By, G. Brian Davis
Passive income is the holy grail of personal finance.
Revenue flows into your bank account, without you having to lift a finger. You earn money while playing with your kids, or lying on the beach, or skiing down a mountain.
With enough passive income, you can cover living expenses and ditch your day job — no matter how old or young you are. Look no further than Rick Orford, founder of The Financially Independent Millennial, who retired at the tender age of 35.
You can earn passive income from many sources, including dividends from stocks, interest payments on bonds, ongoing revenue from passively managed businesses, even royalties on artwork. But real estate particularly excels at generating passive income, which says nothing of its tax advantages or diversification benefits.
As you explore your options for real estate investing, consider the following ways to generate passive income.
1. Long-Term Rental Properties
An oldie-but-goodie, everyone’s familiar with long-term rental properties. Most of us have lived in one, after all.
While not entirely passive — landlords do need to advertise vacant units, screen tenants, enforce lease agreements, and perform repairs — rental properties do generate mostly passive income. And investors can of course hire a property manager to take on the labor of landlording.
Real estate investors can also finance the bulk of their purchases with an investment property loan, letting them pay only 20-25% of the cost out of pocket. In many cases, borrowing rental property loans improve their cash-on-cash returns, rather than diluting them.
Property owners can deduct all property-related expenses from their taxable income, along with some paper expenses like depreciation. Best of all, these deductions live on a separate schedule on your tax return, so investors don’t have to itemize their personal deductions.
In addition to ongoing cash flow, rental properties also typically appreciate in value over time. And speaking of cash flow, that usually improves over time too, as rents rise but your investment property loan payment remains fixed.
2. Short-Term Vacation Rentals
Investors who don’t like the idea of renting to long-term tenants can instead rent their properties to short-term guests through platforms like Airbnb and VRBO.
That eliminates some of the risks of renting to long-term tenants, such as defaults on rent or poor treatment of the property. With short-term rentals, owners can spot property damage immediately and bill the guest responsible. But as a landlord, I can testify firsthand how difficult it is to collect from ex-tenants after they’ve moved out when their security deposit doesn’t cover the property damage they caused or the back rents they still owe.
“Hosting short-term guests is a simple and lucrative way of earning some serious cash and passive income,” explains Kelan Kline of The Savvy Couple. “You can start by renting out a room in your house and slowly work your way up to renting out vacation homes you purchase. Short-term rentals have a much higher ROI than long-term rentals, which is why many real estate investors are turning into Airbnb hosts.”
Granted, short-term rentals come with their own costs and drawbacks. Owners have to furnish the unit, manage bookings, communicate with guests, and of course clean units thoroughly between each booking. But as with long-term rentals, landlords can delegate that work to a property manager if they don’t want to do it themselves.
3. Corporate Rentals
Rather than rent for a few days at a time to a tourist, many investors find better success with medium-term corporate renters. Think travel nurses or businesspeople who need to spend a few months in a location, before returning home or moving on.
They need a furnished unit, and some flexibility to extend their lease term if needed. And they pay high rents, usually covered by their employer. Read - no rent defaults.
These tend to be model renters in other ways too: responsible corporate employees who don’t want any damage or complaints reported back to their employer. Their job is on the line, after all.
Sweetening the pot even further, it reduces turnover for the landlord, who doesn’t have to hassle with cleaning linens or maid service.
While a niche market, “extended stay” guests offer the best of all worlds. Check out this free webinar by corporate rental expert Al Williamson to learn the ropes.
4. Add an ADU or “Granny Pod” to Your Property
In-law suites and carriage houses have been around for centuries, but only in the last decade or so have homeowners started renting them out en masse.
As a form of house hacking, thousands of homeowners have started renting out portions of their property. It could be a standalone structure like a carriage house or, as they’re known these days, accessory dwelling units or ADUs. Or it could be a basement apartment or garage apartment, or some other unit with its own entrance and full bathroom.
The idea is simple: the rent from the extra unit covers most or all of your mortgages, and you get to live for free.
Some homeowners go even further and buy a duplex to live in one unit and rent the other. It comes with even better odds of covering the entire mortgage payment. And conventional mortgage loans allow multifamily properties with up to four units, so you can go as high as a fourplex to maximize rental income.
Run the numbers with a house hacking calculator before committing funds, and don’t forget expenses like repairs and maintenance, vacancy rate, and potentially higher insurance premiums.
5. Offer Parking for Rent
Some property owners offer their parking spaces for rent, in urban or denser suburban neighborhoods. They can make great money doing it too, with no toilets to maintain or tenant headaches.
