Real estate investments commonly serve as a popular way to diversify investment portfolios. And understandably so. Real estate investing comes with a relatively easy to understand investing proposition:
- it can serve as a hedge against inflation,
- results in capital appreciation if held over long periods of time,
- acts as an income-generating asset and
- represents a tax-advantaged investment.
Furthermore, investing in real estate can provide peace-of-mind for the fact it is a tangible asset.
Investing in real estate comes in many flavors with varying degrees of time, effort, commitment and investment. Real estate investing offers opportunities for both passive and active income which you can start making consistently and quickly when done properly.
Keep reading to learn if real estate investing is right for you, the difference between active and passive income from real estate investing, and a variety of ways you can start earning money passively from real estate.
Should You Invest in Real Estate?
Some ways you can invest in real estate involve more risk than others. Your options will depend on your level of capital available, time availability, investment time horizon, among other factors.
Ownership can range from direct ownership and management to direct ownership with a third-party property manager, short-term rentals, real estate investment trusts (REITs), purchasing mortgage-backed securities, crowdsourced ownership, mobile home parks, site storage facilities, land and much more.
Luckily, the first method people tend to have when thinking about real estate investing isn’t the only option available to you as a real estate investor. We will address these alternative investment options below.
When choosing to invest in real estate more passively (other than direct ownership), some of the benefits include:
- Diversifying your investment portfolio
- The possibility of earning money both through dividends and eventual sales
- Low starting costs (depending on your investing preference)
- Having a tangible asset that hedges against inflation
- A variety of tax deductions
Directly renting your properties without a third party and remodeling and “flipping” houses can be very profitable, but they are also active work.
Renting out a vacation home short-term is less work than owning an apartment building with tenants where you need to get money from each month, but even the first option can require a lot of effort.
You can pay a third-party management company to maintain the property for you to make this income source more passive (but you still need to work with them).
Fortunately, there are many ways to earn income from real estate that are truly “set it and forget it” methods. The investment strategies below can either make you money right away, sit as a long-term investment, or do both!
How to Make Passive Income from Real Estate Investing
Remember that any type of investment comes with risks and passive income can still involve a bit of upfront work. However, relative to other investment types, most types of real estate are generally considered safer options.
Plus, if you choose a passive income strategy, like those listed below, you don’t risk wasting much valuable time.
Passive real estate investing has lower return potential than more active investing, but it also leaves you more time for other money-earning opportunities, including more active real estate investments if you so choose.
Pick the real estate income opportunity (or opportunities) that match your current budget and level of risk aversion.
1. Direct Ownership and Management (or with 3rd-Party)
The most common method for real estate investing when considering the investment opportunity is from directly purchasing a property and renting it out to tenants.
However, before choosing to buy a property to rent to others, you should ask yourself a few questions, including:
- Do you want to rent commercial or residential properties?
- Are you interested in ready-to-rent properties or “fixer-uppers?”
- If you don’t already own a suitable property, can you afford the mortgage on another property?
- Do you want to rent directly or through a third-party service like Airbnb?
According to best-selling author and personal finance expert Chris Hogan, “You should be debt-free before you think about buying a place to rent.” Besides not having enough money upfront to pay cash for a rental property, common mistakes people make after buying property to rent include:
- Not being ready to be a landlord (being a landlord isn’t passive)
- Not maintaining enough cash flow
- Being unfamiliar with local codes and ordinances
- Not screening tenants thoroughly
- Not collecting rent promptly
Does all of that sound like a lot of work? It is! Unless you can afford to hire people below you to work as landlords (also known as property managers), this is a very active way to invest in real estate.
My Experience Owning Real Estate Directly
I can speak from experience, having owned three rentals for the past 5 years. One property, a condo in downtown New Orleans, rents easily and for a fair return. It was the best investment I’d made to that point in my life.
It also comes with low maintenance costs and the upkeep has proven extremely low, saving additional investment in the property and allowing the monthly cash flow to remain as a pure return.
With the other two rentals, we have had difficulty filling one with long-term tenants in the past. This mostly relates to the property’s layout, a shotgun house as they’re called in New Orleans. This housing style has all rooms in a row, providing for a single hallway which cuts through all rooms in the property.
