Sorry, But Passive Income is a Myth for Most Investors. Here’s Why.

by | BiggerPockets.com

Are you one of the tens of thousands of people who got into real estate investing so that you could make passive income? Yep, me too. It is probably the number one reason people get into real estate investing in the first place. Ironically, most people are mistaken in thinking that it’s truly “passive.” They think that they don’t have to do anything and that the money will come rolling in as they sit on a beach sipping cocktails. Now, don’t get me wrong, this is a possibility for certain types of investors. But we have to remember that in order to make passive income, you have to do something for that to happen. No, it doesn’t have to be you personally, but there does need to be someone doing the money-making activities.

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The Myth of Passive Income in Real Estate

Let me explain. One of the biggest myths about passive income is that you can make it without actual money. This is just not possible. There has to be someone’s money in the deal—whether it is yours or a private money partner’s. It is the private money partners who are the ones making real hands-off passive income, and that is because they have someone else at work investing their capital for them.

Related: 3 Real Estate Investing Strategies That Aren’t So Passive (& 4 That Are)

In the video, I go into several different options you have to implement capital for others and create passive income for them (while leveraging your time to create profit for yourself). Bottom line: The arrangement between the “money people” and the “doers” is what truly makes passive investing work. So, real estate investors are faced with a decision, do you want to be a “doer” (i.e. active investor) or “money person” (passive investor)?

Leave some thoughts below on passive income and how it plays between money people and the doers investing money for other people.

Looking forward to hearing from you!

About Author

Matt Faircloth

In 2005, Matt founded The DeRosa Group along with his wife, Elizabeth. At the time, the two person company owned and managed two assets – a single family home and a duplex. Over the last nine years, they have grown the company to a 12 person team owning and managing over five million dollars in residential and commercial assets throughout the central NJ and Philadelphia area.

One of DeRosa’s mantras is “to make money while making a difference.”

12 Comments

  1. Rob Cook

    Matt,

    Good points. I have been commenting about this forever, as my own business model, Rental property long-term holds, is what I consider a Business, not an investment (although it could be both).

    I am able to do well in this business, precisely because I am so hands-on with it all, from renovations to property management. I happen to enjoy the work, even though I “retired” 20 years ago, so it is an even better win-win for us. Doing our own work on the rentals gives us a huge edge in every aspect of the business, including cash flow and profitability, durability to permit us to weather market downturns and bad spells of high vacancies or high capital improvement inputs.

    Other than being a financier, as you discussed, I imagine it is a difficult task profitably operating a successful, passive rental realty operation. More power to anyone who is, and can. Maybe I will learn how to someday too 😉

  2. John Underwood

    Passive income is what is generated from the investment for years to come. How you got the money to invest with is a totally different subject.
    I have been lucky that my investment money has come to me via word of mouth on the great things I am doing. So no effort there either for me.
    Then I also have a Self directed IRA so I am using my own funds. So once again I didn’t need to convince anyone to invest in me.
    I could see some people having to create a power point and convince investors to lend them money, but not in my case.
    Then comes the topic of passive income, not finding money.
    Here is where you have systems in place and a team to take care of issues so that a couple of text messages a week at most keeps the Empire running.

    • Matt Faircloth

      Hey John,
      Thanks for the comment. A few thoughts.

      The effort may or may not come from soliciting investors, but that’s not what I’m talking about here.

      The effort I’m talking about that do-ers have to make is in managing. That’s either property management or asset management, both of which do take time and more important than time, responsibility. It sounds like you have done a good job with systemization of your business, which limits the time engagement you have to make for predictable issues. That said, sometimes issues may arise that are outside of your systems. We just had a fire at one of our apartment complexes this weekend. My property manager was on top of it but I still needed to get in the middle to make sure it was being handled properly, call the insurance company, assess the damage, etc…

      Also, being the responsible party for a property does come along with action. The property manager has a long list of actions they need to take, and an asset manager like you also has activities, even if that’s just auditing financial statements and ensuring that your property manager is properly running your asset.

      For your Self Directed IRA, that money can’t touch your own hands so it has to go into a passive investment like a private loan, a partnership with a Do-er, or another vehicle where no action is required on your side. So by my definition that SDIRA is making a passive investment.

      Thanks! Curious to hear more of your thoughts.

      Matt

  3. Since the IRS does not factor in inflation (ie the loss of buying power over time our money) sometimes
    passive money turns out to be a taxed actual loss at time of sale without an tax deferral exchange.

    Yep, you do the math (ie a net present value calculation) including the taxes (like medicare/Obamas tax,
    capital gains, depreciation recapture at 25% of the gain, & State and Local taxes), RE fees, and closing and
    other costs – And see if RE passive income is anything like you have been told.

    Thanks the Fed. for 1031 & 721 exchanges & allowing owner carry back financing after its depreciation recapture tax is timely paid.

    • Matt Faircloth

      Hey James,
      I think I need my CPA to read your comment before I reply, LOL!! Just kidding.

      I think that the passive investor does need to ensure that their income increase each year is exceeding inflation or they will be losing money based on the rising cost of living over time, if their investment income is stagnant.

      Curious to get your thoughts on how the new tax law will effect passive income?

      Matt

  4. Dave Rav

    Good post. I think this topic could certainly be debated for a long time. Arguments and talking points could go both ways. I’d like to present some of mine.

    RE can actually be a hybrid of both passive and active. This could depend on several factors, probably most obvious being as you mentioned if you are a money partner (only involved to seek a return on) or the “boots on the ground” person. But I am going to bring up another point.

    It can be a hybrid if you do the work once such as purchase and renovation of a home (the “active” step), then turn around and sell the asset on say seller financing (passive step). Like a bank, you don’t get involved in anything operationally once your buyer is placed. The only time i could see one having to get involved is if foreclosure occurs or your buyer willingly backs out and gives the home back to you. But, literally it could be years of passive “mailbox money” for you yielding a nice return. In other news, I did a rent-to-own a couple years ago and never heard from the tenant for 13 months! For 13 months, they paid their rent on-time and in full. And there were no major maintenance issues. (The small stuff that came up they took care). That was passive investing right there!

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