Passive income has become a buzzword. The allure of collecting regular paychecks without “actively” working for it is stronger than ever.
Real estate, at least in theory, is one of the most popular ways to create a passive income stream.
The process looks like this: you borrow money from a bank, buy a property, and the tenant pays off your mortgage, then some of it. Once you accumulate more equity, you repeat the process, buy more properties, increase…and boom! You are a real estate magnate.
But the reality is different.
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What about a property 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 your life easier, but personal finance expert Dave Ramsey points out that income is still not as passive as it seems.
“Even though you run the management company, they still have to call you and approve the new $8,400 heating and air system that blew up, or the other day I squeezed $26,000 out of it on one of our commercial buildings,” he said on an episode of The Ramsey Show. “I didn’t feel passive at all.”
Ramsey still loves real estate as an asset class, but cautions investors need to know what they’re getting into.
“I love real estate. It gives you a better rate of return than other investments don’t, but when I hear someone say passive income and real estate in the same sentence, that means they’ve been on 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 real estate like apartment buildings, shopping malls, and office towers.
You can think of a REIT as a giant landlord: 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 out at least 90% of its taxable income to shareholders in the form of dividends each year. In exchange, REITs pay little or no income tax at the corporate level.
Of course, REITs can still fall on hard times. During the pandemic-induced recession in early 2020, several REITs cut their dividends. Their stock prices also fell during the market sell-off.
Some REITs, on the other hand, manage to distribute reliable dividends through thick and thin. Realty Income (O), for example, pays monthly dividends and has generated 118 dividend increases since its IPO in 1994.
Investing in REITs is easy because they are publicly traded.
Unlike buying a home, where transactions can take weeks or even months, you can buy or sell shares of a REIT at any time throughout the trading day. This makes REITs one of the most liquid real estate investment options available.
READ MORE: ‘God have mercy on us all’: Robert Kiyosaki warns economy is ‘biggest bubble’ in history, urges investors to get rid of paper assets – he prefers these real assets instead
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 stock portfolio. And as their name suggests, ETFs trade 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 which to sell. Some ETFs passively track an index, while others are actively managed. They all charge a fee – called the 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 stocks with total net assets of $63.2 billion. Over the past 10 years, VNQ has achieved 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 replicate the real estate sector of the S&P 500 Index. It currently has 30 holdings and an expense ratio of 0.10%. Since its inception in October 2015, the fund 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.
Many crowdfunding investment platforms these days allow you to own a percentage of physical real estate – from rental properties to commercial buildings to plots of land.
Some options are aimed at qualified investors, sometimes with higher minimum investments of up to 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 with a spouse) within the last two years.
If you are not an accredited investor, many platforms allow you to invest small amounts if you wish, even $100.
These platforms make real estate investing more accessible to the general public by simplifying the process and lowering the barrier to entry.
Some crowdfunding platforms also pool money from investors to fund development projects. These transactions typically require longer commitments from investors and offer a different set of risk-reward profiles compared to buying shares in established income-generating rental properties.
For example, development could be delayed and you will not earn rental income on schedule.
Sponsors of crowdfunded real estate deals typically charge investors a fee – usually in the range of 0.5% to 2.5% of whatever you’ve invested.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.