Many people don’t realize that they can choose to actively or passively invest in real estate. For them, investing in real estate has become synonymous with one word – landlord.
We’ve all heard the horror stories of being a landlord. Some people talk about the “terrible three T’s” – tenants, toilets, and trash. Despite the clear benefits of real estate investing, the fear of fielding 2:00 am phone calls keeps many people out of this asset class altogether.
After all, most people want to be investors, not landlords. Creating passive income from real estate is probably a better fit for those people. Passive ownership of commercial multifamily real estate can be a great way to create stable passive income streams.
The difference between active and passive real estate income
The success or failure of the active investor rests in his or her knowledge of acquisitions and operations and the ability to apply that knowledge to construct, hold, and grow a successful real estate portfolio.
There are a multitude of options to invest in. You can choose to invest in commercial properties, single-family homes, and our preferred option, multifamily apartment properties. But if you’re active, expect to get your hands dirty in the day-to-day operations.
Passive ownership of real estate can allow those without expertise to invest in real estate successfully. They can leverage the specialized knowledge of real estate professionals and invest alongside them passively. In that way, they can enjoy the benefits of direct ownership without the responsibilities of management.
As a fractional owner or limited partner in a legal entity that owns real property, the passive investor receives all the benefits of owning real estate. They get their percentage ownership of the cash flow, the tax benefits, the appreciation, and the amortization.
The benefits of passive real estate investments
There are many reasons to own passive real estate investments in your portfolio.
- Generation of cash flow
- Tax breaks and deductions
- Diversification of portfolio
- Recession and inflation hedging
- No landlord or property management responsibilities
- The ability to leverage professional expertise for your benefit
- And more…
How to invest in real estate for passive income
Passive real estate investing is likely the best option for people without the experience or desire to actively manage real estate properties.
You can invest in real estate and build passive income streams without getting your hands dirty. There are many different options for getting started. You can find rental property opportunities by investing in single-family homes, multifamily apartments, and commercial properties such as retail shopping centers, office buildings, industrial warehouses, and other rental properties.
Below is a brief overview of the three most common ways real estate investors create passive income streams.
Private real estate investment funds
Private real estate investment funds allow individual investors to pool their money with other investors to purchase multiple commercial or residential investment properties. You can leverage industry experts, experienced property managers, and proven real estate syndicators by investing in a private investment fund. These private investment funds are led by experienced managers that develop and execute an investment strategy.
This fractional ownership of real estate properties within a private fund is similar to investing in a mutual fund that provides partial ownership of multiple companies. Depending on the fund these properties can be spread across different geographic markets, commercial or residential rental property types, allowing for greater diversification.
Before investing, you’ll want to research the fund to understand its management approach, historical returns, and overall business model to make sure they align with your financial goals. For a deeper discussion of how to determine if a private real estate fund is right for you, check out our Private Real Estate Evaluation Framework.
Creating passive real estate income with 37th Parallel Properties’ Fund II
37th Parallel Properties is an industry leader that specializes in multifamily real estate investments. Since 2008, our real estate investments have provided profitable returns for our investors.
Our newest investment offering, Fund II, is scheduled to open to accredited investors in late second quarter / early third quarter of 2022. In Fund II, we’ll purchase strategic value add and core plus A & B Grade multifamily assets in high-growth markets.
If you’re an accredited investor and want to learn more about investment opportunities in Fund II, click here or schedule some time to see how we can help you create passive income from real estate.
Purchasing private rental properties
It is possible to create real estate passive income from purchasing an investment property and then hiring a property management company to operate the business. This option allows investors to own rental income-generating real estate, but the amount of active effort required will depend on your trust in the property management company.
It is essential to remember that purchasing a property will often require larger amounts of financed capital, leaving you tied to a single property with less opportunity for diversification when compared to fractional real estate investments.
This hands-on approach blurs the line between passive and active income. But, it is an option for investors that want more control and oversight without being a direct property manager.
REITs (real estate investment trusts)
REITs, or real estate investment trusts, are large-scale companies that own, finance, or operate income-producing real estate properties. These companies invest in various types of real estate properties and infrastructure, paying out their profits to shareholders through dividends.
REITs are commonly publicly traded, allowing people to buy and sell them like stocks, making them very liquid real estate investments. But, this also leads REITs to have a higher correlation to the stock market than direct ownership of private real estate. For many investors, this limits the benefit of REITs as it is harder to consider them a diversified income stream separate from stock investments.
Note: REITs don’t offer the same tax advantages as private real estate funds and private property ownership.
What is passive income?
The goal for the passive investor is to create stable streams of passive income (mailbox money) and equity growth without the headaches of management.
There are three broad categories of income recognized by the IRS (Internal Revenue Service):
- Portfolio Income
- Active or Earned Income
- Passive Income
Portfolio income is income that is not earned from business activity or a job. Instead, income generated from royalties, capital gains, dividends, and investments is not considered passive.
Most people are familiar with earned income. It is the income you derive from working at a job or owning a business. But, unfortunately, earned income happens to be the most expensive income there is. So the obvious question here is, how can income be expensive?
The answer is that earned income is highly taxed and, even more costly, you have to trade your most precious resource (time) to get it. You know how it works. The average worker trades 40 hours a week, 50 weeks a year, and does that for 30+ years in exchange for heavily taxed dollars.
Passive income is different. The IRS narrowly defines it as income that is derived from only one of two sources. Those sources are from trade or business activity that you do not materially participate in or from rentals.
The difference between earned and passive income can be boiled down to time. With passive income, you don’t have to trade time for money like you do with earned income. You can earn it while you’re having lunch. You can earn it while you’re watching a movie. You can even earn it while you are sleeping.
Why passive income could be important to you
The point is that passive income isn’t you working for money; instead, your money is working for you.
If you create enough recurrent passive income to cover your monthly expenses, you are financially free and can spend your time as you see fit.
To me, that is what makes passive income so powerful. The older I get, the more I realize how precious time is. Life is short, and it is important to me not to waste a minute of it.
Unlike money, time is nonrenewable. I think Silvia Hartmann said it best when asked which was more important time or money? Her response was, “There is no time lottery where you can hope to win an extra million days.”
What really drove this concept home was when I heard a financial author say, “Rich people buy time, while everyone else sells it.”
When I understood that, I made it my mission to stop selling my time. I started building passive income that allowed me to cut back to part-time work and eventually retire from medicine at the age of 45. It’s not that I no longer work; I just choose to do the work that I’m passionate about. I spend far more time with my family than I used to and no longer miss holidays, birthdays, baseball games, music recitals or any of the other important things in life.
That’s the power of passive income!
Why invest in passive income through multifamily real estate?
As if that wasn’t good enough, the icing on the cake is that passive income from commercial properties and multifamily real estate is also highly tax-advantaged. The tax benefits afforded to apartment investors can allow them to defer taxes for years and, in some cases, even eliminate their tax burden.
Utilizing investments in passive multifamily real estate is a viable, proven way to invest in real estate without having to become a landlord. Instead, you can leverage professional expertise to create stable streams of tax-advantaged passive income that can buy back your time from work to do the things in life that matter most to you. That is what makes commercial and multifamily real estate passive income streams truly priceless.
Check out 37th Parallel’s complete guide to passive real estate investing to learn more about building wealth with a passive income from real estate.