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Passive income has become a big buzzword. The appeal of earning stable salaries without working “actively” is as strong as ever.
One of the most popular ways to create a passive income stream is through real estate, at least in theory.
The process goes something like this: you borrow money from a bank, you buy a property and the tenant pays your mortgage, and more. Once you build up more capital, repeat the process, buy more properties, scale up… and boom! You are a real estate tycoon.
But the reality is different.
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How about a condominium manager?
If you want to be a landlord, you need to find reliable tenants, collect rent, and handle maintenance and repair requests (out of your own pocket).
A good property manager can make life easier, but personal finance expert Dave Ramsey points out that income still isn’t as passive as it sounds.
“Even if you run the management company, they still have to call you and approve the new $8,400 heat and air system that blew up, or I had a $26,000 one brought out the other day on one of our commercial buildings,” he says in an episode of The Ramsey Show. “It didn’t feel passive with me at all.”
Ramsey still likes real estate as an asset class, but he cautions investors should know what they’re getting into.
“I love real estate. It gives you a better rate of return that other investments don’t have, but when I hear someone say passive income and real estate in the same sentence, it means they’ve been to get-rich-quick websites.
So how can you invest in real estate and make it as easy as possible?
Here are three ways to consider.
REITs
REITs stand for real estate investment trusts, which are companies that own income-producing properties such as apartment buildings, shopping malls, and office towers.
You can think of a REIT as a giant landowner: It owns a large number of properties, collects rent from tenants, and passes that rent on to shareholders in the form of regular dividend payments.
To qualify as a REIT, a company must pay at least 90% of its taxable income to shareholders as dividends each year. In return, REITs pay little or no corporate-level income tax.
Of course, REITs can still experience tough times. During the pandemic-induced recession in early 2020, several REITs cut their dividends. Their stock prices also tumbled during the market sell-off.
Some REITs, on the other hand, manage to pay out reliable dividends through thick and thin. Realty Income (O), for example, pays monthly dividends and has made 118 dividend raises since it went public in 1994.
It is easy to invest in REITs because they are publicly traded.
Unlike buying a home, where transactions can take weeks and even months to close, you can buy or sell shares in a REIT any time you want during the trading day. This makes REITs one of the most liquid real estate investment options available.
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Real estate ETFs
Choosing the right REIT or crowdfunding deal requires due diligence on your part. If you’re looking for an easier, more diversified way to invest in real estate, consider exchange-traded funds.
You can think of an ETF as a portfolio of stocks. And as the name suggests, ETFs are traded on major exchanges, making them convenient to buy and sell.
Investors use ETFs to access a diversified portfolio. You don’t have to worry about which stocks to buy and sell. Some ETFs passively track an index, while others are actively managed. All charge a fee, called a management expense ratio, in exchange for managing the fund.
The Vanguard Real Estate ETF (VNQ), for example, offers investors broad exposure to US REITs. The fund holds 167 shares with total net assets of $63.2 billion. Over the past 10 years, VNQ has produced an average annual return of 6.41%. Its management expense ratio is 0.12%.
You can also check out the Real Estate Select Sector SPDR Fund (XLRE), which aims to track the real estate sector of the S&P 500 index. It currently has 30 holdings and an expense ratio of 0.10%. Since the fund’s inception in October 2015, it has delivered an average annual return of 6.56% before tax.
Both of these ETFs pay quarterly distributions.
Crowdfunding platforms
Crowdfunding refers to the practice of funding a project by raising small amounts of money from a large number of people.
Nowadays, many crowdfunding investment platforms allow you to own a percentage of physical real estate, from rental properties to commercial buildings to land parcels.
Some options are aimed at accredited investors, sometimes with higher minimum investments that can reach tens of thousands of dollars.
To be an accredited investor, you must have a net worth of more than $1 million or an earned income of more than $200,000 (or $300,000 together with a spouse) in the past two years.
If you are not an accredited investor, many platforms allow you to invest small amounts, if you wish, even $100.
Such platforms make real estate investing more accessible to the general public by streamlining the process and lowering the barrier to entry.
Some crowdfunding platforms also raise money from investors to finance development projects. These deals typically require longer commitments from investors and offer a different set of risk-reward profiles than buying shares in income-producing rental properties.
For example, development may be delayed and you will not earn rental income in the expected time frame.
Sponsors of crowdfunded real estate deals usually charge investors fees, typically between 0.5% and 2.5% of what you invested.
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This article provides information only and should not be construed as advice. Comes without warranty of any kind.
