Passive income strategies for financial freedom

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How to earn a passive income from a rental property that fits your investor profile?

15th Sep 2018
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Real Estate can give you a passive income. This investment like any other has risks, but if the process of investing is done “right” these risks are reduced and the upside increased. This post will give you a bird’s eye view of the process and potentially will help you identify your strengths and weakness for this job.

The first thing to do is to educate yourself.

What are the alternatives to earning a passive income?

Finding a solution adapted to your needs

Managing yourself

Being a landlord is not a passive undertaking. It requires time, energy and emotional resilience. Tenants can be hard to manage especially for those without a tough skin. Real estate management company can shield from bad tenants, but ultimately it is you who has to take the tough decisions.

A house is an important investment and does not come cheap. It could be that your property rental does not turn a profit. Which is draining, both regarding for your finances and yourself.

Type of property

There are many types of properties that can yield a passive income. Each one of them has different characteristics. It is those characteristics that are important to understand. Some properties are more suitable than others to investors of your particular skill set. If you are handy with tools and have the time, then a single family home with some issues might be ideal for you, if you do not then a new or newly renovated apartment might prove to have fewer faults for you to deal with.

Location and understanding the market in that location is paramount. Each property market is different. Near a school (young families), near jobs (young professionals, near a military base (a lot of families moving in and out) or near a tourist attraction (potential or Airbnb)?

The type of property you choose will determine the type of tenant you will have. A medium house in a middle-class neighbourhood is ideal for middle-class families. This will give you a lot of middle-class tenants to choose from. Buying property in a poor neighbourhood will give you poor tenants who may struggle to pay rent. A high-end beachfront property might fair well in boom times but might be hit hardest during a crash. Apartments, around Campuses around college, are aimed towards students, which tend to be full of energy and tend not to take care of the place as if it was theirs.

Your character and your ability to deal with people is important when choosing a property. You can shield yourself to some extent with a property manager, Ultimately you will have to take the tough decisions.

Finding a property

You already know about looking for a property online. Other areas could be foreclosures and other emergency sales If you are using a real estate agent. Keep in mind that he makes money as a percentage of what you spend. His interest is to make you spend more rather than find a better deal. You can challenge them to base their commission on the first 12 rents received as a ration to the selling price!

Rental Property Management

Each type of property and location has different maintenance needs. Wood needs a lot of maintenance, stone and bricks less so. Residences in a desert need air co, which needs maintenance. A house with a pool is a whole new level of maintenance, as it requires constant care. Maintenance of single-family homes tends to be more costly and complex, as the problem could be hidden for longer while a problem in an apartment might be raised by the neighbours. Think water leaks.

Financing and Taxes

Banks: Their interest is to give you the largest loan possible within your limits. Their interest is to earn interest. You run the risk of overleveraging if you listen to your bank too much.

Speaking to an accountant can help decide if these rentals should be set up as a sole proprietor or an LLC. Different setups have different implications on taxation of income and capital gains. Alternative ways to finance your purchase is by getting a loan from your parents or your Aunt’s IRA account.

Some general guides on expenses

  • 1% rental return on the purchase price of your property when possible.
  • 1% of rent as turnover cost and five-yearly expenses 30%
  • 10% of rent for general repairs
  • 10% of rent for management Fees
  • ?% in Property Taxes

Renting / Passive Income

There are three ways to make money from property

  • Buying under market value
  • Buying at market value with the aim of property appreciation
  • Buying a property with a good rental income to purchase price ratio.

Calculating your Break Even rent pricing is important; profit is made when you purchase a property, not after purchase. If not you would be Putting in more than you are getting out, think of this like feeding the property with the aim for capital gains. However, this would be a capital gains play rather than a passive income one.

There are government schemes which encourage landlords to rent their properties to difficult markets such as council rental guarantee schemes in the UK or leasing it to the government for the long term.

Tenants – The source of your passive income

Tenants will be occupying one of your most expensive assets, treating them with respect and professionalism is important. Vetting a tenant is easy using services such as Screeningworks.com.

It is important to know your rights and obligations when it comes to tenants. For Example; what info can you keep on file and how should it be secured. Contracts are a must, and they do need to be checked by a lawyer. Do not become too friendly with your tenants that is a recipe for disaster. Make a walk through with them and take pictures of all the facilities of the rental. Explain what their responsibility is and what is yours. When something falls under your responsibility fix it and if they are liable to pay for it, arrange a payment plan during the rental rather than deducting it from the deposit.

Tenants should contractually be obliged to report faults in 24 hours, and if they do not they are liable for damages caused beyond that point.

You can be creative with tenants (if the law allows it) for example you can offer them monthly contracts, to show them that you mean to keep them happy. Or offer them the 12th month for half the price.

Risks / Avoiding common Landlord Mistakes

Market timing is one way of knowing at what stage of the bubble phase a market is in. It is impossible to know if the market will stay in a bubble and how long for. After crash markets do eventually recover but it might take them ten years.

Property is not liquid. When selling fast, one is losing part of his capital for the facility to liquidate fast. Getting a mortgage or remortgage is one way to increase liquidity. Stocks, Cash and Bonds tend to be more liquid then Real Estate.

Conclusion

Property is one of the tools used for FIRE (Financial Independence and Early Retirement) Read More: leanFIRE vs fatFIRE. There are other tools to consider such as Staking or  Crypto passive income. Investing in real estate is possible, you just need to find the right match between your skills and needs and those of the real estate investment. Ultimately a good rental property can give you passive income and allow you to live more and work less.

Not investment advice. Not financial advice. Consult your financial advisor. Not a recommendation to buy, sell or hold. The staff of this site may own this digital asset/s mentioned on this page. Investing is risky and you may lose all your capital. See full disclaimer.

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