This housing style works well for families who do not need as much privacy, say, as a set of college roommates. We have had the property filled with graduate students at nearby Tulane University and have had the great fortune of choosing good tenants to call as neighbors.
As for the final rental, this one is also in this shotgun house but has separate accommodations, allowing for us to list the unit as a short-term rental on AirBnB. I will discuss more of this arrangement later in the post.
2. Short-Term Rentals
With short-term rentals, you can often charge more on a nightly basis than you would with longer-term tenants and you don’t need to spend time chasing down rent. If you use a third party, such as Airbnb, for short-term rentals of a property you already own, you can earn money relatively passively.
Airbnb isn’t your only option. There are competitors, such as Booking.com and TripAdvisor rentals, but Airbnb is the clear leader.
The average Airbnb host makes about $924 a month and in some countries Airbnb’s Host Guarantee program gives you protection up to a million dollars in damages if guests aren’t thoughtful.
Most full-time Airbnb real estate investors started out by using Airbnb as a part-time side project. You can even rent just a room in your home, rather than an entire house or apartment.
Personally, my wife and I rented out a spare bedroom in our home for two and a half years to add some extra income to our bottom line. This money, when combined with rent collected from long-term tenants living in another unit on the property, completely covered our mortgage and living expenses.
We managed to save a significant amount of money during this time to put us on the path toward buying our first home together as a family. We can directly point toward these rented units as how we managed to make a substantial contribution to our down payment fund.
When we hosted guests, one of the major downsides of the short-term rental were the hassles of constant scheduling and cleaning requirements, but there are ways to minimize this. We planned ahead and developed an efficient routine to flip the room between guests.
However, you have ways to combat these problems. You may increase the passiveness of renting out your space by setting higher minimum night stays for guests.
We found setting a 3-night minimum kept us booked most weekends during busy season (October – May in New Orleans) and netted us around $500 – $800/month.
The logic is simple: instead of allowing single-night guests, you can set a two or three-day minimum. The fewer turnovers, the less work.
You can also hire cleaners who know to automatically clean when guests leave and stock up on needed supplies.
One thing we did to make our listing stand out was bringing in a freelance photographer to take attractive photos of our space. You might consider hiring a freelancer from Fiverr to improve your listing as well to grab your potential guests’ attention.
These services can include writing detailed and compelling listing descriptions, taking photos of the space for rent, promoting your listing, creating a welcome book for guests when they arrive, and much, much more.
The more unique and value-added services you can provide, the better reviews you will receive from guests. These little details will make your listing special and help you get on your way toward becoming a Superhost and earning a respectable side income with space you already have available.
3. Real Estate Investment Trusts (REITs)
A real estate investment trust (REIT) is a company that owns income-producing real estate and pools investors’ money to gain and manage real estate properties. Typically, REITs are high-end or commercial properties and they can fluctuate in correlation with the stock market.
REITs allow you to invest in the real estate sector in a completely passive manner as you essentially own a share of the fund. The rental payments pass through to REIT owners on a monthly, quarterly, or annual basis.
People who invest in REITs receive dividends in the same way you receive dividends from certain stocks and these returns are usually higher than most other stocks.
A benefit to REITs that you don’t have with a lot of other real estate investments is that your money stays liquid because you can sell at any time.
The upfront costs for investing in a REIT are relatively low and they are simple to purchase through a brokerage account.
If you find choosing between hundreds of publicly-traded REITs intimidating, you might consider investing in a real estate exchange-traded fund (ETF).
With ETFs, a professional fund manager decides which REITs to invest in and uses investors’ money to buy groups of REITs. There are far fewer options to choose from if you want an ETF instead.
For both real estate investment trusts and real estate exchange-traded funds, income is taxed as a capital gain tax rate rather than as passive income. Despite the tax categorization, it’s about as passive of income as it comes.
There is always the possibility a REIT investment could go down in value in a tough market so make sure to research top funds first and be financially able to hold investments long-term to avoid selling during a dip.
You can buy publicly-traded REITs through most major online discount brokers. I recommend using the free stock trading app, Webull.
The platform has a long list of commercial REITs to choose from and comes with free stocks for signing up to the service after making an initial qualifying deposit.