But that’s not the only way to make money renting out parking.
Property owners can rent out large garages or outdoor parking areas for RVs, boats, and other large vehicles that many suburbanites simply can’t fit in their driveways. Some go as far as to rent out mobile home parking, whether to road-tripping tourists passing through or to long-term residents. It helps to install water, sewer, and electric hookup, but it’s not strictly necessary if you just rent by the night to people driving through.
6. Commercial Real Estate
Alternatively, investors can go bigger with commercial real estate.
This umbrella category includes residential properties with five or more units, office space, retail space, restaurant and bar buildings, industrial properties, and mixed-use buildings. Investors can go as small as a local coffee shop or as large as a skyscraper.
Before investing hundreds of thousands of dollars, invest the time to learn how to invest in commercial real estate. Start simple with articles, podcasts, and books, then consider taking a course to dive deeper.
The good news is that because of the higher price tags involved, commercial real estate investors face less competition than residential investors. And like single-family properties, you can take out an investment property loan to buy commercial real estate.
7. Publicly-Traded REITs
If all that sounds like a lot of work, consider simply buying a share in a real estate investment trust (REIT). These companies trade on public stock exchanges, so investors can buy and sell shares instantly.
“The high dividend yield alone from REITs is enough to have any budding or veteran investor gravitate towards them,” explains Orlando Rodriguez of Credit.com. “For passive, low-maintenance real estate investment assets, public REITs are ideal. Both those novices and those who have real estate experience will view publicly-traded REITs as great portfolio diversifiers and long-term investments.
“There are different types of REITs, such as equity REITs that own properties directly and mortgage REITs that own loans secured against properties. Choose what’s best for you and your goals. And as with any publicly-traded investment, always be on the lookout for market fluctuations.”
The SEC requires that all publicly-traded REITs payout at least 90% of their profits to shareholders each year, in the form of dividends. That ensures high passive income, but beware that it also limits the growth potential for share prices, as REITs aren’t free to reinvest their profits to grow their real estate portfolios.
If you’re new to REITs, see SureDividend’s list of the top ten REITs for dividend yield.
8. Private REITs
For less volatility — and less liquidity — investors can buy shares in private REITs.
A form of real estate crowdfunding investment, these shares don’t trade on public stock exchanges. Instead, investors buy shares directly from the company. It gets trickier when it comes time to sell however since they don’t trade on the open market. Investors must typically sell their shares back to the issuing company, which often penalizes investors if they sell within the first few years of buying.
So crowdfunded REITs offer a stable long-term investment, but one you can’t liquidate at a moment’s notice.
Like their publicly-traded counterparts, these pooled funds either own properties or they own debt secured against real estate. In many cases, they own both, to provide both ongoing passive income from debt interest payments and also the growth potential of appreciation.
Note that the SEC regulates real estate crowdfunding investments differently than public REITs. Private REITs don’t have to pay out 90% of their profits in dividends, which gives them more flexibility to reinvest profits to buy more properties and grow the value of their portfolios.
9. Crowdfunded Real Estate Loans
Yes, some real estate crowdfunding investments own debt and pool them together in a REIT. But that’s not the only way you can invest in crowdfunded real estate loans.
Some hard money lenders raise money for their loans from the public. They issue short-term loans to house flippers to buy and renovate properties and charge high-interest rates on them. Interest that you can earn by funding these loans, by picking and choosing which ones you want to fund, and investing as little or as much as you like.
My favorite of these is GroundFloor, which lets you invest as little as $10 in any given loan.
I also appreciate that these are short-term investments, usually 6-18 months. That sets them apart from other real estate crowdfunding investments, which typically have money to stay put for a minimum of five years.
10. Private Notes
You don’t have to go through a crowdfunding platform to lend money to real estate investors. If you know a successful investor personally, you can issue your own private investment property loan.
For example, I know a couple in Ohio who’s had great success in their real estate investments. But they extended beyond their comfort zone, buying a portfolio of nine single-family homes as a single transaction. They had trouble financing all of it, so I lent them money privately at 10% interest. Because they were paying 24% interest, having put some of the cost on their credit cards, my loan represented a bargain. It also came instantaneously, with few questions asked.
As the lender, you have the borrower sign a note: the legal document certifying that one party borrowed money from another. You can also record a lien against the property if you like so that if the borrower defaults, you can foreclose and take back the property.
You can structure these loans do charge interest only or to amortize, so the borrowers gradually pay down the loan balance over time. For example, a $25,000 loan repaid interest-only at 10% costs $2,500 per year in interest, which can be paid monthly, quarterly, or however else you agree on with the borrower.
