How To Create Passive Income In Real Estate

"PASSIVE INCOME" written on a chalk board

Passive investing is one of the most common strategies for increasing your income, growing your investment portfolio and building a healthy nest egg for the future. Done right, it won't have to take lots of your time and energy. Real estate is a great choice for building passive income streams. There is, however, an added risk. As a result, this strategy isn't for every investor. We review what passive income is, why real estate plays a role and how you can use it to reach your financial goals.

Deciding on whether or not to invest in passive income assets is best done in consultation with a financial advisor.

What Is Real Estate Passive Income?

Whether you're eyeing early retirement or just want a more secure financial situation, building passive income sources can be key. Put simply, passive income is a strategy that allows investors to generate revenue without continuous, active involvement.

Investors can utilize various real estate options to generate this passive income. Some may purchase and manage rental homes while others might opt to invest in commercial properties.

Why Passive Income Matters

No matter your career, your income is inevitably limited by time. Whether you work on salary, make an hourly wage or even have a side hustle that earns extra money, you will eventually run out of hours in the day in which you are able to generate more income. And that's not even to mention the toll that non-stop work would take on your mental, emotional and household health.

Passive income changes that. While the actual level of involvement will vary from one investment to the next, the idea is that once your real estate investments are established, they can generate revenue on their own. Essentially, you are able to earn money while you work your 9-to-5, while you sleep and even while you're on vacation with your family.

These passively earned funds can be used to boost your savings accounts, pay off debt, save for your kids' college, achieve financial independence or even provide income throughout your retirement.

Types of Real Estate Passive Income

There are many different avenues to choose from when considering passive income real estate investments. The one you should choose will depend on your level of experience, your available cash flow and the time you can afford to dedicate to your investment. Here are a few real estate investment options to consider.

Single-Family Home (SFH)

A single-family home, or SFH, is an individual, standalone rental property, such as a house or even a condo unit. These properties can be purchased and then rented out to a single tenant, a couple or even a family. This provides both long-term asset growth and, in many cases, additional monthly revenue.

An SFH is one of the most common choices for real estate investment. However, they can also be risky, as turnovers and vacancies equate to income lost for landlords.

Multi-Family Units

Another option for rental property is the multi-family unit, such as a duplex, triplex or quadplex. These units allow you to generate income from multiple tenants while only managing one physical property.

This can be easier in some ways (one mortgage, one property tax bill, etc.), and it generates more revenue than a single-family property. It also allows you to spread the risk of a vacancy out over multiple units, buffering the financial impact. However, it also means managing multiple leases, tenants and potential vacancies at the same time.

Apartment Buildings

If you're looking at a larger passive income scale, apartment buildings — which include properties with five units or more — may meet your needs. As with multi-family properties, these investment properties can be more streamlined in some ways and increase the potential for passive revenue income.

Apartment buildings also require a much more involved management process, however; you may want to hire a property manager to find tenants, collect rent and facilitate repairs, all of which can affect your revenue.

Storage Units/Facilities

Both urban and rural communities can benefit from storage unit facilities, which are in demand in nearly every populated area of the country. With multiple units and relatively-low overhead, storage facilities can be a great way to generate passive income.

Your revenue will depend on the number of units you own, as well as factors such as climate control and customer access. You will likely need to consider the costs of property management, security and insurance.

Vacation Homes

A vacation property can be a fun and lucrative option for generating passive income. These properties can be purchased in areas that you and your family already enjoy visiting, allowing you to use the home certain weeks out of the year and rent it out the rest of the time. In some cases, it may pay for itself, your vacations there and then some. Costs include the usual homeownership expenses (repairs, updates, insurance, etc.) as well as management costs, rental platform fees and housekeeping services.

You will also need to account for tourist trends and seasonal vacancies.

REITs

If you're looking for a hands-off, extremely passive investment option, real estate investment trusts (or REITs) may be the way to go. REITs are essentially companies that own real property or hold the mortgages for properties. When you invest in REITs, you are purchasing shares of that property and benefitting from the growth of the asset.

As the properties appreciate in value, so will your shares, which you can eventually sell for a higher price. You may also receive dividends from your REITs, which provides you with a passive income stream.

Commercial Property

Depending on your available capital, you could consider purchasing a commercial building, industrial complex or even blended residential/commercial (mixed-use) properties. These generally require a much higher initial investment than residential properties. As such, they may be better suited to investors with partners and/or significant available capital.

Commercial properties have the potential to bring in stable passive income with long-term tenants. However, be sure to account for lengthier vacancies and higher remodeling costs.

P2P Lending

If you have the capital available, but don't necessarily want to deal with the hands-on requirements of landlords or property flippers, peer-to-peer (P2P) lending could be worth a look.

With P2P platforms, you are able to lend out your capital to other real estate investors. This enables them to remodel, flip, or rehab their own property with your funds. Your loan will then be repaid — with interest — earning you a passive return in a relatively short period of time.

How to Invest in Real Estate

So, you know the most common types of passive real estate investments. Now how do you actually get started investing in real estate? There are three key steps you should take.

Know What You Can Afford

As with all investments, it's imperative that you first know what you can afford to invest in the first place. Yes, creating passive income streams is an important part of the financial freedom journey. However, it shouldn't come at the sacrifice of your financial stability.

Spend some time considering your current cash flow and available funds. Can you afford to hold an investment through a worst-case scenario, such as an extended tenant vacancy or major property repair?

Choose Your Level of Involvement

Just how passive do you want your real estate investment to be? If you want a completely hands-off process, consider investing in REITs or peer-to-peer lending platforms. If you don't mind basic property management, a single-family home might be worth considering.

Consider how much time you have to invest in your real estate venture right now. Then, pick a passive income approach that maximizes the return on your time.

Analyze Profitability

Some passive income investments are more profitable than others. Some may provide you with a passive income stream today, while others are more of a long-term investment. Which is more important to you?

Before investing, crunch the numbers to determine your investment's profitability. Be sure to take into consideration your financial plans, retirement strategy, available cash reserves and the time you're willing (and able) to commit. In some cases, a less profitable investment may make the most sense for your unique situation. Conversely, you may need to wait a few years before seeing the true return on your passive real estate investment.

The Bottom Line

Passive income streams can help you build a sustainable financial plan that supports you into retirement and beyond. Real estate investments are a great choice for generating that passive income and can be tailored to almost anyone's situation. Regardless of how much time or capital you have to invest, you can find a real estate passive income option to fit. Real estate passive income can bolster your savings, eliminate personal debt and support a small business venture. Or, for many investors, it can simply ensure that your life after retirement is as financially secure as possible.

Investing Tips

Consider working with a financial advisor experienced in real estate. Finding the right financial advisor who fits your needs doesn't have to be hard. SmartAsset's free tool matches you with financial advisors in your area in five minutes. If you're ready to be matched with local advisors who will help you achieve your financial goals, get started now.
Do you have a rough estimate as to how much the property you're looking to buy will cost? If so, the mortgage calculator from SmartAsset can help you decipher about how much your loan will cost on a monthly basis. Through this tool, you can integrate a bunch of other factors, such as an interest rate, down payment, loan type, taxes and more.

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