Webull will provide you with any REIT’s current price, volume, % turnover, market cap, analyst ratings, recent news stories, and more. This makes it easy to conduct market research on several REITs before choosing which one you can invest in confidently.
If you you’d like to consider a non-publicly traded REIT option, you may want to look into Streitwise, a professionally-managed REIT service targeting commercial real estate properties.
The service caters to accredited and non-accredited investors alike and charges up to 80% less than the company’s non-traded REIT competitors.
4. Mortgage Notes
Another way to create passive income through real estate is by creating or purchasing a mortgage note. You can buy performing and non-performing mortgage notes from other investors, commonly with a small discount.
Alternatively, you can create a note from a property you own using owner financing. Mortgages and notes are two separate contracts used by lenders to provide buyers with money to buy real estate.
A promissory note outlines the repayment of a debt and the mortgage secures the lender’s property as collateral if the buyer defaults. Some home buyers choose to take out a home loan as a private note instead of a traditional loan.
You can think of investing in notes like you’re taking the place of a bank. Each month, the buyer pays you a monthly principal and interest (if the borrower wants to pay off the mortgage faster, it can eat into your returns).
It’s the buyer’s responsibility to maintain the property, have insurance, and pay taxes. Your job is to collect a check every month and keep records of the payments and debt balance.
In the event the property owner fails to make payments, you take ownership of the property.
Income earned from mortgage notes is categorized as “interest income.” The interest collected on the loan during the given tax year is taxed as ordinary income.
Overall, this form of passive real estate investing can be very complex and likely is a better fit for people already somewhat familiar with mortgage notes.
5. Crowdfunding Real Estate (Residential and Commercial)
Real estate crowdfunding is still a relatively new way to earn passive income. It lets you invest in assets you might not otherwise be able to, such as a high-rise apartment building.
You also benefit from the expertise of people who know how to add value to the property in cost-effective ways.
Investing in real estate through a crowdfunding platform allows you to find deals, usually debt-based investments, that pay you a fixed payment for a set amount of time. These platforms allow you to make money while you sleep as opposed to concerned over managing tenants.
Depending on the investment opportunity, dividend returns may be paid monthly, quarterly, or annually. Other opportunities offer you a slice of future profits from the property’s sale or distribution while some provide a combination of both.
Remember, these types of investments are usually illiquid, so they are meant as a long-term investment.
How to Begin Real Estate Investing with Crowdfunding
Fundrise is considered the first company to crowdfund real estate investments successfully and is currently the largest real estate crowdfunding platform. It remains a leading service for helping people to start investing in real estate.
Fundrise acts similarly to a REIT where you get to invest in real estate portfolios. With Fundrise’s Starter Portfolio, the minimum to invest is only $10.
They’ll help you create a customized portfolio based on your personal goals and you can track your performance and view updates in real time with this passive income app.
Consider signing up for an account to learn more about the service and whether this alternative investment option would be a good fit for your investment portfolio.
If you’re in a high income bracket, the real estate crowdfunded investment company EquityMultiple may be a good fit for you. The minimum investment for this company is $5,000 and they focus on individuals interested in commercial real estate investing.
However, that same $5,000 can also make money on Fundrise and may involve less effort on your end.
6. Mobile Home Parks
Investors who buy a mobile home park own the land where the mobile homes park. The investors do not own the mobile homes themselves, but do collect rent from residents on the property.
In a sense, you act as a landlord of an apartment complex where the units are mobile homes instead of rooms in a building.
Mobile home parks do particularly well during times of economic stress or when housing prices are skyrocketing. When the economy is turbulent, people often seek this type of affordable housing and demand is currently high.
There is typically minimal tenant turnover because moving homes in and out of a mobile home park tends to carry a high cost.
Mobile home parks let investment companies acquire more units per investor dollar as well as diversify your risk. This means you face less risk by having many trailers than only a handful of rental homes.
However, this investment requires a significant amount of capital-intensive to get started, so investors sometimes choose to invest in deals as part of a fund.
7. Self-Storage Facilities
Rather than renting out buildings people live in for any amount of time, some real estate investors choose to rent out storage facilities for storing people’s physical possessions. Storage facilities are high in demand around almost the entire country.
These types of buildings allow you to avoid most of the active work that comes from having tenants and can work well as a passive income source.
