10–12 minutes to read

The Power of Real Estate’s Passive Income

A comment that one of my friends recently made while we were having a conversation about investing was:

“When I get to $100,000, I’m going to buy my first home that I will rent out, with cash. I’m only now about $20,000 off.”

For quite some time, I argued with his logic saying, “why would you do that when you can stay liquid and then just provide leverage for yourself by using a renter’s money?” My argument was that if he would need $100,000 shortly after purchasing his rental property with cash, perhaps because of some emergency or other investment opportunity, then he would be strapped for cash and would have to end up either selling the house or taking out a home equity loan. Both of those options were stupid to me, especially after he just would have had $100,000 cash in the bank.

I argued that he could keep the $100,000 liquid, borrow the money from the bank, and just have his renters pay the mortgage for him. All the while, he would have a property that he wouldn’t have to put one dollar in, with the exception of normal wear and tear, and taxes AND he’d get to keep his cash reserves.

He quickly rebutted and claimed that the home wouldn’t be his, it would be the banks. Additionally, he argued what would be the point of having the home if it wasn’t providing any income benefits to him? He wanted to pay $100,000 cash so that he could generate “passive income.” In other words, he wanted whatever the rent would be to come to his pocket every month, guaranteed, as opposed to having the home as a liability where he would have to rely on his renters to make payment.

I argued further.

I told him that if his renters decided to unexpectedly move out, he wouldn’t have to worry because he would already have the $100,000 standing by to make the mortgage payments until he found another renter.

At that point, I thought I had him cornered in the debate until he reminded me that if he were to start making payments to the bank, those payments would also include interest. Hence, he would then be losing money by paying money to the bank that he wouldn’t otherwise have to make if he had owned the home free and clear.

I couldn’t argue there.

So, I went back to my argument that it shouldn’t really matter because he’d still have close to $100,000, a liquid asset, in the bank. And that’s when he struck up the term “passive income” again.

My friend rebutted my statement again by saying, “if the home was paid for, I would have money coming in every month, almost guaranteeing me at least a  12% annual return if I collected rent of $1000 monthly, and I wouldn’t have to lose money if my renters stopped paying because the house would be paid-in-full. Where else can you guarantee me a 12% return on my investment even when the market of the commodity takes a down turn? Certainly not in the stock market? So when I get my $100,000 saved, this is where my money will go.

Passive Income and it’s Power

It wasn’t until weeks later that I fully reflected and understood what my friend was exclaiming about passive income. Passive income is money that is earned by practically doing nothing. If people lived in his rental property, ever month his bank account would increase by $1,000 although he really did nothing to receive it. As long as he has renters, he’d get their monthly stream of monies.

If his $100,000 were sitting in the bank, it would only be collecting whatever interest rate the bank would shell out. For instance, online so-called high-yield savings accounts are only paying about 1% annually. If his $100,000 were invested in the stock market, that has recently been taking crazy, unexpected roller coaster rides, there would be no guaranteed income stream for him other than paid dividends, but his money would be “locked up” and if needed when his underlying investments were low, would certainly yield a loss. In other words, investing $100,000 in the markets that are much more volatile than say, real estate rental payments, is far riskier AND does not payout a constant stream of passive income. OR if it did, it would be rare to expect 1% of one’s investment every month.

So although his $100,000 would be “tied up” in a home, he would be generating $12,000 a year on one investment. In two years, he would have received $24,000. And in 5 years, his $100,000 investment would yield $60,000. Ideally, after a little over eight years, his $100,000 investment would have earned it’s payback AND it’s possible that he would be able to sell his home at that point for at least $100,000, assuming that the housing market soon stabilizes. So he is right, where else can we practically guarantee such “passive income” other than real estate.

My Plan for Passive Real Estate Income

Unfortunately, I’m not as lucky as my friend to have almost $100,000 cash saved to make a big one-time rental property investment. (Let’s just say that I was too focused on “locking” my money up in a retirement account that I don’t even have access to for another thirty years and that has been taking hit after hit in this downward market.) However, I WILL soon have two homes. One of my homes I will live in for the next two years and then turn it into a rental property, and the other home is already a rental property, though it is not yet paid in full.

His plan for passive income is what I have planned for my two properties, though I just didn’t look at these investments in the same manner as my friend. I have a plan to have both homes paid off within fifteen years (hopefully within 8 years), and afterwards I would have two choices. I could continue to collect rent from both homes while paying cash for a third home to live in, or live in one of my existing homes while collecting passive income from the other. Either way, they are plans to continually receive income for the rest of my life that is dependent on me, not the stock market.

So my advice is that everyone should find a rental property, pay that sucker off as quickly as possible, and then live to enjoy the rewards of collecting the passive income. Can you image receiving an extra $1000 monthly, from doing relatively nothing, that can be used to supplement any other source of income that you receive? Today, prices on homes are super low. For example, the home that I recently purchased for $100,000 sold for $150,000 in 2007, and prices are only going to get lower. My point, though, is not to focus on trying to time when homes get to their lowest valuations, but is to say that home prices are pretty damn low already, which makes it a great time to find a property that you can eventually use to generate passive income.

Don’t prevent wealth, find and buy a home or an investment property!

 

Comments

  1. You make a wonderful case for owning a home for passive income! If the house is in a great location and easily ‘rentable’, it is an excellent investment. As you say, where else could you get such high returns on your investment.

    Very nice post!

  2. Exactly the point I’ve been trying to make to people about buying the house WITHOUT a mortgage! Its not about having the 100k in the bank and owning the home with a mortgage. Its about having the house without a mortgage period end of story. Passive income sounds good too 🙂

Subscribe to Blog via Email

Enter your email address to subscribe to this blog and receive notifications of new posts by email.

Leave a Reply

%d bloggers like this: