How to Build Passive income through Real Estate
Passive income is money that you earn in a manner that requires little to no effort on your part to maintain. Essentially, you earn passive income when you put your money to work for you.
While this strategy may take some time on the front end to set up since you have to earn the capital or put in the initial effort, your money could start earning you passive income in your sleep.
And who wouldn’t want to make money while sleeping? Or on vacation?
Building up passive income through real estate investing is one of the most popular paths that investors take to create that income stream.
There are many benefits to investing passively in real estate, that many of these other investment vehicles don’t have and not only does real estate appreciate in value, it can also pay you attractive dividends.
If you’re looking to maximize your passive wealth by investing in commercial real estate, here are 12 ways to do it:
Construction & Development
The first method of building passive income in real estate is development and construction.
Real estate development is a very intense process by which a real estate developer acquires raw land and finances a real estate project, builds or hires a contractor to construct the project, creates, imagines, and orchestrates the entire process from conception to delivery.
With so much involved in re-imagining a site, development and construction can be very capital intensive.
So, these developers often raise the necessary equity from investors and combine that with debt from a lender in order to fully capitalize a project.
As long as our country continues to grow and real estate needs shift, there will always be demand for new construction projects. In the Southeast, for example, there’s a limited inventory of housing since the population has been growing significantly in recent years.
You could invest with a local group of contractors and developers that are building anything from single-family residential homes to office towers. Be sure to thoroughly vet the group and make sure you understand all of the implications of the project and the investment.
Real estate developments can be among the riskiest endeavors in real estate, but when they are successful, they can be among the greatest wealth-builders in commercial real estate.
2. Crowdfunding
Crowdfunding is another excellent way for a new investor to begin growing passive income in real estate.
Online fundraising sites have grown in popularity over the last decade.
These platforms, such as Fundrise and Realty Mogul, allow individuals to passively invest in commercial or residential real estate projects. Not only will these investors receive passive income through cash flow distributions, they may also own equity in the deal.
Similar to placing capital with a Real Estate Investment Trust, you may invest as little as $500 and combine your cash with other investors to take down larger projects. Ultimately, investors get the benefit of cash flow (dividends and distributions), as well as long-term appreciation of the properties you “own.”
The best part? You don’t have to be accredited.
That means new or younger investors will be able to take advantage of these online real estate investing platforms to begin building passive real estate income.
The ease of use with an online platform combined with a lower cost of entry makes crowdfunding an excellent investment option for any investor looking to maximize their passive wealth.
3. Exchange-Traded Funds
An exchange-traded fund (ETF) is a grouping of stocks or bonds into one single fund. ETFs offer diversification and lower costs like index and mutual funds.
These ETFs may invest in stocks issued by real estate investment trusts (REITs) that own office, retail, hospitality, etc.
REITs are an amalgamation of real estate companies that own or finance income producing properties, and ETFs may invest in multiple REITs. This diversification certainly helps lower the risk of investing in real estate.
Another attractive aspect of investing in ETFs is that you, as the investor, get the passive income potential that is provided by real estate while having the liquidity of a stock.
4. Hard Money Lending
Hard money lending certainly takes a bit of skill and finesse, but it’s a wonderful way to build wealth and expand your streams of passive real estate income.
If you’ve saved a significant amount of cash and aren’t interested in investing in your own deals, becoming a hard money lender could be the path for you.
Real estate investors utilize hard money when they are unable to qualify for a traditional bank loan or only need capital for a short period of time. Hard money is also an option for investors who are just looking to fix and flip a project on a quick timeline.
Hard money lenders will usually charge an upfront fee in the 2-3 points range plus 10-12%+ annual interest on the loan. Of course, these numbers will vary from lender to lender and you can set your own terms.
Not bad for a passive investment!
However, you do need to take caution as a hard money lender and be sure to fully vet not only the group receiving the loan, but also the project they’re taking down. After all, if you end up having to foreclose on the property, your passive income will become an active job and you want to be sure it could be a successful project.
5. Hire A Property Manager
Maybe you already own real estate and you’re looking for other options. Maybe you want to invest in commercial real estate nearby but aren’t interested in having any partners.
If that’s the case, then hiring a property manager to handle your projects is the way to go.
While this route could still technically be considered an “active” investment, having the right property management company in place will help turn nearly any project into a passive real estate investment.
Let your property managers do all the heavy lifting.
Commercial property management companies will typically charge anywhere from 4% to 10% of gross rents collected, depending on the size of the project. They run the day to day for your investment - any minor repairs, touring and vetting prospective tenants, collecting rents, and so much more.
The strategy here is to ensure that the commercial investments you’re making can, of course, afford to pay a property management company. Even if you decide to run your commercial real estate investment yourself, if you don’t have enough cash flow to pay for management, you should probably walk from that deal.
6. Mutual Funds
Similar to investing in real estate ETFs, you can also passively invest in real estate mutual funds.
Real estate mutual funds are professionally managed investments that place capital in a variety of products, most often REIT stocks, real estate related stocks, or a combination of the two. Investors purchase shares of the mutual fund at the fund's current net asset value.
Mutual funds are often a low cost alternative to other passive real estate investment options. You can quickly find an investing fund’s track record, which will help you during your vetting process.
