Passive income is one of the most popular topics in personal finance. And for good reason! There is nothing more appealing than having monthly income show up in your bank account after doing zero work. However, getting to this point is not always a simple task.
The first thing to understand is that building passive income takes time, dedication and needs to be aligned with your future goals. This is a marathon, not a sprint and you’re going to need a good reason to keep at it past the first few weeks. Some popular ones include:
- Family: Not wanting to miss your kids childhood because you are at work.
- Philanthropy: A lot of people may seek to spend their time contributing to a greater good. Often, this involves a pay cut for a length of time.
- Freedom: Travelling the world, or being able to not live in one set location are important to many people.
Non Accredited Investment Opportunities
Investors seeking passive income have three primary investment options:
- Single Family Real Estate
- Multi Family Real Estate
- Dividend Stocks
All three will help you earn income without having to work for it, but each option has it’s own pro’s and cons. To build meaningful income streams from these assets, first, you are going to have to focus on saving money to purchase them. Whether it’s an initial down payment or building a sizable dividend portfolio, it takes money to make money.
Let’s say you have saved $50,000 to put towards creating passive income. Now, you want to know which investment maximizes your chance for success. Let’s explore how far 50k will get you in 3 different scenarios. These examples are for educational purposes only, we are not providing investment advice in this article. Simply, illustrating a point.
Single Family Real Estate
In the first scenario we’re going to use RoofStock to purchase our single family investment property. Single family real estate is the most intuitive way for most people to break into real estate. It’s logical and approachable. You can even live in your property for a few years and then rent it out down the road. If this type of passive income interests you but you’re unsure where to start, making a free account with Roofstock allows you to see a ton of investment properties all over the country.
Alright, back to the point, you have that $50,000 ready to go so let’s see what they can do for you.
Roofstock’s dashboard gives you all the key metrics for any property that’s listed on their site. The asking price of this home is $115,000 (often a negotiable number). Below that you’ll see a sliding scale for down payment (in percent of the purchase price). Change this and Roofstock will automatically calculate your initial investment. The estimate for the initial investment above ($45,223) includes down payment, closing costs and an estimate for any immediate repairs that might need to be made.
Finding an Appropriate Down Payment Amount
You might be wondering why the down payment is only $45,223 when we have 50K to put down. The reason is that when you buy a property, you need to have money set aside from day one to cover repairs. A good rule of thumb is 10% (5K) of the amount you have saved (50K). Things break unexpectedly no matter how well you inspect a property. You don’t want to be facing the stress of a large unexpected maintenance expense.
Above you can see the total return you will make in the first five years. The total return includes: cashflow and estimated appreciation, in this case it is $34,499. All the other numbers pictured refer to annual numbers. The cashflow for your first year will be $4,199.
Not bad for a 45K investment! Cashflow is the most relevant of these numbers because it factors in loan payments , property taxes, management fees and maintenance cost. It is the bottom line you will make after all these expenses. The other key number to pay attention to is annualized return (13.9% for this property).
Annualized return is the percentage return on your initial $45,223 which includes cashflow and appreciation. Roofstock uses Zillow data to estimate property appreciation. The combination of these two values is the total return you make on your investment per year . Annualized return is often referred to as Internal Rate of Return (IRR). We will refer to it as IRR for the remainder of this article. IRR is one of the most useful metrics for comparing total annual return between different investments.
Your Potential Returns
Okay, let’s see how your 50K would perform as an investment in this property.
- $349/month in income. Maintenance costs come up and decrease this.
- IRR of 13.9% At this rate your investment will double in five years. See note below.
- Tax benefits: In addition to cashflow and total return, owning a rental property comes with a slew of tax benefits such as depreciation and maintenance expenses that will likely help you lower your tax bill while increasing income.
Rule of 72
There is a simple rule of thumb that you can use to estimate how long it will take your money to double. It’s called the Rule of 72. Take 72 and divide by your IRR. In this case 72/13.9 is about five years.
If you’ve done the hard work of saving your money, single family real estate is a pretty compelling investment. You can make hundreds per month in passive income while building your equity and reducing you tax bill. The only catch is that you need to put in a lot of leg work to find a property on your own. Again, the most passive way to do this is through RoofStock but you will need to find a property that will allow you to have positive cash flow.
If you are interested in single family investments, here are a few resources:
- How to Invest in Real Estate Using the VA Loan
- Buy it, Rent It, Profit
- Bigger Pockets: The Book on Rental Property Investing
Multi-Family Real Estate
In the second scenario we’re going to use Upward Capital to purchase our multi-family investment property. With multi-family real estate you are buying a building that has multiple rental units that each generate their own regular source of income. The most basic multi-family property is a duplex which is a single structure with two separate units. Buying a small multi family is similar to buying a single family property. In fact you can even buy up to a quadplex with the VA loan.
On the other hand, multi-family investments can scale all the way to large apartment complexes with thousands of renters. For the purpose of this article, we are going to focus on larger multi family buildings. Larger buildings tend to be more passive, for example a building with over 70 units typically has a dedicated property manager. There are two primary ways to invest in large multifamily buildings: as a syndicator and as an investor.
How to Invest: As a Syndicator
A real estate professional who coordinates investments in a Multi Family building. They do all the legwork (and there’s a lot) for a slice of the pie. They are compensated with a share of the proceeds similar to investors who are entitled to a share proportionate to their investment amount. Syndication is essentially real estate crowdfunding.
Multifamily real estate takes a significant amount of work to break into as a syndicator. The primary way you find properties that are larger than 4 units are through real estate brokers. Most brokers are not interested in sending you their properties until you have already bought one. Here are some of the problems you will need to solve to land your first deal:
- Finding enough people willing to give you money to make the down payment (investors)
- Finding a wealthy investor who can put up collateral to get the loan approved. The bank wants to have the joint net worth of the investors be great enough to act as collateral for the loan. Often, you need to bring in a high net worth individual to accomplish this.
- Finding a loan
- Underwriting a property
- Property Manager (full time). The rule of thumb is full time staff for properties over 70 units.
- Legal paperwork for this whole process
- Finding properties which requires dedicating a lot of time developing relationships with brokers who will sell the property to you.
Networking is a huge part of this. You’re going to need to convince people to invest with you while developing a network of professionals such as a broker, underwriter and lender. To help start this process, you’re going to want to attend a few masterminds, read a few books and build a robust network before you start. If you’re curious, here are some of the best resources to learn:
- If your are curious about learning more but don’t want to commit to a master mind yet then we recommend Financial Freedom With Real Estate Investing by Michael Blank. He is one of the most prolific real estate syndicators and the book is an exciting and useful read whether you plan to lead or invest in a syndication.
- If you are serious about learning more as a syndicator then it makes sense to join a mastermind. This is a blend of an online course and networking. The War Room MasterMind is highly rated and attended by a lot of military investors.
How To Invest: As an Investor
Syndication can be pretty daunting. While lucrative, it definitely requires a high level of motivation to break into. Fortunately, there are professionals who will do this for you. If you take part as an investor you are essentially helping You get a slice of the pie proportionate to your input. This is literally as passive as it gets.
The trick is to find a reputable syndicator and not someone who’s running a scam or isn’t honest about the investment you are getting involved in. After all, you are forking over a large amount of savings. Here are a couple of options you have to help you achieve this:
Most syndicators only accept accredited investors. These are investors with seven figures liquid net worth that does not include equity in your home or have an annual income of $200,000 ($300,000 if married). If you are an unaccredited investor you will need to get in contact with a syndicator before you invest in anything. Usually this is a phone call where they introduce themselves and walk through what they’re offering. It is okay to call just to learn more. Per SEC rules syndicators need to have existing relationships with unaccredited investors before investing in a property, so this is how that is accomplished.
- Upward Capital: I know the founder personally and 100% stand behind them. Currently I am saving to invest with these guys. Their most recent deal is exceeding all the predicted return metrics. (The numbers are even better than our example). Military owned and operated. Accepts non accredited investors.
- Military To Millionaire: David Pere is an active duty marine who is well known in the real estate investing world. He also offers syndication opportunities in his investments. He accepts non accredited investors.
There are a ton of other ones out there but these two are legitimate syndicators with a proven track record. Many other syndications are only available to accredited investors. Lastly, these guys are both military and to me that’s a huge plus.
Your Potential Returns
SEC rules prohibit us from walking through any specific examples but here is what you can expect to see as far as returns on your hypothetical $50,000 investment (calculated using the most conservative returns).
- Dividends (8-10%)
- $333/month in income
- Appreciation (15-20% IRR including dividends)
- Your initial investment would double in 4.8 years.
- Tax write offs
- Similar to single family, you will be able to receive tax benefits that are applied to the building (just in your proportional share).
Multi family may feel like an exotic investment to many new investors. In fact, it can be simpler to invest in multi family real estate than single family. If you focus on saving money and find a good syndicator then you will get all the advantages of real estate without much upfront work required. It is also a great diversification play, you will have a wealth building investment whose performance is not dependent on how the stock market is doing. If you are trying to create passive income streams, multi family investments make a great addition to your overall portfolio.
In the third and final scenario, we will be investing our 50K in dividend stocks. Dividend stocks are a common way to earn passive income. There are a ton of companies out there that pay dividends, but if you’re going to live off the dividend income then it is key to find a company who is not at a risk of cutting their payout. In addition, you’ll want to own companies who continue to grow their dividend year after year. One particular group of stocks that satisfies this criteria is Dividend Aristocrats. These stocks have raised their dividends consecutively for at least 25 years. Let’s pick a well known dividend aristocrat (IBM) and see what a 50K investment with this company would get us.
The P/E Ratio is a measurement of how many dollars you will pay for $1 of IBM’s earning. This is a good way to compare the relative price of a stock. The dividend yield is how much you will earn in dividends for each dollar invested. In this case it is 4.8 cents.
Your Potential Returns for 50k of IBM
- $200/month ($2,400/year) in passive income (current yield 4.80%)
- 1.4% IRR. Your investment would double in 51 years. The stock price has decreased so total return is lower than the dividend.