11. Raw Land
I recently started investing in land, which comes with some enormous advantages over residential properties.
First, investors don’t have to hassle with nonpaying tenants or lengthy eviction proceedings. I never want to hear the words “Check’s in the mail!” again, never want to have to go to rent court again, never want to pay to clean out all the junk that an ex-tenant abandoned in my property again.
Second, land investors don’t have to worry about repairs or maintenance. Tenants can do incredible damage, and even when they don’t, properties still need ongoing upkeep.
Third, the land is cheap. I’ve bought parcels of land for a few hundred dollars before. That means no investment property loan, no interest payments, and no risk of overleveraging yourself. Read up on other advantages of land over existing homes for more details.
My partners and I buy land that the owners don’t want anymore, and we turn around sell it to people who have a use for it. Those uses include building a home, or recreational uses such as hunting, fishing, camping, hiking, dirt biking, and so on.
But how does it produce passive income? Land investors earn income by offering owner financing to the buyer. If the buyer defaults on payments, they simply lose the rights to the land. If they pay the owner financing in full, the title transfers to them. Easy peasy.
To learn the business of investing in land, check out REtipster’s excellent course.
12. Mobile Home Parks
As another non-sexy but high-return investment, consider mobile home parks.
Again, you don’t have to maintain any buildings, other than perhaps a small office. The tenants maintain their own mobile homes.
Because few mobile home parks have been built in recent decades, supply remains tight even as demand continues to grow. It came as no surprise that mobile home parks performed particularly well throughout the pandemic.
But the business comes with its own quirks and pitfalls, like any real estate business. If you’re interested, do some reading and consider taking a course, such as Mobile Home University.
A friend of mine in the industry recently approached me about a project he’s working on: building a self-storage facility.
As with vacant land, it comes with far less regulation and headaches. If tenants default on rent, owners can terminate their lease relatively quickly and cheaply, compared to residential renters. It costs far less per square foot to build or buy, and to maintain.
And the cash flow can be impressive.
In some ways it’s more of a real estate-related business — but one you can automate to generate passive income. The greatest challenge lies in running the numbers accurately before buying, and once owned, maximizing your occupancy rate through effective marketing.
Don’t just go out and buy a self-storage facility. Learn about the industry, and consider partnering with more experienced investors on your first deal. Or start small, by simply renting out spare storage space in your own home or garage, through a platform like Neighbor.com.
14. Real Estate Syndications
A real estate syndication works similarly to a crowdfunded real estate investment, where multiple investors all contribute money toward a large project. However, it’s structured differently, as investors become fractional owners of one specific property. Darren Robertson of Northern Virginia Home Pro explains that “Passive investors also typically sign away decision-making rights to the syndicator: the person who found the deal and will oversee the property’s renovation or ongoing management.”
These deals are also regulated differently by the SEC, and in most cases, only accredited investors can participate. To qualify, investors must have a net worth of at least $1 million or have $200,000 in income for the last two years ($300,000 for married couples).
Real estate syndications offer a great way to passively invest in large real estate projects that you wouldn’t otherwise be able to afford, such as apartment buildings or commercial office buildings. But they also come with plenty of risks, so make sure you understand how real estate syndications work before investing your hard-earned money.
15. Do a Joint Venture with an Experienced Partner
You don’t have to join a full-scale real estate syndication to partner on a real estate project.
Instead, consider just finding a real estate investor you can trust, and going in with them on their next deal.
"If you have the funds but not the time or desire to invest in real estate, partnering with an active investor might be the way to go,” offers Kristen Herhold of Clever Real Estate. “Let's say you want to invest in rental properties but don't want to be a landlord or work with a property management company. You can provide a large chunk of money for the property's purchase and upkeep while your partner handles the labor and decisions.
“Similarly, if you want to invest in fixer-uppers, you can invest your money while your partner plans the work, hires contractors, and works with a real estate agent to buy and sell the properties.
“Working with an active investor will allow you to get a return on your investment without a lot of time and effort on your part."
You may need to settle for a lesser share of the returns on your first deal or two, but that’s the price of education. Think of it as a few “apprenticing” deals if you want, where you learn the ropes before going out and investing on your own.
There’s no right or wrong way to build passive income from real estate. All of these income streams come with their pros and cons. Start with education, but don’t stand on the sidelines for more than a month or two — there’s no education like rolling up your sleeves and getting your hands dirty.
This article originally appeared on The Financially Independent Millennial and was republished with permission.