Facility costs and vacancies can scale across several units, which makes it a relatively low per-unit cost.
However, large facilities may require you to hire a management team which can cut into your profits and time. It boils down to how much scale you can achieve.
The good news is that it’s easy to start small with this sort of investment. If you aren’t ready to rent several units, start with one. People with an empty barn, garage, or large shed can easily rent out space in those to test out if they enjoy this strategy for passive income.
Real estate investing doesn’t even have to involve buildings. You can invest in raw land.
Unfortunately, this passive income option doesn’t produce money as quickly as some of the other choices. But once you rent or sell the land, your profits can more than make up for it.
As far as renting the land, some choose to rent it to farmers or people who want a garden, but don’t have space for one at home.
The website Shared Earth helps landowners connect with farmers. You can also check in with community groups.
Another option is to use the land as a dog park. Depending on the location, size, and characteristics of your land, there are many options.
If you choose simply to sell the land, you can avoid having anything close to the responsibilities that come with tenants.
A popular strategy is to purchase land in an up-and-coming area that will soon be developed and then sell it for a profit when the area becomes more desirable. You can choose to sell it all as one unit or divide it up into smaller sections.
My father-in-law has done this extensively during his career. He purchases properties in areas he believes will become in-demand over time and holds on to them while they increase in value.
Currently, he has a 3-acre plot of land located directly adjacent to two subdivisions under construction. He knows these property developers would have interest in his land and wants to market it to them directly.
His strategy has worked for several families looking to build generational wealth because of his patient capital.
Taxes for Passive Real Estate Investing
Passive income from real estate investing comes with several tax advantages. One of the main benefits is deducting expenses against your taxable income.
Some of your deductions may include:
- Property maintenance, repairs, or improvements
- Property tax
- Landlord insurance
- Marketing expenses
- Mortgage interest
- Property management fees
If you choose to invest in real estate with an entity, such as a limited partnership (LP) or limited liability company (LLC), you open yourself up to even more deductions.
You may be able to deduct office space and supplies (including a home office), legal and professional fees, and certain travel expenses.
These can qualify as self-employment tax deductions. You may also deduct relevant membership fees and meals with current or prospective clients, though special rules apply.
Another common tax advantage for real estate investing is MACRS depreciation. When you own an income-producing investment property for at least a year, you can slowly depreciate the property’s cost. This means you can deduct a property’s loss in value over its expected life.
For residential properties, this is considered 27.5 years and commercial property is considered 39 years. Additionally, you can depreciate certain capital expenses, such as replacing a roof.
Note that when a property is sold, the IRS requires you to include recaptured depreciation on the Section 1231 or 1250 property. This requires the seller to realize the accumulated depreciation as ordinary income with a cap at 25%.
However, you can avoid a depreciation recapture with a Section 1031 exchange. This tax arrangement, colloquially referred to as simply a “1031 exchange” receives its name from Section 1031 of the IRS tax code.
It is a legal transaction where real estate investors swap an investment property for a like-kind property, thus avoiding capital gains and depreciation recapture on the property’s disposition (sale or transfer).
For real estate investing, when you sell a property you owned for a year or longer, you can pay advantageous long-term capital gains taxes rather than ordinary income taxes.
However, if you sell a property for more than you paid for it and owned it for less than a year, these gains fall subject to short-term capital gains, equivalent to ordinary income taxes.
Typically, capital gains are typically a lower tax rate than ordinary income, depending on your income level.
Overall, the taxes involved with real estate investing can become tricky. If you have little experience earning passive income from real estate investing, I highly recommend consulting a professional.
The cost of a tax professional can more than pay for itself when they find all the possible tax breaks for your situation.
Real estate investments tend to have more stable returns over time as compared to stocks. These predictable and tax-advantaged returns make real estate an excellent addition to your investment portfolio.
Further, over the long-run, these investments act as a great hedge against inflation. Some require more work than others, making some forms of real estate investing feel like a full-time job. Others listed, however, can create more passive income streams for your financial picture.
Thankfully, now, more than ever, you have numerous options for investing in real estate. Depending on your available capital, risk tolerance, willingness to invest your time and investing time horizon, the options laid out above would likely appeal to your long-term investing goals. Consider signing up for one of the services mentioned to learn more.