Creating passive or residual income is the ultimate investment dream for many, and it can be achieved via real estate. In fact, savvy investors have been using real estate as a way to create residual income for decades. What exactly is residual income? Simply put, it is income that continues to be generated after the initial effort has been expended.
Unlike linear income, which is compensation that comes in the form of wages, commission, or salary, residual income allows you to continue seeing benefits long after the initial “work” has been done. Stock dividends, interest on notes, and rental property income are all examples.
If you’re interested in creating residual income through real estate, here are a few pointers:
Know your real estate investment options
There are several different ways to create residual income opportunities via real estate, and it’s important to research each one to determine what’s best for you and your goals. Consider these options:
- Investment properties: An investment property is one purchased with the sole purpose of earning revenue. It could be a commercial space you’ll lease out or a residential rental unit. Not only will this type of investment provide potential appreciation and tax benefits over the long term, but it can also provide residual income in the form of monthly rent (after expenses).
- Private equity funds: This is a collective investment fund that pools the money of many investors to invest in real estate, and real estate experts who have very stringent underwriting standards often run them. Keep in mind that these funds traditionally carry high investment minimums but can generate up to 20 percent of any profits earned (depending on the fund).
- Real estate investment trusts (REITs): These are primarily large portfolios of income-producing real estate, which are required by law to distribute 90 percent of their earnings to investors each year. There are both traded and nontraded REITs, with traded tending to correlate with market activity. REITs produce dividends similar to stocks.
- New opportunities: Advances in technology have led to a wide assortment of online options for real estate investment —with sites such as Fundrise, Patch of Land, and Realty Mogul being top players. Similar in many ways to REITs and PE funds, these options have a crowdfunding element.
Be smart about residual income
As you start out, be smart about the programs and types of investments you choose. If you decide to purchase a few investment properties, for example, be sure to research and use state and local incentive programs. Always look into HUD and pre-foreclosure options, which could allow you to purchase your first properties at a considerable discount.
You should also consult with your accountant to ensure that you’re up-to-speed on tax benefits, as they are one of the positive benefits that come from investing in real estate.
Identify who will manage the property
The premise of residual income is that you have little to no work to put in after the initial investment. If you choose REITs or PE funds, then you’re all set. But what if you choose investment properties?
Although most of the work will happen initially (making updates to the property, etc.), with real estate, there are always a few things that need to be taken care of here and there. Who will collect the rent? How will tenant issues be taken care of? Who will repaint when a tenant moves out?
From the beginning, be sure to determine how this work will be taken care of. Will you do it yourself? Will you hire a property manager? Calculate these costs when you’re evaluating your investment options.
Putting it together
Regardless of how you choose to pursue earning residual income, the most important aspect of investing in real estate is the calculation and evaluation of every opportunity that comes your way. Figure out which approach makes the most sense for your situation and come up with residual income goals that are attainable.
Diversification into different types of assets is one of the most efficient ways to build a portfolio that will bring in the residual income you desire.
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