- Limited Tax Advantages: Dividend stocks will not give you write-offs like real estate but the income is taxed lower than regular income.
The underwhelming annual performance highlights the disadvantage of single stock investing. With dividend stocks especially, investors tend to build large positions in a single high yielding company. If you put all your eggs in one basket and it underperforms then so will your wealth accumulation. For example, the stock price of ATT is the same today that it was in 1997. All your gains would be from dividends only. This does not perform well compared to every other investment which give you both dividends and appreciation.
Dividend index funds are also an option. They are safer because you are not dependent on the performance of one company but do tend to have a lower yield than a lot of individual dividend stocks. One example is Vanguard’s High Dividend Yield ETF (VYM) which is currently yielding 3.06%.
Your Potential Returns
A 50K investment in VYM yielding 3.06% would get you:
- $127.50/ month ($1530/year) in passive income (current yield 3.06%). The dividends are distributed quarterly.
- 11.57% Annualized return (equivalent to IRR). 6.2 years to double your investment.
- Limited Tax Advantages: Dividend stocks will not give you write-offs like real estate but the income is taxed lower than regular income.
Although, individual stocks may have a higher yield, there is significant risk in putting a large amount of your wealth into a single company. As you can see with IBM there is significant risk when that one company underperforms compared to the market. Index funds will allow you to diversify at the cost of a (usually) lower yield. The biggest drawback to creating passive income with dividend stocks is that it takes a lot of money to create enough income to live off of. For example, it would take $500,000 to make $2,000/ month off of a stock yielding 5%. That’s hardly enough to pay rent in most areas.
The other issue is that stock market valuation are historically high. Because the price of stocks has risen for the last 10 years, it is increasingly difficult to find dividend stocks that are attractively priced. Point in case, the S&P 500 historically had a dividend yield above 3%. At the time of this writing it is 1.53%.
Dividend stocks, have a place in every portfolio, but with the current market environment it will take a long time to build serious income. If you are interested in learning more about dividend stock investing here are some resources for you.
Side by Side Comparison
For the more visual types out there, here’s a chart that summarizes what we’ve covered. Passiveness is a relative scale that weights the work required to set up and maintain these investments. For the comparison we used the performance of the Vanguard High Dividend Yield ETF because of the more comparable overall return(IRR).
Return on $50,000 investment among various assets:
|Monthly Income ($)||Passiveness||Tax Benefits||IRR/Annualized Return (%)||Time To Double Investment (Years)|
|Dividend Stock ETF||127.5||1||N||11.57||6.2|
Pros and Cons
Okay, hopefully by now you can see that if you are willing to save your hard earned money there are some pretty exciting investment opportunities out there. But which is the best? This will depend on your preferences and comfort level.
- Diversification- Performance is not affected by stock market.
- Medium Liquidity: You control if you want to sell or refinance but that still takes time to execute.
- Most work to set up if you’re going it alone. Roofstock can help by acting a “syndicator” to streamline the process.
- Your income stream is dependent on a single rental unit.
- Less work to set up if you are an investor. A lot if you are a syndicator.
- Your income stream is not dependent on a single rental unit.
- Least Liquid- You do not control resale or refinance.
- Least control of investment-finding a reputable syndicator is key.
- Least Work- As simple as setting up automatic investments with your brokerage.
- Most Liquid- Instant liquidity unless market is down then it may not make sense to sell.
- Lowest Yield: It is difficult to find a quality stock that will yield as much as real estate in current market.
- Less Diversified: The appreciation of the dividend stocks can still be affected by the overall market.
Bonus: Another way to Invest In Real Estate
Maybe you want to start investing in real estate and earning passive income, but you don’t yet have $50K. You want to start with a $10 investment and continue to put your savings to work every month. Fundrise will allow you to capture the performance of real estate without a large initial payment.
They do this by dividing their professionally managed real estate portfolio into shares that you can buy.
Here’s how it works:
- You fund your account with your chosen amount. There lowest limit is $10.
- Once your transfer is complete, you choose the fund you want to invest in. Some of their funds require a larger funding of $2000 to become available to you.
- Your investment has a flat fee of 1% if you sell it in the first year(early withdrawal penalty). After that, you have the opportunity to sell every quarter (3 months). If you are a long term investor this is not an issue. In general, we do not recommend investing money unless you don’t plan to touch it for at least five years.
- Your funds will appreciate over time and the price per share will increase. This is based on the underlying value of the real estate increasing.
- You receive dividends every quarter. You can choose to have those dividends deposited to your bank account, creating a truly passive income source.
Their Income eREIT 2019 fund offers dividends of over 8%. Finding a yield like that is extremely hard in today’s market.
Additionally, they offer a intuitive dashboard that allows you to see and understand your investments. Here is a snapshot from my account when I was just getting started with them.
Essentially, this is similar to buying shares of a dividend stock but the underlying performance is based on recession resistant real estate. Fundrise is a really awesome way to start building passive income if you want to start today.