There are countless ways to invest in real estate. While flipping houses, wholesaling, or other active income strategies can make money, the ultimate goal for many investors is to buy a passive investment, one that provides a steady, reliable income stream over a long period of time. Passive income investing has the potential to replace your earned income or grow your savings account and retirement accounts without having to actively trade your time to do so.
Earning a return on your investment, which can be a dividend investment, interest income, or cash flow through rental real estate, allows you to grow your money passively over time while securing your investment through real estate. If you're on the hunt for the best passive income investments in real estate, take a look at the five best ways to earn a passive income stream.
Dividend investing, through real estate investment trusts (REITs) or other dividend-paying real estate stocks, can be an extremely viable way to invest passively and is arguably one of the best passive income investments because of the quality of their portfolios, liquidity, dividend returns, and ease and affordability of investing.
A REIT, which follows special requirements in order to qualify, including earning 75% or more of its income through real estate while paying out at least 90% of its taxable income to shareholders, can be publicly traded on the stock market or privately traded. Publicly traded REITs are the easiest way to participate as an investor, as shares can be purchased through a market account. The investor earns passive income through dividends, which are paid monthly or quarterly, depending on the REIT.
There are REITs in nearly every real estate category imaginable, including residential real estate and real estate debt, but commercial real estate is most abundant. REITs ultimately allow investors to passively participate in the ownership and management of institutional-quality investments secured by real estate that normally would be out of reach outside of this investment vehicle.
Crowdfunding real estate is relatively new in the world of real estate investing. Most crowdfunding platforms, which connect investors to investment opportunities, require you to be an accredited investor, meaning this isn't available to all investors. However, for those who qualify, crowdfunding can be a viable passive income opportunity.
In a real estate crowdfunding transaction, a third-party investor, often referred to as the sponsor, submits an investment opportunity for funding, in which multiple investors can pool their money to fund the acquisition of the property. The sponsor manages the asset, paying a specified return on the investment, which can include interest payments, equity share, or a combination.
This investment strategy can be a riskier passive investment, simply because the success of the project relies largely on the management and oversight of the sponsor, in addition to the viability and potential of the real estate investment itself. But it can provide above-average returns compared to other passive investment opportunities. There are a number of reputable crowdfunding platforms known for thoroughly vetting their sponsor projects and offer strong historical performance.
Each crowdfunding investment will have a specified holding period, but most require the funds to be invested for several years, meaning this method of investing is best suited for patient investors.
Mortgage notes and private lending
Another option for earning passive income in real estate is creating a private loan or holding a mortgage note. A common strategy for investors who own physical real estate is carrying or holding owner financing, in which they operate as the bank to a third-party buyer, who repays the loan on the property to the original owner over a specified period of time.
However, you don't have to own property to participate in mortgage notes or lending. Investors can also purchase existing mortgage notes from banks and other lenders, as well as lend to investors through private lending.
In all of the scenarios above, the real estate investor who lent money earns interest income in addition to the principal balance that was borrowed. Interest income can be an extremely passive investment strategy, because you as the lender aren't responsible for maintaining the property or paying any property-related expenses -- the borrower is.
Hiring a third-party servicing company further reduces the involvement in the investment and adds a layer of security by having a licensed servicer collect payments, communicate with the borrower, and keep financial records for you.
Mortgage notes can be held for a few months to years, with most mortgages falling between 5- to 30-year terms. If liquidity is needed, investors can sell their mortgage on the secondary market. However, that may result in a discount, meaning investors should prepare to hold their investment for the term of the loan.
Another option for generating passive income through real estate is investing in a private equity firm. Private equity firms can invest in a multitude of real estate assets, from commercial property, residential real estate, or real estate debt securities, allowing investors to participate in the investments through a fund. The fund will outline its rate of return for investors, which could be interest payments or an equity split, depending on the fund.
Like crowdfunding real estate, the private equity firm may require you to be an accredited investor in order to participate and can be a riskier passive income investment. It's extremely important to vet the company and determine its experience level as it relates to the opportunity and funding agreement before investing.
Most private equity firms will have a minimum investment amount and require you to hold your funds with the firm for several years, meaning it's not a liquid passive investment and best for patient investors to wait to see their investment returned to them.
Rental income, which is earned by owning residential or commercial real estate and rented to a tenant, qualifies as both a passive and active investment. Because of the process required to find and acquire the property, which may include getting financing from a lending institution, as well as managing the property on an ongoing basis, it's the least passive income strategy when compared to other investment strategies mentioned above.
Using a third-party management company will greatly reduce the ongoing burden of property management and thus make it more passive. Investors earn cash flow each month from the difference between any related debt payments and holding costs with the property and the annual rental rate charged to the tenant.
In addition to being a passive income source, investors who own rental property have the opportunity to benefit from other tax benefits through this passive income idea as well.
The Millionacres bottom line
These aren't the only passive investing options. Investors looking for more traditional passive investments can always turn to treasury bonds, mutual funds, or non-real estate-related dividend stocks. However, for those looking to target passive income investing in real estate, I hope these five passive income ideas help spark ways you can invest in real estate in a more passive way, earning residual income while still having the exposure to the real estate market.
As with any investment, it's important to conduct thorough due diligence on each investment opportunity and determine the potential risk to reward as it relates to your risk tolerance and portfolio.