While there are many ways to make money in the real estate industry, in this article we will give an overview of how to create passive income streams using real estate. This would exclude being a real estate agent, a virtual assistant, or a wholesaler or other types of jobs that could be used as side hustles to build up seed money (extra cash) to invest in passive income opportunities. Real estate is an interesting asset class that many people and businesses need which means there are many ways to produce income.

What is Real Estate?

In it’s simplest form, real estate consists of land and physical properties. You can buy land and develop it into something or you can buy a physical structure. The typical path the majority of people take to making money from real estate is buying their own house. Similar to owning a stock, most people will buy a home and let the market appreciation increase the value of the asset they are holding. While this does happen, you can’t control the market.

Single family homes get valued based on the value of homes being bought and sold near by. If people near you are buying similar homes to yours for higher prices than what you paid for, then the perceived value of your home will increase. Land also appreciates as plots around it are bought for higher prices. Commercial properties, used for business purposes, are generally compared to their competitors as well but there is more emphasis on the income it is currently producing at the time of purchase.

How does this grow my passive income?

The main source of passive income from real estate has to do with renting out the space you own to someone else who is willing to pay for the space for a contracted amount of time. People need a place to live and a place to conduct business, if they can’t afford to buy their own space then they rent it from you.

Once you’ve acquired a home, apartment, a billboard, land, storage, parking lot, etc. then depending on your investment strategy, it’s time to add value. This may include cleaning up the outside or inside of the building or land you purchased. In order for people to want to pay for it, it must be comparable to similar real estate offered in the surrounding area. You may do this personally or pay a contractor who specializes in renovations. At this point, you can either work with a property management company that specializes in advertising and maintaining properties similar to yours so that you can focus on other investments, or you can manage it all yourself.

As soon as you have a tenant, someone who is willing to pay for your space for a contracted amount of time, then they can start paying you. This is done typically on a monthly basis and the funds are sent to your bank account. Depending on whether you have a management company in place or not, that may be the last thing you do. Every month, the tenant will pay rent and you will receive money in your bank account. If you own your building by yourself, then you get to keep all the money. If owned in partnership with a lender, then you will use part of those funds to pay your lender back.

Why do I want this passive income stream?

Like other investment products, real estate can also give you market appreciation and income. However, investment real estate also has a lot of expenses which can be used to potentially offset the taxable income like businesses do. Outside of the fees we spoke about earlier which can be used to reduce your taxable income, depreciation is another expense that you can use against your income. Depreciation is the gradual devaluing of an asset like a vehicle, machine, building, etc. until it reaches zero. Each year, it depreciates and is considered an expense even though you haven’t spent any money.

This is only amplified the more expensive the property is. Working with your accountant, you may even qualify to use any leftover depreciation to cover other passive income streams you have. Real estate becomes an essential portion of a passive income portfolio when you can decrease the taxes you have to pay on your income without having to spend additional money (beyond hiring a good accountant).

Risks and Considerations

“With great power, comes great responsibility”. When you begin building your own assets to produce income, you take on a different risk than other passive income streams you can buy or borrow, and that risk is you. As discussed, in real estate you are a landlord and will be held to the national and local law standards. You now control other’s fates in respect to where they reside or do business. It’s your job to hire the right help (accountants, lawyers, contractors, management company, insurance agent, broker, etc.) to make your dreams become a reality. Obviously, if that is too much for you there are private investments and REITs that specialize in doing the heavy lifting for you, but you are not in control and are at the mercy of the manager’s ability. The returns may not be as large as if you did it on your own but that is the trade off you must make as a passive investor.

Other risks that may not be in your control but that you have to deal with include:

• If the tenants damage the property, do you have the right insurance coverage, contractors, and processes in place to either fix it or remove the tenant, fix it, and then re-rent it quickly to cover the costs of owning real estate?

• What if the bank calls your loan due because they need the money, what is your plan of action?

• If the value of real estate drops due to economic factors and your tenant loses their job, do you have a plan in place of how your mortgage will still be paid and how you will handle a non-paying tenant? (Selling in this scenario might mean losing money depending on your initial purchase price)

• Since you are using expenses to offset your taxable income, are you and your accountant prepared for an audit from your national or state income tax regulating organization?

While there are a lot of risks, as mentioned earlier there are also a lot of rewards for those who can mitigate risk. One way to mitigate risk is to consume a lot of knowledge (podcasts, YouTube, local investor meetups, online forums, books, etc.).