air in the best school district in the state (here). When I buy and when they turn over I have multiple applications every time from nothing more than a sign in the window. And that gives me my choice of renter. And the homes that I’m buying, right off the MLS I might add, each throw off $250-$300 per month in net cash flow. And that doesn’t include the very nice and substantial depreciation deduction that I receive every year to offset the taxes I pay on my day job income.

    Is there work involved? Of course. I had a garage door spring break on a house last month. One call and $225 later it was fixed. That’s the only maintenance that I have had to do on any of the 11 this year so far.

    So instead of suggesting that passive is a pipe dream, perhaps a better approach would be to suggest that people learn the right way to find, but, rent, and manage rental properties. To learn from someone that has already done it BEFORE spending a lot of time and effort chasing foreclosures and other bad deals.

    Passive income is a reality. And with these real estate market conditions, we also have the ironic opportunity to use one crappy market, real estate, to offset the losses that we have all experienced in another one, the stock market, and salvage our retirement.

    If we do it right. That’s the key. Isn’t it always?

    Dennis Fassett
    .-= Dennis Fassett´s last blog ..Arrowhead – #923 =-.

  8. Dennis,

    That is super. I have been investing for 10 years. I have had many rental properties and still hold a half dozen. I have been a realtor for 5 years. I have honestly heard many stories like yours but as for myself and every last investor I know our experiences are much more sobering.

    You may; however, have missed the point of my post. My agenda is to bring investors expectations down to earth. There are plenty of other people out there who are telling them how to buy right. I buy right, I make money but I still have to work at it.

    I do; however, think it is really poor form to add a link on my blog to one of your posts. I welcome your comments but don’t use my blog to advertise.

    Justin Pierce

    • Justin –
      Dennis wasn’t advertising . . . one of the things that our blog does to help promote those people who do come and comment is to promote their last blog article. If his article was just spammy garbage, it would be another story, but since his contribution to the discussion was absolutely worthwhile, I see no reason to remove it. If you still think otherwise, please let me know.

      Thanks for the understanding both of you.

  9. Dennis,

    No that’s my mistake. I see what it is now. When I looked at the link I thought it was an advertisement. But it looks like it just might be something attached to your profile.

    Thanks for reading the post and thanks for taking the time to make comments.

    Feel free to contact me over at the biggerpockets social networking side. Or, just email me. I might be willing to interview you about your strategies and success story as a counterweight to this story.

    Like anything in life, there are now absolutes. I think investors need to see the whole picture, both the good and the bad. I certainly love and believe in real estate as a wealth and life builder.

    Justin Pierce

  10. Marcus,

    Integrate into your local real estate investment community. Investors are eager to accept anyone, just jump right in. Join your local real estate investment group and attend meetings. Join social networking sites like Let it be known that you’re looking for a mentor. Be selective. Talk to lots of people. You need an actual mentor, someone with the goal of helping you become successful. Not someone who’s just going to take your money.

    Good luck,

  11. Justin,

    Well said, this should be read by anyone looking into RE. I am going to get back on Biggerpockets and look for a mentor. I began into investing in multi’s @ the absolute worst time, worked hard, did well for 4 years, and then lost most of it. Feels like I am starting over, however armed with experience, knowledge, and much better prices.



  12. Well said, Eric. I took a big beating on a venture a few years back. I now consider that event and the lessons I took from it to be one of my greatest assets. Even more important than the education is the confidence I now have. I know, from that deal, that no matter how much I lose I can always make it back with interest if I am willing to work hard and educate myself. You can’t buy a degree in self assurance. You must earn that title at the school of hard knocks where the only tuition fee is blood, sweat, tears, and bitter humility.

  13. I buy mobiles on land for cash that was and is made from flips. I pay 10k for each one and cashflow $500 a month after all expenses. I have 13 rented and owned free and clear. I work on average 5 yours per week. It can be done.I hate leverage and will never use it again.

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