In addition, mutual funds are sometimes run by economists and seasoned commercial real estate veterans, so you’re likely in good hands.
7. Owner Financing / Debt
Don’t want to run your own commercial real estate investments? Become the debt financier for someone else’s!
Like hard money lending, as a debt financier you act as the bank in an operator’s commercial real estate investment. This option is an excellent route to take if you already own the real estate, enjoy monthly passive income, and don’t want to pay hefty taxes.
Similar to a traditional bank, you take anywhere from 5% to 20% down with an amortization schedule between 15 and 30 years at a predetermined interest rate. Most of the passive investors that I see taking this route will have a 5-7 year balloon on the mortgage.
Your spread as the investor is whatever interest rate on which you and the operator come to terms and you retain 1st position on the deal.
If the buyer ever defaults on their mortgage, you have the ability to foreclose on the property and either keep it or resell it.
8. Invest with a Real Estate Company
Maybe you don’t want to find, fund, and operate your own deals but are willing to pay someone else to do that. If you’re looking to keep it local, you could invest directly with a commercial real estate company in your area.
By investing locally, you’ll be able to drive by your projects whenever you like and will be able to offer input on future acquisitions thanks to your knowledge of the market.
Companies that focus on real estate can be in development, construction, and brokerage, but could also include specific properties like hotels, office parks, shopping malls, and other commercial real estate developments. The beauty here is, while you’re still focused on passive income, you can influence the decision-making, if you’re so inclined.
As with any of these other passive investments, I recommend that you conduct thorough due diligence before you buy shares in local company or co-found your own. However, this option is an excellent path to take if you’re looking for exposure to a specific type of real estate investment and are able to perform enough due research on the company (or partners) and their previous projects.
9. Real Estate Investment Trust
Real estate investment trusts are companies that own or finance income-producing real estate across a broad range of asset types and classes. These real estate companies have to meet a number of requirements to qualify as REITs. Most REITs trade on major stock exchanges, and they offer a number of benefits to investors.
Just like ETFs and mutual funds, you don’t actually own anything when you invest in a real estate investment trust. REITs can also help you diversify your portfolio, as they will invest in multiple different asset classes.
Like other stocks and bonds, REITs have plenty of the long-term data to offer, which will help dispel any uncertainty about the ups and downs of the real estate market.
It’s recommended that if you decide to invest in real estate investment trusts that you stay away from non-traded REITs and aim only for publicly-traded REITs. Non-traded REITs have become notorious for their lack of liquidity, higher fees, and lack transparency, creating unnecessary risk for investors.
10. Real Estate Notes
Real estate notes are promissory notes that are secured by a specified mortgage loan. Essentially, the mortgage that already exists on a property.
When purchasing real estate notes through a bank, you’re usually buying debt at prices that are well below what a retail investor would pay. If the loan is non-performing, i.e. the property owner has defaulted on their mortgage, the bank may be willing to part with the real estate note for less.
I’ve seen discounts in the range of 5%–50% off the current market value.
But they are sold at discount for a reason: the homeowner is non-performing. And non-performing real estate notes are bad for cash flow and balance sheets. However, most investors will see that as an opportunity to build their wealth.
As the new note-holder, when the homeowner defaults, you can take possession of the property and turn it into a long-term rental, fix and flip the house, or just resell it.
You should know with absolute certainty what you’re getting into, whether you invest with a bank or a real estate investor, because you may end up with that property one day.
11. Syndication
A real estate syndication is simply the pooling of funds from numerous investors for the purpose of acquiring various types of real estate projects. Similar to some of your options above, a syndication can be as small as a few investors buying a small office building to fifty plus investors taking down a shopping center.
These capital raised can be used for acquisition, renovation, construction, development, tenant improvements - pretty much anything within the project.
In my experience, the General Partner, who operates the deal, typically takes anywhere from 20%-30% equity in the project and sells the rest to passive investors, called “Limited Partners.” These investors may or may not see some sort of preferred return on their capital, but will have cash flow distributions (passive income), as well as equity in the project.
12. Transactional Funding
Transactional funding is similar to hard money and debt financing, but you’re only financing the a real estate deal that is in between closings. This type of lending is typically a very, very short-term financing solution for real estate investors that intend on being in and out of their real estate deals quickly.
The most demand for this type of funding comes from wholesalers, who use transactional funding to help them accomplish a double-close.
For example, you, as the transactional money, would help them close on the purchase of a property in the morning and they pay you off when they sell that property (double-close) in the afternoon.
It’s very easy to see how these deals could turn sideways fairly quickly, so it’s important that you understand the deal, since you may wind up owning a new piece of real estate.
Lenders in the transactional funding world don’t like their capital to be out for very long, since they can build wealth faster by charging points every time capital is lent.
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About the Author:
Tyler Cauble, Founder & President of The Cauble Group, is a commercial real estate broker and investor based in East Nashville. He’s the best selling author of Open for Business: The Insider’s Guide to Leasing Commercial Real Estate and has focused his career on serving commercial real estate investors as a board member for the Real Estate Investors of Nashville. Learn more at www.TylerCauble.com
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