Two (Deceptively Hard) Questions to Answer BEFORE Investing in Real Estate

It may seem obvious what we are all trying to do by getting into real estate investing (REI), but I think it’s worth breaking it down. I think the reality is that we aren’t all necessarily in exactly the same boat in terms of our goals, so I say we throw them all onto the table! I think there are two components to this conversation:

What are your goals with REI?
What are you doing to achieve them?

Again, these answers may seem obvious or benign, but I believe there are some people out there who are trying to achieve their goals the wrong way. I’ll elaborate on that after I tell you my goals and methods.

One Investor’s Goals and Methods

And by one investor, I mean me! I’ll tell you up front that the first book that really got my REI juices going, or maybe more specifically my understanding of money juices going, was Rich Dad Poor Dad by Robert Kiyosaki. I’m sure none of you can relate to that, huh? Kidding. I’ve never heard of another book that truly lit the fire under so many people.

Now, by no means am I an advocate of diving into his hugely priced programs, but I will say that his line of books are the reason I am where I am today. The main takeaway I had from Rich Dad Poor Dad was the idea of passive income, and I especially understood it more thoroughly when he explained the Cash Flow Quadrant.

The reason I tell you this is just because it’s a good lead-in to my goals and methods.

My REI Goal: Lifestyle Design (via Passive Income)

I didn’t necessarily start out with lifestyle design as my primary focus because truly I didn’t get introduced to the concept until quite a ways into my journey, but the passive income idea is what really took me once I started reading the Rich Dad books, and I later began to equate passive income to lifestyle design.

The reason I invest in REI, aside from the fact that it’s extremely fun, is because I want passive income. Or more generally, I want free money. Nothing beats having money show up in my bank account without me having had to do anything for it other than throw down my initial investment. By having free money show up in my account, I’m then allowed to have more freedom in my daily life because I’m no longer dependent on a 9-5 job that I hate.

Or if I am still dependent on that job, free money still opens the door to get the ball rolling to create different options. Or if replacing a salary isn’t the goal of passive income, passive income can allow for more fun stuff to be bought, more vacations, more financial security and diversification, and just overall more options. For me, I want my entire income to be passive. Why? Because I want to sleep in every day if I want to, I want to be able to say yes to a lunch invite with a friend, I want to be able to travel whenever I want to, and I don’t want to have to report to anyone, or work if I don’t want to. I’m not to the point of not having to work at all yet because I don’t have that much passive income, but I’ve gotten a great start with it! (If you don’t believe me, check out “Don’t Believe Passive Income is Awesome? Check Out the Diary of My Week!“)

My REI Method to Achieve Said Goal: Rental Properties

Here’s where things get interesting, and it’s driving towards why I’m writing this article at all. My goal is lifestyle design, but via passive income. A big misnomer about REI is what is and what isn’t actually passive income. You could look at it in terms of what the IRS deems passive income versus active income, but let’s just look at it as the income you don’t have to work for versus the income you do have to work for.

Flipping gives you active income. You have to physically be present and work in order to make money flipping. The only way to not have to show up is to hire enough people under you to do the actual work — but then that falls under the category of starting a business that you outsource (which is the other way to make passive income outside of rental properties). There are some components of flipping I would consider to be passive income, sort of, like the additional equity that gets built in by improving the property. Wholesaling, however, is actually a job so there is nothing passive coming from that (again, unless you make an outsourced business out of it). See the similarities here? In both flipping and wholesaling, you have to work for the money.

For more information on active vs. passive income, check out “The Truth About Active Income vs. Passive Income.”

Now, in comparison I don’t do jack for my rental properties. I literally make money in my sleep with those things. I do no work on them, I put no effort into them, and I usually don’t even think about them. Does that sound passive to you? It does to me! Now, here’s where I’ll continue to hint towards people being confused. There is a big difference in how passive the income is on my rental properties versus the income of other rental properties. I use a property manager on my properties, and therefore he’s the one doing all the work on them. I don’t do any. That is very different from landlording your own properties.

If you are the landlord, there is a good chance you are throwing that “passive” concept right out the window. See the difference? I do no work on my properties, so my income from them is truly passive. If I had to do all of the work of landlording, that income wouldn’t be quite as passive. Now, if you are a really good landlord with good systems, you likely don’t have to do a lot of work on your properties, so keep in mind this explanation is case-dependent. Regardless of how your properties are managed, the IRS will still consider them passive, so that’s exciting (better tax benefits), but don’t forego the idea that your income may not be as passive as you think if you are having to do that much work for it.

To get back to me and my methods now, when I set out to analyze an REI deal, I keep in mind that my goal with REI is lifestyle design, and therefore passive income. Knowing that, I first decide whether an opportunity is in support of that. If someone came to me and asked if I was interested in wholesaling, I’d say no way! Because it’s not passive. I’m not in the market for another job, and that’s what wholesaling is. If my goal were something different, like just income period, I may consider the wholesaling idea.

A Common Misconception When Considering REI Goals

I’ve already alluded to it: Opportunities many might consider to be for passive income really aren’t all that passive. Actually, let me break it down into different phrasing that is better and more clear:

Not all investments are just investments; many of them are actually work.

That’s the misconception — investing versus working. Be very clear on this. Wholesaling is the biggest example. Not one ounce of wholesaling is actually investing. Yes, it’s related to REI and can give you tremendous skills in the REI field, but wholesaling is 100% work. Only by working will you earn any income with wholesaling.

Flipping is more of a combination of investing and working. You have to do a lot of work to succeed with flipping, but there is an investment component in it because if you exert X amount of work and Y amount of money into a flip, you are oftentimes going to earn an income worth more than what you put into it.

Wait, does that make sense? Let’s say you buy a property to flip. You put $50,000 into the materials and supplies, and you work X amount of hours that equate to, who knows, like $10,000. But you sell the house for $100,000 over what you got it for. You invested $50,000 into it (cash for the supplies), and you worked the equivalent of $10,000 worth. That totals to $60,000 and you got $100,000, so $40,000 of that is definitely free money in your pocket, but really that $50,000 was just an initial investment, so more accurately, for $10,000 worth of work, you made $40,000. How ‘bout that! See the combo of investing and working in there?

Rental properties, assuming you use a property manager to make it purely passive, doesn’t have a work component. Maybe five minutes a year, as it is with my properties, but I hardly think that counts against the passivity of the income. If I was landlording, I would begin to consider some portion of my income passive and some of it from “working” on the properties.

So any time you are presented with an REI opportunity, or if you are just pondering different ways to go with REI, really understand the level of work versus investment the opportunity presents and compare that to your goals. Find what fits best, both for your goals and for your skill set.

Related: 7 Tips to Help You (Actually) Achieve Your Entrepreneurial Goals This Year

This explanation is really just a sidebar to what I really want to know, which is…

What Are Your REI Goals and Methods for Achieving Them?

This is what I really want to hear! What better way to learn more about REI and the opportunities in the field than to hear about what other people are doing? I doubt I even know all of the options out there! It’s also a good way for people to hear things, even goals, that maybe they haven’t considered before and would like to incorporate into their own lives.

Some common goals with REI include:

Financial security to varying degrees
Financial diversification (do you not trust the stock market anymore?!)
Lifestyle design
Something to pass onto kids and grandkids
Having a challenge
To have fun!

What are your goals with REI? I know you have them because you are on BiggerPockets! And then what are your methods for achieving your goals? Have you already done them, or are you just starting out? Let’s see how many people we can get responding to these questions so we can build a huge encyclopedia (okay, maybe the more current word would be Wikipedia) of REI options!

Ready… Set… Go!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.